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Tax Incentives for Private Life Annuities and the Social Security Reform: Effects on Consumption and on Adverse Selection

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  • Susanne Pech

Abstract

In a two-period model with uncertainty about life expectancy, we analyze several measures that are typically included in a social security reform: tax incentives for private life annuities, a cut in the social security benefits, and an increase in the social security tax. First, we look at the demand side and study the effects on old-age provision for a given annuity price. It is shown that tax incentives for life annuities indeed stimulate annuity demand, if a cut in the supply of public goods to finance the tax incentives does not influence the private consumption choice. In this case, such incentives counteract the negative effects on old-age consumption of the other two reform instruments adopted to maintain long-run solvency of the social security system. However, when considering an increase in the income tax to finance the tax incentives, the positive effect on annuity demand is smaller and may even turn negative for some individuals. Second, we assess the effects of the reform measures on the equilibrium price, in view of an adverse-selection problem in the private annuity market. We find that a cut in the social security benefit rate reduces the adverse selection and consequently the equilibrium price, while an increase in the social security tax raises the equilibrium price. The effect of a tax incentive for life annuities is ambiguous and depends on the degree of risk aversion of the individuals. Adverse selection is mitigated if the coefficient of relative risk aversion does not exceed a critical value, which is shown to be higher in the case when the tax incentives are financed by a reduction in public goods than in the case when they are financed by an increase in the income tax.

Suggested Citation

  • Susanne Pech, 2004. "Tax Incentives for Private Life Annuities and the Social Security Reform: Effects on Consumption and on Adverse Selection," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 60(4), pages 556-556, December.
  • Handle: RePEc:mhr:finarc:urn:sici:0015-2218(200412)60:4_556:tifpla_2.0.tx_2-b
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    References listed on IDEAS

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    1. Johann K. Brunner & Susanne Pech, 2006. "Adverse selection in the annuity market with sequential and simultaneous insurance demand," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 31(2), pages 111-146, December.
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    Cited by:

    1. Johann Brunner & Susanne Pech, 2008. "Optimum taxation of life annuities," Social Choice and Welfare, Springer;The Society for Social Choice and Welfare, vol. 30(2), pages 285-303, February.
    2. Susanne Pech, 2004. "Portfolio decisions on life annuities and financial assets with longevity and income uncertainty," Economics working papers 2004-14, Department of Economics, Johannes Kepler University Linz, Austria.
    3. Bütler, Monika & Ramsden, Alma, 2016. "Pricing annuities: The role of taxation in retirement decisions," Annual Conference 2016 (Augsburg): Demographic Change 145525, Verein für Socialpolitik / German Economic Association.
    4. Johann K. Brunner & Susanne Pech, 2006. "Adverse selection in the annuity market with sequential and simultaneous insurance demand," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 31(2), pages 111-146, December.
    5. Susanne Pech, 2004. "Adverse Selection with individual- and joint-life annuities," Economics working papers 2004-12, Department of Economics, Johannes Kepler University Linz, Austria.
    6. Bütler, Monika & Ramsden, Alma, 2017. "How taxes impact the choice between an annuity and the lump sum at retirement," Economics Working Paper Series 1701, University of St. Gallen, School of Economics and Political Science.

    More about this item

    Keywords

    annuity market; uncertain lifetime; adverse selection; tax incentives; social security;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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