Redistributive Impact of Pension Systems Anita M. Schwarz Lead Economist Europe and Central Asia Region World Bank

Redistribution in Pension Systems u Intergenerational –From one generation to another –PAYG systems always take contributions from one generation and give to another, but the question is whether some generations are expected to get more than they pay while others get less u Intragenerational –From rich to poor within the same generation or vice versa

What Causes Intergenerational Redistribution in PAYG? u As population ages, contribution rates need to rise, benefits need to fall, and retirement ages need to rise u Benefits received by the early generations relative to what they pay is much higher than what is affordable for later generations u If there are 10 workers per elderly person, each retiree can get 10 x the contribution ; if there are only 2 workers per elderly person, each retiree can get only twice the contribution

US Example

Intergenerational in Funded u Systematic redistribution disappears u All generations do not receive equal rates of return, but differences are not predictable

Intragenerational in PAYG u Intentional u Unintentional u Deficit Financing (interintragenerational)

Intentional Redistribution u Benefit formula might pay higher benefits for low income u Minimum pension tends to favor low income u Maximum pension limits what higher income individuals get

Unintentional u Different wage growth patterns for different people; –If pensions are based on final salary or on only a few years’ wages, tends to favor higher income u Different life expectancies for different people –High income tend to live longer u Different work histories –High income start later and work more continuously

Definitions to be Used in Examples u High income –Starts career at age 23; retires at retirement age –Starts career earning 150% of average wage for 23 year old –Wages grow each year at 120% of average wage growth –Mortality is 80% of average u Average –Starts career at age 21; retires at retirement age –Starts career earning 100% of average wage for 21 year old –Wages grow each year at 100% of average wage growth –Mortality is 100% of average u Low –Starts career at age 18; retires at retirement age –Starts career earning 50% of average wage for 18 year old –Wages grow each year at 80% of average wage growth –Mortality is 120% of average

Actual Examples

Actual Examples (2)

Actual Examples (3)

Deficit Financing u When system runs a deficit, contributions often supplemented with general revenue u Those eligible for pension might be different from those who contribute to general revenue –Large informal sector that does not contribute and will not be eligible for pensions –General revenue includes some from informal sector –Informal sector workers generally lower income than formal sector workers, resulting in reverse redistribution

Deficit Financing in Turkey

Intragenerational in Funded u Intentional –Mexican peso per day, but financed by government, not by other workers –Minimum pension guarantee – also financed by government u Unintentional –Annuity phase: higher income longer-life individuals in same annuity pool with lower income shorter-life individuals u Transition period

Slovak Example Note: Funded pillar assumes full annuitization

Deficit Financing Slovakia Case

Outcome Under Funded u Does not eliminate regressive redistribution as long as fully annuitized –Phased withdrawal with balance going to family can reduce this considerably u Can be compensated through minimum pension guarantees or through public contributions targeted at low income workers – Mexico –But must be careful not to eliminate the incentive to contribute or to correctly declare earnings u Alternatively, design of first pillar in multipillar systems can be designed to be redistributive –Not popular in Central Europe –Argentina has highly progressively redistributive first pillar; Lithuania has a basic pension in the first pillar; Kazakstan has instituted a demogrant

Conclusions u Adding funded pillars almost fully eliminates systematic intergenerational redistribution, aside from transition period u Funded pillars reduce unintentional intragenerational redistribution, but cannot eliminate this because of the annuitization process –Can address through progressively redistributive first pillar, through targeted government contributions, or through minimum pension guarantees u Funded pillars reduce future unintentional redistribution from outside the pension system to those covered by making the systems more financially self-sustainable