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Designing a linear pension scheme with forced savings and wage heterogeneity

Author

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  • Helmuth Cremer
  • Philippe Donder
  • Dario Maldonado
  • Pierre Pestieau

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Abstract

This paper studies the optimal linear pension scheme when society consists of rational and myopic individuals. Myopic individuals have, ex ante, a strong preference for the present even though, ex post, they would regret not to have saved enough. While rational and myopic persons share the same ex post intertemporal preferences, only the rational agents make their savings decisions according to these preferences. Individuals are also distinguished by their productivity. The social objective is “paternalistic”: the utilitarian welfare function depends on ex post utilities. We examine how the presence of myopic individuals affects both the size of the pension system and the degree of redistribution it operates. The relationship between proportion of myopic individuals and characteristics of the pension system turns out to be much more complex than one would have conjectured. Neither the impact on the level of pensions nor the effect on their redistributive degree are unambiguous. Nevertheless, we show that under some plausible assumptions adding myopic individuals increases the level of pension benefits and leads to a shift from a flat or even targeted scheme to a partially contributory one. However, we also provide an example where the degree of redistribution is not a monotonic function of the proportion of myopic individuals.
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Suggested Citation

  • Helmuth Cremer & Philippe Donder & Dario Maldonado & Pierre Pestieau, 2008. "Designing a linear pension scheme with forced savings and wage heterogeneity," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 15(5), pages 547-562, October.
  • Handle: RePEc:kap:itaxpf:v:15:y:2008:i:5:p:547-562
    DOI: 10.1007/s10797-007-9031-2
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    References listed on IDEAS

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    1. Cremer, Helmuth & De Donder, Philippe & Maldonado, Dario & Pestieau, Pierre, 2007. "Voting over type and generosity of a pension system when some individuals are myopic," Journal of Public Economics, Elsevier, vol. 91(10), pages 2041-2061, November.
    2. Helmuth Cremer & Philippe De Donder & Dario Maldonado & Pierre Pestieau, 2009. "Forced Saving, Redistribution, and Nonlinear Social Security Schemes," Southern Economic Journal, Southern Economic Association, vol. 76(1), pages 86-98, July.
    3. Ted O'Donoghue & Matthew Rabin, 2001. "Choice and Procrastination," The Quarterly Journal of Economics, Oxford University Press, vol. 116(1), pages 121-160.
    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. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
    6. Martin Feldstein, 1985. "The Optimal Level of Social Security Benefits," The Quarterly Journal of Economics, Oxford University Press, vol. 100(2), pages 303-320.
    7. Pierre Pestieau & Uri Possen, 2008. "Prodigality And Myopia-Two Rationales For Social Security," Manchester School, University of Manchester, vol. 76(6), pages 629-652, December.
    8. Homburg, Stefan, 2000. "Compulsory savings in the welfare state," Journal of Public Economics, Elsevier, vol. 77(2), pages 233-239, August.
    9. Ayşe İmrohoroğlu & Selahattin İmrohoroğlu & Douglas H. Joines, 2003. "Time-Inconsistent Preferences and Social Security," The Quarterly Journal of Economics, Oxford University Press, vol. 118(2), pages 745-784.
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    11. Summers, Lawrence H, 1989. "Some Simple Economics of Mandated Benefits," American Economic Review, American Economic Association, vol. 79(2), pages 177-183, May.
    12. George-Marios Angeletos, 2001. "The Hyberbolic Consumption Model: Calibration, Simulation, and Empirical Evaluation," Journal of Economic Perspectives, American Economic Association, vol. 15(3), pages 47-68, Summer.
    13. A. J. Auerbach & M. Feldstein (ed.), 2002. "Handbook of Public Economics," Handbook of Public Economics, Elsevier, edition 1, volume 3, number 3.
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    Citations

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    Cited by:

    1. Cremer, Helmuth & Pestieau, Pierre, 2011. "Myopia, redistribution and pensions," European Economic Review, Elsevier, vol. 55(2), pages 165-175, February.
    2. Bagchi, Shantanu, 2015. "Labor supply and the optimality of Social Security," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 167-185.
    3. Caliendo, Frank N. & Guo, Nick L., 2014. "Roosevelt And Prescott Come To An Agreement," Macroeconomic Dynamics, Cambridge University Press, vol. 18(06), pages 1383-1402, September.
    4. Guo, Nick L. & Caliendo, Frank N., 2014. "Time-inconsistent preferences and time-inconsistent policies," Journal of Mathematical Economics, Elsevier, vol. 51(C), pages 102-108.
    5. Caliendo, Frank N., 2011. "Time-inconsistent preferences and social security: Revisited in continuous time," Journal of Economic Dynamics and Control, Elsevier, vol. 35(5), pages 668-675, May.
    6. Matteo Bassi, 2008. "An Egg Today and a Chicken Tomorrow: A Model of Social Security with Quasi-Hyperbolic Discounting," CSEF Working Papers 205, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    7. Gahramanov Emin, 2016. "On the Demographics and the Severity of the Social Security Crisis," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 16(2), pages 1001-1028, April.

    More about this item

    Keywords

    Social security; Myopia; Dual-self model; H55; D91;

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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