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On the optimal design of pension systems

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  • Hans Fehr
  • Johannes Uhde

Abstract

The present paper aims to quantify efficiency properties of flat and earnings-related pay-as-you-go financed social security systems of various institutional designs in order to identify an optimal pension design. Starting from a benchmark economy without social security, we introduce alternative pension systems and compare the costs arising from liquidity constraints as well as distortions of labor supply versus the benefits from insurance provision against income and lifespan uncertainty. Our findings suggest an optimal replacement rate of about 50 % of average earnings. In our model a single-tier earnings-related pension system yields the highest efficiency gains dominating flat benefits as well as two-tier systems of any form. We also show that the negative correlation between pension progressivity and pension generosity of real-world social security systems can be justified on efficiency grounds. Finally, our results indicate a positive impact of means-testing flat benefits against earnings-related benefits within multi-pillar pension systems. Copyright Springer Science+Business Media New York 2013

Suggested Citation

  • Hans Fehr & Johannes Uhde, 2013. "On the optimal design of pension systems," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 40(3), pages 457-482, August.
    • Handle: RePEc:kap:empiri:v:40:y:2013:i:3:p:457-482
    DOI: 10.1007/s10663-013-9214-2
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    References listed on IDEAS

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    13. András Simonovits, 2006. "Optimal Design of Pension Rule with Flexible Retirement: The Two-Type Case," Journal of Economics, Springer, vol. 89(3), pages 197-222, December.
    14. Hans Fehr, 2009. "Computable Stochastic Equilibrium Models and Their Use in Pension- and Ageing Research," De Economist, Springer, vol. 157(4), pages 359-416, December.
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    Cited by:

    1. Nick Draper & André Nibbelink & Johannes Uhde, 2013. "An Assessment of Alternatives for the Dutch First Pension Pillar, The Design of Pension Schemes," CPB Discussion Paper 259.rdf, CPB Netherlands Bureau for Economic Policy Analysis.
    2. Sanchez-Romero, Miguel & Schuster, Philip & Prskawetz, Alexia, 2021. "Redistributive effects of pension reforms: Who are the winners and losers?," ECON WPS - Working Papers in Economic Theory and Policy 06/2021, TU Wien, Institute of Statistics and Mathematical Methods in Economics, Economics Research Unit.
    3. Mu, Huaizhong & Yang, Ao, 2022. "Calculation of the transition coefficient and moderate level of China's pension system unification," Finance Research Letters, Elsevier, vol. 49(C).
    4. Bielecki, Marcin & Goraus, Karolina & Hagemejer, Jan & Makarski, Krzysztof & Tyrowicz, Joanna, 2015. "Small assumptions (can) have a large bearing: evaluating pension system reforms with OLG models," Economic Modelling, Elsevier, vol. 48(C), pages 210-221.
    5. Nick Draper & André Nibbelink & Johannes Uhde, 2015. "An Assessment of Alternatives for the Dutch First Pension Pillar System," De Economist, Springer, vol. 163(3), pages 281-302, September.
    6. Fehr, Hans & Uhde, Johannes, 2014. "Means-testing and economic efficiency in pension design," Economic Modelling, Elsevier, vol. 44(S1), pages 57-67.
    7. Insook lee, 2023. "Optimal Progressivity of Public Pension Benefit and Labor Income Tax," Hacienda Pública Española / Review of Public Economics, IEF, vol. 246(3), pages 3-35, September.
    8. George Kudrna, 2015. "Means Testing of Public Pensions: The Case of Australia," Working Papers wp338, University of Michigan, Michigan Retirement Research Center.
    9. Kudrna, George, 2016. "Economy-wide effects of means-tested pensions: The case of Australia," The Journal of the Economics of Ageing, Elsevier, vol. 7(C), pages 17-29.
    10. Nick Draper & André Nibbelink & Johannes Uhde, 2013. "An Assessment of Alternatives for the Dutch First Pension Pillar, The Design of Pension Schemes," CPB Discussion Paper 259, CPB Netherlands Bureau for Economic Policy Analysis.
    11. R. Melis & A. Trudda, 2014. "Mixed pension systems sustainability," Working Paper CRENoS 201413, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.

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    More about this item

    Keywords

    Stochastic OLG model; Flat versus earnings-related pension; Means-testing; C68; H55;
    All these keywords.

    JEL classification:

    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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