Working Paper: CEPR ID: DP3439
Authors: Marcello Damato; Vincenzo Galasso
Abstract: Recent reforms of the Italian social security system (Amato-Dini reforms) aimed at reversing the upward trend in Government pension spending. The main provisions of these reforms are: i) the adoption of a (unfunded) defined contribution system as a basis for computing pensions benefits, ii) a sharp reduction in the incentives to retire early, iii) an increase in the statutory retirement age, and iv) the indexation of pensions to price inflation rather than to wage growth. This Paper evaluates the long-run political sustainability of this new pension system. We use a general equilibrium model calibrated to reproduce the main Italian demographic, economic and political aspects as well as the social security system before and after the reforms. We simulate our model to compute the equilibrium tax rate that is preferred by a majority of voters at steady state, i.e., in the year 2050, given the structural characteristics of the Italian economy and for different retirement ages. To evaluate the effectiveness of the reforms, we compare the equilibrium tax rate under the new regime with the equilibrium tax rate that would have prevailed in absence of reforms. Two main aspects of the aging process are relevant to our analysis: i) the increase in the dependency ratio, which reduces the profitability of the (unfunded) social security system and ii) the increased political influence of the elderly voters. Our simulation suggests that, to retain its political sustainability under the Amato-Dini regime, the equilibrium social security tax rate has to increase from 38% in 1992 to 48.9% in 2050. At steady state, the most effective provision of the reform in reducing pension spending is an increase in the retirement age. The switch to a (unfunded) defined contribution system has mainly redistributive implications, while eliminating the indexation of pension benefits to wage growth induces a majority of voters to increase the replacement rate at retirement.
Keywords: Defined Benefits; Demographic Dynamics; Political Equilibria
JEL Codes: D72; E17; H55
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Amato-Dini reforms (E69) | increase in equilibrium social security tax rate (H55) |
| increase in retirement age (J26) | sustainability of the system (Q01) |
| switch to unfunded defined contribution system (H55) | alters the distribution of benefits (D30) |
| eliminating indexation of pension benefits to wage growth (J32) | increase in replacement rate at retirement (H55) |