We analyze the political stability of capital funded social security. In particular, using a stylized theoretical framework we study the mechanisms behind governments capturing pension assets in order to lower current taxes. This is followed by an analysis of the analogous mechanisms in a fully-fledged overlapping generations model with intra-cohort heterogeneity. Funding is efficient in a Kaldor-Hicks sense. Individuals vote on capturing the accumulated pension assets and replacing the funded pension pillar with a pay-as-you-go scheme. We show that even if capturing assets reduces welfare in the long run, it always has sufficient political support from those alive at the moment of the vote.

1. Political (In)Stability of Funded Pensions
Roel Beetsma (University of Amsterdam and European Fiscal Board)
Oliwia Komada (GRAPE and WSE)
Krzysztof Makarski (GRAPE and WSE)
Joanna Tyrowicz (GRAPE, IAAEU, UW, and IZA)
Netspar International Pension Workshop
Leiden, 2020
1

2. Literature
Political support for social security:
• existence of inter-generational transfer
e.g. Samuelson 1958, Aaron 1966, Breyer 1989, Boll et al. 1994, Krieger and Ruhose 2013
• size of these transfers
e.g. Browning 1975, Boldrin and Rustichini 2000, Casamatta et al. 2001
• political economy of a social contract
coalition: low productive workers + retirees
Sjoblom 1985, Boadway and Wildasin 1989a,b, Cooley and Soares 1996, 1999a,b, Tabellini 2000, Conde- Ruiz and Galasso 2005, Kelley
2014, Parlevliet 2017
2

3. Literature
Political support for social security:
• existence of inter-generational transfer
e.g. Samuelson 1958, Aaron 1966, Breyer 1989, Boll et al. 1994, Krieger and Ruhose 2013
• size of these transfers
e.g. Browning 1975, Boldrin and Rustichini 2000, Casamatta et al. 2001
• political economy of a social contract
coalition: low productive workers + retirees
Sjoblom 1985, Boadway and Wildasin 1989a,b, Cooley and Soares 1996, 1999a,b, Tabellini 2000, Conde- Ruiz and Galasso 2005, Kelley
2014, Parlevliet 2017
Conclusion: social security is politically feasible → becomes politically stable.
2

4. Literature
Political support for social security:
• existence of inter-generational transfer
e.g. Samuelson 1958, Aaron 1966, Breyer 1989, Boll et al. 1994, Krieger and Ruhose 2013
• size of these transfers
e.g. Browning 1975, Boldrin and Rustichini 2000, Casamatta et al. 2001
• political economy of a social contract
coalition: low productive workers + retirees
Sjoblom 1985, Boadway and Wildasin 1989a,b, Cooley and Soares 1996, 1999a,b, Tabellini 2000, Conde- Ruiz and Galasso 2005, Kelley
2014, Parlevliet 2017
Conclusion: social security is politically feasible → becomes politically stable.
Once working cohorts denie to contribute to PS → no future cohort pays for its
pension.
2

5. Literature
Political support for social security:
• existence of inter-generational transfer
e.g. Samuelson 1958, Aaron 1966, Breyer 1989, Boll et al. 1994, Krieger and Ruhose 2013
• size of these transfers
e.g. Browning 1975, Boldrin and Rustichini 2000, Casamatta et al. 2001
• political economy of a social contract
coalition: low productive workers + retirees
Sjoblom 1985, Boadway and Wildasin 1989a,b, Cooley and Soares 1996, 1999a,b, Tabellini 2000, Conde- Ruiz and Galasso 2005, Kelley
2014, Parlevliet 2017
Conclusion: social security is politically feasible → becomes politically stable.
Once working cohorts denie to contribute to PS → no future cohort pays for its
pension. But: true for PAYG scheme,
This paper: political (in)stability of funded pillar
2

6. Motivation

7. The rise and fall of the funded pillar
• Many countries introduced at least partial funding.
see Holzman and Stiglitz 2001, Bonoli and Shinkawa 2006, Gruber and Wise 2009
• Reform: DB PAYG → FDC:
• immediate cost and delayed gains,
• improve welfare eg. Makarski et al. 2017
3

8. Reform DB → FDC: r > g thus funded pillar increase welfare
Welfare gains from introducing FDC in 1999. Consumption equivalent expressed in % of
permanent consumption from the partial funding scenario.
4

9. Literature review - continued
• Despite general welfare gains...
• ... most of these reforms got reversed.
Jarrett (2011); Schwarz et al. (2014)
• (At least) Some of the reversals reduce welfare.
Hagemejer et al. (2015)
Our contribution
• Understand/explain reversal of reforms in many countries
• Analyzing political economy of funded pillar.
Study political stability of the funded pillar
5

10. What we do:
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Has political support when introduced.
6

11. What we do:
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Has political support when introduced.
Key question:
Does it eventually become politically stable?
6

12. What we do:
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Has political support when introduced.
Key question:
Does it eventually become politically stable?
Otherwise: rethink original funding.
6

13. What we do:
Suppose there already is funded part in pension system:
→ Brings stable gains in the long-run.
→ Has political support when introduced.
Key question:
Does it eventually become politically stable?
Otherwise: rethink original funding.
Tool:
Overlapping generations model with intra-cohort heterogeneity
6

14. Results - preview
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
7

15. Results - preview
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
7

16. Table of contents
Motivation
Theoretical model
Quantitative model
Calibration
Voting
Results
Conclusions
8

17. Theoretical model

18. (Stylized) theoretical model: partial equilibrium OLG model
• Households: 3-periods, each period vote on pensions
• Government: collects T for: pensions, public good and debt cost
• Pension system: DC, PAYG and funded, returns: g and r, with r > g.
• Small open economy: w grows at the rate of g, r is given.
• Voting: pure majority voting.
• Equilibrium: Markov perfect equilibrium.
Strategies are functions of state variables and take future voting as given.
9

19. Consumers
Lifetime budget
c1,t +
c2,t+1
(1 + r)
+
c3,t+2
(1 + r)2
= WEt
WEt = wt − Υt +
wt+1 − Υt+1
(1 + r)
+
b3,t+2 − Υt+2
(1 + r)2
10

20. Consumers
Lifetime budget
c1,t +
c2,t+1
(1 + r)
+
c3,t+2
(1 + r)2
= WEt
WEt = wt − Υt +
wt+1 − Υt+1
(1 + r)
+
b3,t+2 − Υt+2
(1 + r)2
Enough to work with ∆WE for normative inference
10

21. Policy scenarios in period t.
1. Status quo
Two pillar system with τP
t = τP
, τF
t = τF
, with τP
+ τF
= τ.
2. Abandoning pensions (a la Cooley & Soares, 1999)
No pensions b3,t = 0 + no contributions τF
t = τP
t = 0.
3. Abandoning funded pensions
Current pensions intact.
One pillar system with τP
t = τ, τF
t = 0, contributions shifted [1].
Assets captured f F
2,t = (1 + r)wt /(1 + g) [2].
[1] + [2] −→ taxes ↓ by approximately ∆Υt = (f F
2,t + 2τF
wt )/3 ≈ τF
wt .
11

22. Proposition 1. PAYG system is stable. Cooley & Soares (1999).
• old vote status quo: lose pensions, so no gain
• middle-aged vote status quo
∆WEt = τwt
gain: contributions today
−
(1 + g)2
τwt−1 + (1 + g)τwt
(1 + r)
loss: future pensions
• young vote abandon
∆WEt =
(1 + r)2
− (1 + g)2
(1 + r)2
τP
wt +
(r − g)
(1 + r)2
τP
wt+1
gain: due to r>g
12

23. Proposition 2. Funding is unstable. Our result
• old vote abandon because they pay lower taxes: ∆WEt = −∆Υt
• young vote abandon
∆WEt = ∆Υt(≈ τF
wt)
gain: lower taxes
−
(r − g)(3 + 2g + r)
(1 + r)2
τF
wt
loss: lower pensions, r>g
• middle-aged, can go either way (depending on parameters), but it no
longer matters
13

24. Proposition 3. Abandon funding if two pillars. Our result
Keeping PAYG is an equilibrium strategy [Proposition 1].
14

25. Proposition 3. Abandon funding if two pillars. Our result
Keeping PAYG is an equilibrium strategy [Proposition 1].
Keeping funding is NOT an equilibrium strategy [Proposition 2], and
abandoning funding IS an equilibrium strategy [this proposition].
14

26. Quantitative model

27. Model similar to theoretical model, except:
• General equilibrium (small open economy, Schmitt-Grohe and Uribe, 2003 )
• Households heterogeneous, belong to a type κ:
• time discounting δκ
• relative leisure preference 1 − φκ
• productivity level ωκ
• “born” at 21 (j = 1) and survive with πj,t live up to 100 years (J = 80)
• perfectly elastic labor supply
• status quo: transition from PAYG DB to two-pillar DC
15

28. Pension system
Initial steady state: defined benefit
• Exogenous contribution rate τ and an exogenous replacement rate ρ
bDB
¯J,κ,t
= ρw¯J−1,t−1ωκl¯J−1,κ,t−1
indexed by payroll growth rate
16

29. Pension system
Initial steady state: defined benefit
• Exogenous contribution rate τ and an exogenous replacement rate ρ
bDB
¯J,κ,t
= ρw¯J−1,t−1ωκl¯J−1,κ,t−1
indexed by payroll growth rate
Reform: partially funded defined contribution
• Exogenous contribution rate τ = τPAYG + τFF and actuarially fair individual accounts
bDC
¯J,κ,t
=
”savings”PAYG
¯J,κ,t
+ savingsFF
¯J,κ,t
expected remaining lifetime¯J,t
• Contributions and pensions are indexed by:
• payroll growth rate in PAYG,
• tax free interest rate in funded part.
16

30. Government
• Collects taxes τc
, τl
, τk
(sum up to T).
• Covers public good spending
• Covers pension system’s deficit
• Budget closed with τc
17

31. Calibration

32. Macroeconomic environment: Polish economy in 1998
Financial market and firms
• global interest rate r∗
= 2%
• risk premium ξ = 0.03 → domestic interest rate
• deprecation d → investment rate 21%
• capital share in GDP α = 0.3
• technological progress zt slows down from 3% to 1.5%, data + AWG projection
Taxation
• labor τl → labor income tax revenues to labor revenue
• consumption τl → VAT revenues over GDP
• capital τk de iure rate 19%
• fiscal rule ρ i D → smooth adjustment of debt and τc
• debt do GDP D/Y = 45%
Pension system
• contribution τ → share of benefits in GDP
• replacement rate ρ → SF deficit
18

33. Macroeconomic environment: Polish economy in 1998
Demography
• Eurostat forecast
• longevity ↑
• fertility ↓
Heterogeneity
• productivity ωκ 10 values based on Structure of Earnings Survey Eurostat
• leisure φκ 4 values based on Structure of Earnings Survey Eurostat
• discount factor δκ 3 values to match wealth Gini and interest rate
19

34. Voting

35. Political economy
What happens within each vote?
• Policy 0 - status quo keep funded pillar as it is
20

36. Political economy
What happens within each vote?
• Policy 0 - status quo keep funded pillar as it is
• Policy 1 - shift of contributions: funded ⇒ PAYG
(Central and Eastern European countries)
20

37. Political economy
What happens within each vote?
• Policy 0 - status quo keep funded pillar as it is
• Policy 1 - shift of contributions: funded ⇒ PAYG
(Central and Eastern European countries)
• Policy 2 - shift of assets
20

38. Political economy
What happens within each vote?
• Policy 0 - status quo keep funded pillar as it is
• Policy 1 - shift of contributions: funded ⇒ PAYG
(Central and Eastern European countries)
• Policy 2 - shift of assets
• Policy 3 - a combination of the two
(ex. Hungary, Poland, Bulgaria, Slovakia)
20

39. Results

40. Voting results: funding is not stable.
Political support for each policy change against status quo.
21

41. Rational voters always want to withdraw it.
Political support for each policy change against status quo.
22

42. Vote for policy change
Policy 3: both shifts, voting in 2012, consumption equivalent under the veil of ignorance expressed in %
of permanent consumption from the partial funding scenario
23

43. Vote for policy change, because of lower taxation...
Decomposition of consumption equivalent via partial equilibrium.
24

44. ...regardless of lower pension benefits.
Decomposition of consumption equivalent via partial equilibrium.
tax pensions
25

45. No coalition: almost all voters support abolition
Policy 3: both shifts, voting in 2012, consumption equivalent expressed in %
of permanent consumption from the partial funding scenario
26

46. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
poverty
27

47. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
2. We are more equal in the poorer world.
poverty
27

48. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
2. We are more equal in the poorer world.
3. The effect almost disappears when the base is kept constant.
Percentage of population with consumption below 60% of median consumption from the initial ss.
poverty
27

49. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
2. We are more equal in the poorer world.
3. The effect almost disappears when the base is kept constant.
Percentage of population with consumption below 60% of median consumption from the initial ss.
4. The effect almost disappears in the long run.
poverty
27

50. Abolition (almost) does not effect inequalities
1. Policy change slightly reduce poverty.
Percentage of population with consumption below 60% of median consumption.
2. We are more equal in the poorer world.
3. The effect almost disappears when the base is kept constant.
Percentage of population with consumption below 60% of median consumption from the initial ss.
4. The effect almost disappears in the long run.
5. The short run improvement concerns mainly retires.
poverty
27

51. Funding more stable if voters care about their children
Support for reducing funded pillar as a function of altruism: voting in 2012,
0 → standard voting,
0.5 → parents care about children’s utility half as much as about their own.
28

52. If voters are altruistic, funding is more stable
So far, agents are not concerned about the welfare of the future cohorts.
29

53. If voters are altruistic, funding is more stable
So far, agents are not concerned about the welfare of the future cohorts.
How does altruism impact voting results?
29

54. If voters are altruistic, funding is more stable
So far, agents are not concerned about the welfare of the future cohorts.
How does altruism impact voting results?
1. Agents remain egoistic when optimizing lifetime utility.
29

55. If voters are altruistic, funding is more stable
So far, agents are not concerned about the welfare of the future cohorts.
How does altruism impact voting results?
1. Agents remain egoistic when optimizing lifetime utility.
2. But they consider the utility of their children when voting.
29

56. If voters are altruistic, funding is more stable
So far, agents are not concerned about the welfare of the future cohorts.
How does altruism impact voting results?
1. Agents remain egoistic when optimizing lifetime utility.
2. But they consider the utility of their children when voting.
3. If agents value the welfare of their children as half their own or more –
reducing the funded pillar is no longer politically viable.
29

57. If voters are altruistic, funding is more stable
So far, agents are not concerned about the welfare of the future cohorts.
How does altruism impact voting results?
1. Agents remain egoistic when optimizing lifetime utility.
2. But they consider the utility of their children when voting.
3. If agents value the welfare of their children as half their own or more –
reducing the funded pillar is no longer politically viable.
4. The results are the same regardless children inherit parents preferences
and productivity endowments or not.
29

58. Conclusions

59. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
30

60. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
30

61. Conclusions
1. Distribution of welfare costs and gains →
abolition of funded pillar always has political support.
2. No coalitions almost all voters support abolition
3. Correct assignment of property rights crucial for stability.
30

62. Questions or suggestions?
Thank you!
w: grape.org.pl
t: grape org
f: grape.org
e: k.makarski@grape.org.pl
31

63. Vote for policy change, because of lower taxation...
Differences in consumption tax relative to baseline (DB→NDC)
expressed in percentage points.
32

64. ... due to conversion of explicit into implicit debt...
Differences in debt level relative to baseline (DB→NDC)
expressed in percentage points.
33

65. ...regardless of lower pension benefits...
Differences in pension benefits relative to baseline (DB→NDC)
expressed in percentage points.
34

66. ... which are lower due to slower accumulation in PAYG pillar
35

67. Demography
Number of 20-years old Mortality rate for
60-years old
36

68. Demography
Number of 20-years old Mortality rate for
60-years old
⇓ ⇓
rI
↓ rII
↓
36

69. Heterogeneity - productivity ω
SES Eurostat 1998, Poland
Productivity ω
Result: 10 values for ω
37

70. Heterogeneity - leisure preference φ
SES Eurostat, 1998, Poland
Leisure preference φ
Result: 4 values for φ
38

71. Heterogeneity - discount factors δ
• We calibrate the central value of δ to match the investment rate
• We don’t have the data on stratified mortality rates or wealth
• We split the model population ad hoc into 3 groups
• Their discount factors are (0.98δ, δ, 1.02δ)
• In total we have 120 types within each cohort
• The resulting consumption Gini index in the initial steady state is 25.5,
consistent with Brzezinski (2011)
39

72. Reform DB → FDC, immediate cost and delayed gains
Differences in pension system deficit in % of GDP
between DB and FDC scenario
40

73. Reform DB → FDC, welfare effect and support
The share of population gaining from introducing FDC in 1999.
41

74. Reform DB → FDC, after transition period everybody gains
The share of population gaining from introducing FDC in 1999.
42