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Welfare and generational equity in sustainable unfunded pension systems

  • Auerbach, Alan J.
  • Lee, Ronald

Using stochastic simulations we analyze how public pension structures spread the risks arising from demographic and economic shocks across generations. We consider several actual and hypothetical sustainable PAYGO pension structures, including: (1) versions of the US Social Security system with annual adjustments of taxes or benefits to maintain fiscal balance; (2) Sweden's Notional Defined Contribution system and several variants developed to improve fiscal stability; and (3) the German system, which also includes annual adjustments to maintain fiscal balance. For each system, we present descriptive measures of uncertainty in representative outcomes for a typical generation and across generations. We then estimate expected utility for generations based on simplifying assumptions and incorporate these expected utility calculations in an overall social welfare measure. Using a horizontal equity index, we also compare the different systems' performance in terms of how neighboring generations are treated. While the actual Swedish system smoothes stochastic fluctuations more than any other and produces the highest degree of horizontal equity, it does so by accumulating a buffer stock of assets that alleviates the need for frequent adjustments. In terms of social welfare, this accumulation of assets leads to a lower average rate of return that more than offsets the benefits of risk reduction, leaving systems with more frequent adjustments that spread risks broadly among generations as those most preferred.

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Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 95 (2011)
Issue (Month): 1-2 (February)
Pages: 16-27

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Handle: RePEc:eee:pubeco:v:95:y:2011:i:1-2:p:16-27
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505578

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  1. Florence Legros, 2003. "Notional Defined Contribution : a Comparison of the French and the German Point Systems," Working Papers 2003-14, CEPII research center.
  2. Carter, Lawrence R. & Lee, Ronald D., 1992. "Modeling and forecasting US sex differentials in mortality," International Journal of Forecasting, Elsevier, vol. 8(3), pages 393-411, November.
  3. Alexander Ludwig & Michael Reiter, 2008. "Sharing Demographic Risk – Who is Afraid of the Baby Bust?," MEA discussion paper series 08166, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
  4. Feldstein, Martin & Liebman, Jeffrey B., 2002. "Social security," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 32, pages 2245-2324 Elsevier.
  5. Alan J. Auerbach & Ronald Lee, 2006. "Notional Defined Contribution Pension Systems in a Stochastic Context: Design and Stability," NBER Working Papers 12805, National Bureau of Economic Research, Inc.
  6. Axel Boersch-Supan & Christina B. Wilke, 2004. "The German Public Pension System: How it Was, How it Will Be," NBER Working Papers 10525, National Bureau of Economic Research, Inc.
  7. Settergren, Ole & Mikula, Boguslaw D., 2005. "The Rate of Return of Pay-As-You-Go Pension Systems: A More Exact Consumption-Loan Model of Interest," Discussion Paper 249, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.
  8. Settergren, Ole & Mikula, Boguslaw D., 2005. "The rate of return of pay-as-you-go pension systems: a more exact consumption-loan model of interest," Journal of Pension Economics and Finance, Cambridge University Press, vol. 4(02), pages 115-138, July.
  9. Alan J. Auerbach & Kevin A. Hassett, 1999. "A New Measure of Horizontal Equity," NBER Working Papers 7035, National Bureau of Economic Research, Inc.
  10. Jonathan Gruber & David A. Wise, 1999. "Social Security and Retirement around the World," NBER Books, National Bureau of Economic Research, Inc, number grub99-1, December.
  11. James M. Poterba, 2001. "Demographic Structure And Asset Returns," The Review of Economics and Statistics, MIT Press, vol. 83(4), pages 565-584, November.
  12. Legros, Florence, 2003. "Notional Defined Contribution : A Comparison of the French and the German Point Systems," Economics Papers from University Paris Dauphine 123456789/6478, Paris Dauphine University.
  13. Ronald Lee & Timothy Miller & Michael Anderson, 2004. "Stochastic Infinite Horizon Forecasts for Social Security and Related Studies," NBER Working Papers 10917, National Bureau of Economic Research, Inc.
  14. Ronald Lee & Shripad Tuljapurkar, 1998. "Stochastic Forecasts for Social Security," NBER Chapters, in: Frontiers in the Economics of Aging, pages 393-428 National Bureau of Economic Research, Inc.
  15. Ronald D. Lee & Michael W. Anderson & Shripad Tuljapurkar, 2003. "Stochastic Forecasts of the Social Security Trust Fund," Working Papers wp043, University of Michigan, Michigan Retirement Research Center.
  16. Jeffrey R. Brown & Jeffrey B. Liebman & David A. Wise, 2009. "Social Security Policy in a Changing Environment," NBER Books, National Bureau of Economic Research, Inc, number brow08-1, December.
  17. Lee, Ronald D., 1993. "Modeling and forecasting the time series of US fertility: Age distribution, range, and ultimate level," International Journal of Forecasting, Elsevier, vol. 9(2), pages 187-202, August.
  18. Valkonen, Tarmo, 2002. "Demographic Uncertainty and Taxes," Discussion Papers 816, The Research Institute of the Finnish Economy.
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