Earnings related pension schemes and human capital formation

Abstract

In this paper, I show that traditional earnings related pay-as-you-go pension systems as we see them in many OECD countries subsidize human capital formation. The reason is that these systems come along with an implicit tax structure that features high tax rates at the beginning of working life and low tax rates toward the end. When the costs of human capital investment are mainly time costs, such an implicit tax structure lowers the costs of human capital investments and simultaneously increases the payoff. The fact that higher skilled workers tend to have steeper wage profiles over the working phase than the unskilled enforces this mechanism. I first show this result in a simple analytical model and then quantify the macroeconomic and welfare effects of making the implicit tax structure age independent in a large-scale overlapping generation model, in which households can invest in human capital both by going to college and through on-the-job training. In terms of welfare, such a reform comes along with a lot of intergenerational redistribution. Although the welfare of current retirees may increase by about 4.5% of their remaining life-time resources, current older workers will lose due to an increase in their implicit tax rates. The welfare of future generations slightly declines by 0.1%.

Inequality in an OLG economy with heterogeneous cohorts and pension systems

“…Indeed, they find that while an introduction of a fully funded DC system increases labor supply and effective retirement age for all ability groups, it has negative impact on human capital formation relative to a DB system. This result is in line with the result byKindermann (2015) that DB systems subsidize human capital formation relative to DC systems, as the implicit tax structure in DB systems favors earnings paths with high slope (corresponding to high human capital formation) relative to flat earnings paths (corresponding to low human capital formation).…”

Pension reform in an OLG model with heterogeneous abilities

“…Others have investigated the relationship between the pension system and investment in human capital, as a major determinant of productivity and growth (e.g., Zhang, 1995; Kemnitz and Wigger, 2000; Docquier and Paddison, 2003; Zhang and Zhang, 2003; Le Garrec, 2012). Most recently, Ludwig et al (2012), Buyse et al (2013) and Kindermann (2015) made progress by studying pension reform in OLG models where both employment by age and human capital are endogenous.…”

“…Some authors model individuals with different human capital (or skill) levels when they enter the model (e.g., Sommacal, 2006; Fehr et al , 2013). Others introduce individuals with the same initial human capital, but different learning abilities (e.g., Docquier and Paddison, 2003; Kindermann, 2015). Another assumption to make is whether or not human capital and productivity are subject to idiosyncratic shocks during life, as for example in Fehr et al (2013).…”

Incentive extension of pay-as-you-go pension system

“…To implement this extension and achieve the effects of prolonging active participation, it is necessary to have a complex of reforms in the systems of social investment and social insurance. It means investment in education, healthcare and living standards in general, reliably and dependably organizing social insurance and human capital (Mincer, 1984) financing schemes (Kindermann, 2015). The more the pension system will have equivalency (earnings-related benefits) and closed (self-sufficient and balanced budget), the more effective will be its basic function of old-age security and strengthening the role of productive services that can prolong both horizon and zenith of citizens' productive employment (Valenčík, 2014).…”