10- Fiscal Policy And Aging:

Public Pension Programs

(Chapter 12)
Public Finance, An International Perspective
Joshua E.Greene
 A pension plan is an employee benefit that
Pension / commits the employer (government may acts as
Retirement employer) to make regular contributions to a pool
of money set aside to fund payments made to
Program eligible employees after they retire.
 The social and economic implications of an aging
population are becoming increasingly apparent in
Economic many industrialized nations around the globe.
Issues of An Over 20% of the population of 17 countries
Aging consists of persons 65 years or older
Population
In 2000, 5.7% of Turkey's population was aged 65
and over. This rate increased to 9.9% in 2022.
 Industrial countries have largely completed what is
called the "demographic transition"—the transition
from a largely rural agrarian society with high fertility
Demographi and mortality rates to a predominantly urban industrial
c Window or society with low fertility and mortality rates.
Demographi At an early stage of this transition, fertility rates fall,
leading to fewer young mouths to feed. During this
c Dividend period, the labor force temporarily grows more rapidly
than the population dependent on it, freeing up
resources for investment in economic development and
family welfare. Other things being equal, per capita
income grows more rapidly too. That's the first dividend.
 A second dividend is also possible. A population
concentrated at older working ages and facing an
extended period of retirement has a powerful incentive
Demographi to accumulate assets—unless it is confident that its
c Window or needs will be provided for by families or governments.
Whether these additional assets are invested
Demographi domestically or abroad, national income rises.
c Dividend In short, the first dividend yields a transitory bonus, and
the second transforms that bonus into greater assets
and sustainable development. These outcomes are not
automatic but depend on the implementation of
effective policies.
 Public The nature of public pension programs (benefits
and coverage) differs considerably from one
Pension country to another, although all are publicly
Programs mandated.
 Both market failures and other considerations
have been used to justify public pension programs
Because of Market Faliures:
Justificatio 1. Myopia
ns for 2. Distributional Concerns
Public 3. Adverse Selection
Pension 4. Imperfections in information
Programs
5. Moral hazard,
As it is mentioned above, among market faliures , this is income distribution in Turkey,
and social transfers softens income disparities
 Both market failures and other considerations
have been used to justify public pension programs
Justificatio
ns for Because of Other Considerations:
Public 1. Efficiency
Pension 2. Insuring Families against cost of aging relatives
Programs 3. Regulation and oversight of private pensions
 Year Current The importance of current
Transfers/ transfers in budget
Expenditures
(Interest expenditures, which are
Importance payments
excluded) %
especially payments for
retirement payments of SGK
of Pension 2006 37,7 (Social Security Institution)
The figure also shows us that
programs in 2010 41,0
those expenditures can not
the budget 2015 40,0 be postponed, so there is a
small room for other
2020 46,5
expenditures 2021 44,5
expenditures

2022 42,8
 Public pension programs come in two broad types:
Types of 1. Funded systems and
Public 2. Pay-as-you-go programs (PAYGs)

Pension 3. Partially Funded Programs

Programs
 Enrollees (socially insured people) accumulate
assets in governmentapproved accounts, and
Types of benefits depend on the amount of contributions,
Public plus any interest or other earnings received.
Although a public agency often holds and
Pension administers enrollees’ accounts, as is done in
Programs: some countries, the accounts can also be privately
managed (with public oversight), as in some
Funded others.
systems In either case, however, the accounts are funded
with individual and employer contributions
mandated by law.
 Types of
Important point in funded systems is they assure
Public only the amount of contributions and earnings in
Pension these accounts, funded programs represent a
Programs: public sector version of the defined contribution
plans that many private firms have introduced in
Funded recent years.
systems
 Contributions (tax payments) from current earners
fund the benefits provided to current retirees. Current
Types of earners, in turn, may expect to receive benefits
Public funded by those working when they retire. PAYG
Pension programs typically provide benefits based on the
enrollee’s years of service, age, and level of
Programs: contributions. Thus, they represent a kind of defined
PAYG benefit pension plan, similar to plans that many large
Programs corporations offered earlier on and that still
characterize the pension plans for employees of some
(intergeneration
government and public sector agencies. Benefits are
al solidarity)
designed to replace a certain percentage of pre-
retirement earnings
 Types of The main part of Sweden’s pension system (the
Public inkomstpension), for example, is considered a partially
funded program, because benefits are based on a
Pension buffer fund plus contributions from present earners,
Programs: and benefits adjust if payment liabilities fall below
Partially available funds. Under the inkomstpension, individual
pension benefits are indexed (adjustedupward) yearly
Funded by the percentage increase in an income index,
Programs less1.6%.
 Types of
Public
Pension The degree of indexing is reduced if payment liabilities
exceed the available funds, and benefits remain below
Programs: the “index line” until anticipated revenues rise enough
Partially for available funds to again equal or exceed liabilities
Funded
Programs
Advantages
and Risk of Pension programs each have their advantages
Public
and risks.
Pension
Programs
 1. Fully funded systems address the myopia problem by
compelling young and middle-aged workers to
Advantages accumulate funds for retirement.
of Fully 2. Pension benefits depend on the amounts accumulated
Funded in individual pension accounts, so the government need
Programs not provide benefits that exceed what enrollees have
paid into the system. Thus it does not directly impose
financial burden on the budget
 3. By compelling enrollees to save for their retirement,
fully funded systems also reduce the financial burdens
on families to provide for elderly relatives
4. Fully funded systems, like defined contribution pension
Advantages plans in the private sector, place the risk of investment
and Risks of on the contributor.
Fully 5. Enrollees bear the financial responsibility if they choose
Funded to invest amounts above the minimum in assets whose
values can vary.
Programs
6. However, the main risk with fully funded systems is that
the required contributions and earnings on them may
be too small to provide a “reasonable” income for
retirees.
 1. Like fully funded programs, address the myopia
problem and reduce the burden on family members of
providing financial support to elderly relatives
2. PAYG systems can address distributional problems by
Advantages skewing benefits in favor of low-income retirees, so
and Risks of that payments cover a larger percentage of pre-
PAYG retirement earnings for the less affluent than for higher
income enrollees.
Programs
3. PAYG systems also relieve enrollees of having to decide
how to invest their accumulated savings, since they
receive a defined benefit based on their contributions
and years of enrollment in the program.
 4. PAYG programs can give retirees a higher benefit than
they might have earned in a fully funded system, if
average contributions from earners rise faster than
benefits over time.
The reason is that the effective “rate of return” in a PAYG
Advantages system depends on both the rate of population (labor force)
and Risks of growth (*), which raises the number of earners
contributing to the system, and the rate of productivity
PAYG growth, which (if earnings rise with productivity) raises the
Programs average wage rate and, thus, the average contribution per
worker.
(*) It is a point on which the proponents of population growth stand. But
the end of continued population growth would be devastating for the
world.
 Advantages In mathematics:
and Risks of Rate of return = ((1 + rate of population growth/100)
PAYG
∗(1 + rate of productivity growth/100) − 1)∗100
Programs
 5. PAYG systems face the risk of underfunding. If
contributions from current workers fall short of
current benefit obligations, the government must
Advantag make up the shortfall—by raising revenues or
es and transferring funds from other programs to fund public
pension benefits. If the government cannot (or
Risks of refuses to) do this, then retiree benefits must be
PAYG reduced.
Programs This problem becomes acute as the population ages,
because the number of those working and contributing to
the system falls relative to the number of retirees. (This is
the problem of some OECD countries, whose face growing
financial burdens as the ratio of retirees to workers increases.)
 6. Adverse consequences of high contribution rates. To obtain
reasonable funding, many country programs impose
contribution rates of 20% or more. It is known that
Advantag increasing employment taxes on employers are largely or
es and fully shifted to employees in the form of lower wages and
Risks of some firms may find it cheaper to limit hiring and instead
make existing employees work overtime
PAYG
7. Discouraging private retirement savings. Some economists
Programs have argued that the availability of public pensions reduces
the incentives for private retirement savings
8. Eligibility rules sometimes allow early retirement at high
costs.
 9. Different retirement ages for men and women. The public
pension programs of a number of countries,
Advantag 10. Problems with tax collection at small firms and
es and independent contractors. A number of countries, including
Risks of Greece and Turkey, have found it difficult to collect the
required employment taxes from small firms and
PAYG independent contractors. (premium amnesties)
Programs 11. Unintended intergenerational transfers. Many PAYG
systems benefit the first generation of recipients, who
receive benefits without having contributed for as many
years as enrollees in later generations
 Maintaining financial balance in PAYG systems requires
satisfying the following mathematical relationship:
Advantag
es and sWL = PN
Risks of s: contribution (tax) rate on earnings
PAYG W:average nominal wage (or earnings)
Programs L:number of workers
P: average pension
N:number of pensioners
 If the number of earners declines relative to the number of
Advantag pensioners (dependency ratio= Enrolles/Pensioners), either the
average contribution per worker (sW) must rise or pension
es and payouts must be cut by reducing the average pension or the
Risks of number of persons eligible to receive pensions (by increasing
PAYG the retirement age, for example).
Programs The above relationship also implies the following relationship
among the critical parameters:
(sW/P) = (N/L)
 Although the risks from population aging are clearest with
PAYG pension systems, fully funded systems can also encounter
difficulties. The problem arises because retirees in fully funded
systems accumulate financial assets but in fact want real goods
and services. If aging leads to a shrinking workforce and less
Aging output per person, prices of goods and services will rise and the
Problems real value of retirees’ financial assets will decline.
Thus, some analysts contend that choosing a fully funded
program over a PAYG system does not fundamentally prevent
the adverse effects on retirees of an aging population. Instead,
countries need to address the aging problem by increasing
productivity or expanding immigration, to increase the ratio of
workers to retirees.
 As the aging problem increases, the social security/pension
system gets into trouble.
Aging 1. The longer life in retirement (improved health conditions),
Problems the greater the financing problem and the lower the
dependency ratio.
2. This calls for more workers (population growth), which brings
the financial burden to grow even more after a few years.
 1. Risks from adverse macroeconomic shocks.
Risks 2. Demographic risks.
affecting 3. Political risks.
all pension 4. Management risk.
systems 5. Investment risk.