In the traditional autarkical family, the resources currently devoted by the workers and obtained by the retired of the same clan are the same, the contributions/retirement pensions ratio is always equal to one. In public retirement pension schemes, in contrast, direct resource transfers are replaced by roundabout social-security systems. In Discussion Paper No. 463, Research Fellow Fiorella Padoa Schioppa argues that a public retirement pension scheme based on a pay-as-you-go mechanism will typically lead to perverse redistributions from the worse-off to the better-off segments of the population. Groups with the highest demographic growth (usually the poorest) and working in labour markets with the greatest rates of change of wages and employment levels (those with the highest unemployment levels) provide pensions for the groups with the greatest concentrations of elderly and retired (typically the better-off).

Moreover, a social-security system is also more prone to lead to deficit spending for two reasons: participants raise their demands for benefits without increasing their willingness to bear the costs; and they reduce their natality rate without postponing their own retirements to allow for the increase in their expected lifespans.

Padoa Schioppa uses a formal overlapping generations model to demonstrate that the contributions/retirement pensions ratio for a given effective social-security tax rate is higher the lower are: (i) the dependency rate (ratio of old to young); (ii) the inactivity rate (ratio of retired to employed); and (iii) the replacement rate (ratio of the real pension to the real wage). Further, the dependency rate varies not with the level, but (negatively) with the rate of growth of population; the inactivity rate not with the level of employment but with its rate of change across different cohorts (again negatively); and the replacement rate not with the level of wages but with its rate of change over time. The levels and rates of variation of these variables are usually negatively correlated, so flat or insufficiently progressive social-security tax rates must lead to perverse redistributions of pensions.

Padoa Schioppa focuses on Italy as a case-study of such redistributions, where the most dynamic social groups are also the poorest. Although the poor Mezzogiorno enjoys a lower effective social-security tax rate than the rich North-Centre, its retired/employed ratio is only half that of the North-Centre, whereas the replacement rates of the two regions are identical, so pension resources flow from the Mezzogiorno to the North- Centre.

Padoa Schioppa concludes with a number of policy proposals to eliminate these distortionary redistributions. The intragenerational redistribution in favour of those whose incomes increase in the period immediately preceding retirement may be reduced by basing pensions on average lifetime real wages, not those of the last five years; Italy's social-security deficit may be controlled by reducing the ratio of the real pension to the pensionable real wage closer to the `standard' European level; and the resource redistribution by sex may be corrected by a gradual increase in the female compulsory retirement age. A further reduction of the Mezzogiorno's marginal tax rate would then be necessary in order to eliminate all interregional redistributions induced by the pay-as-you-go scheme.

Undesirable Redistributions in the Retirement Public Pension Schemes: The Italian Case Study
Fiorella Padoa Schioppa

Discussion Paper No. 463, September 1990 (HR)