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Should Pensions be Progressive? Yes, at least in Germany!

  • Hans Fehr
  • Manuel Kallweit
  • Fabian Kindermann

Recent reforms that aim at reducing the upcoming burdens of population ageing might seriously harm low income individuals. An increase in old-age poverty and disability will be the result. Under this prospect, the present paper quantitatively characterizes the optimal progressivity of unfunded pension systems in an overlapping generations model with idiosyncratic income, disability and longevity risk as well as endogenous labor supply at the intensive and extensive margin. Focusing on the German pension system, our model features the most recent demographic projections and distinguishes three skill classes with skill-dependent risk profiles. Starting from a baseline path that reflects a purely earnings related pension system, we increase the degree of progressivity and compute the resulting macroeconomic, welfare and efficiency effects. For our most preferred parametrization we find an optimal flat-rate pension share of 40 percent. This indicates that in Germany recent reforms that aim at raising retirement age and cutting benefit levels should be complemented by increases in pension progressivity, since improved insurance provision dominates higher labor supply distortions. In addition, we also find that reductions in the benefit level (i.e. privatization) will only reduce economic efficiency.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3636.

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Date of creation: 2011
Date of revision:
Handle: RePEc:ces:ceswps:_3636
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  1. Love, David A., 2007. "What can the life-cycle model tell us about 401(k) contributions and participation?," Journal of Pension Economics and Finance, Cambridge University Press, vol. 6(02), pages 147-185, July.
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  11. Shinichi Nishiyama & Kent Smetters, 2008. "The Optimal Design of Social Security Benefits," Working Papers wp197, University of Michigan, Michigan Retirement Research Center.
  12. Hans Fehr & Christian Habermann, 2005. "Risk Sharing and Efficiency Implications of Progressive Pension Arrangements," DNB Working Papers 064, Netherlands Central Bank, Research Department.
  13. Duggan, Mark & Singleton, Perry & Song, Jae, 2007. "Aching to retire? The rise in the full retirement age and its impact on the social security disability rolls," Journal of Public Economics, Elsevier, vol. 91(7-8), pages 1327-1350, August.
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  15. Sheshinski, E. & Diamond, P., 1992. "Economic Aspects of Optimal Disability Benefits," Working papers 92-5, Massachusetts Institute of Technology (MIT), Department of Economics.
  16. Fehr, Hans & Kallweit, Manuel & Kindermann, Fabian, 2012. "Pension reform with variable retirement age: a simulation analysis for Germany," Journal of Pension Economics and Finance, Cambridge University Press, vol. 11(03), pages 389-417, July.
  17. Alfonso R. Sánchez Martín, 2001. "Endogenous Retirement And Public Pension System Reform In Spain," Economics Working Papers we013503, Universidad Carlos III, Departamento de Economía.
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  21. Friedrich Breyer & Stefan Hupfeld, 2008. "Fairness of Public Pensions and Old-Age Poverty," Discussion Papers of DIW Berlin 817, DIW Berlin, German Institute for Economic Research.
  22. Imrohoroglu, Selahattin & Kitao, Sagiri, 2009. "Labor supply elasticity and social security reform," Journal of Public Economics, Elsevier, vol. 93(7-8), pages 867-878, August.
  23. Stefan Arent & Wolfgang Nagl, 2010. "A Fragile Pillar: Statutory Pensions and the Risk of Old-Age Poverty in Germany," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 66(4), pages 419-441, December.
  24. Christian Habermann & Fabian Kindermann, 2007. "Multidimensional Spline Interpolation: Theory and Applications," Computational Economics, Society for Computational Economics, vol. 30(2), pages 153-169, September.
  25. Robert Fenge & Silke Uebelmesser & Martin Werding, 2006. "On the Optimal Timing of Implicit Social Security Taxes Over the Life Cycle," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 62(1), pages 68-107, March.
  26. Kotlikoff, Laurence J. & Smetters, Kent & Walliser, Jan, 2007. "Mitigating America's demographic dilemma by pre-funding social security," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 247-266, March.
  27. Georg Erber & Ulrich Fritsche, 2009. "Productivity Growth in Germany: No Sustainable Economic Recovery in Sight," Weekly Report, DIW Berlin, German Institute for Economic Research, vol. 5(3), pages 19-25.
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