The eBook begins by showing that, over the last decades, most major pension reforms in Europe and the US have centred on four main policy levers:
- reducing the level of pension benefits
- strengthening marginal financial incentives for later retirement
- increasing the age at which individuals can start claiming benefits (early retirement age)
- increasing the age at which individuals are entitled to full pension benefits (normal retirement age)
Figure 2 illustrates these policy trends by showing how the benefit replacement rate (the ratio of pension benefits to pre-retirement earnings), marginal financial incentives and early and normal retirement ages have evolved in the OECD over the past decades.
Figure 2 Past, current and future gross replacement rate, implicit tax rate, early retirement age and normal retirement age in the OECD
Note: The figure shows OECD averages for the gross replacement rate (GRR), implicit tax on working longer (ITAX), early retirement age (ERA) and normal retirement age (NRA). Past values refer to data from 2002, and current values refer to the latest year of available data, which is 2022 for GRR, ERA and NRA, and 2012 for ITAX. For ERA and NRA, future values are based projections made in 2022. The GRR is gross pension entitlement at retirement relative to pre-retirement earnings for male workers with average earnings. The current GRR is for an individual entering the workforce at age 22 in 2022 and retiring after a full career, while the past GRR is for an individual who started working at age 20 in 2002 and retired after a full career. The ITAX is a measure of marginal financial incentives and is defined as the change in social security wealth incurred when delaying retirement by one year, divided by the after-tax earnings from working that additional year. The current ERA is for men retiring in 2022 after a full career starting at age 22, while the past ERA is for men retiring in 2002 after a full career from age 20. The future ERA is for men entering the labor market in 2022 at the age of 22 and retiring after a full career. The current NRA is for men retiring in 2022 after a full career starting at age 22. The past NRA is for men retiring in 2002 after a full career from age 20. The future NRA is for men entering the labor market in 2022 at the age of 22 and retiring after a full career. For GRR, ERA and NRA, the average includes all OECD countries at the respective time of calculation. The ITAX average includes Denmark, France, Germany, Italy, Japan, the Netherlands, Spain, Sweden, and the UK for both time periods.
Source: OECD (2005, 2023) and Börsch-Supan and Coile (2023)
Classifying reforms on the basis of these four design features offers a simple way of mapping reform efforts across pension systems, cutting through the complexity of the specific rules in which these systems vary. Moreover, we argue that the predicted impacts of these types of reforms on labour supply and retirement can be intuitively understood in a simple conceptual framework. Such a framework, together with many examples of real-world pension reforms across European countries, are laid out in the second chapter of the eBook (Giupponi and Seibold 2024b).
How to effectively encourage later retirement
The eBook then examines recent empirical evidence on the effectiveness of these reform options in impacting retirement behaviour and social security finances. A first key insight emerging from the literature is that statutory retirement ages, i.e. the early retirement age and the normal retirement age, have a large impact on retirement behaviour. Reforms increasing statutory ages across many European countries have proven highly effective in inducing individuals to retire later, and these reforms have had substantial positive fiscal effects (Seibold 2024). Recent research demonstrates that the outsized influence of statutory retirement ages cannot be explained by standard models of economic behaviour (e.g. Kanninen et al. 2020, Magesan et al. 2021). Instead, many workers appear to view these ages as psychological reference points – a ‘normal’ time to retire
In contrast, marginal financial incentives are less effective in influencing retirement behaviour. Since the early 1990s, many European countries have introduced or strengthened financial penalties for early retirement and rewards for late retirement. However, empirical evidence suggests that such financial incentives alone have small effects on retirement choices, and modest or even negative effects on social security finances. In addition, such reforms shift resources from individuals retiring early to those retiring late, which can be undesirable from a distributional viewpoint.
Another key lever of retirement policy is the level of pension benefits. Lowering pension payments has a mechanical positive effect on the fiscal balance of the pension system. In addition, benefit cuts have the potential to exert further indirect fiscal effects by inducing individuals to increase labour supply and postpone retirement. Empirical studies suggest that reducing benefit levels indeed has substantial positive effects on supply both close to and far from retirement (Artmann et al. 2023). Thus, from a fiscal perspective, this reform option offers a ‘double dividend’. The welfare implications of cutting benefits are more nuanced, though – they depend on whether fiscal gains outweigh the welfare losses of those individuals with reduced pensions who are induced to work longer (Giupponi, 2024).
Distributional consequences of pension reform
Policy debates around pension reform often revolve around their impact on the fiscal balance of the pension system. While these considerations are crucial, they can overlook other fundamental aspects of pension systems: their role in providing insurance and their potential to redistribute resources across individuals (Landais and Spinnewijn 2024a). For instance, pension reforms that penalise early retirement and reward late retirement redistribute from early to late retirees. Recent empirical evidence suggests that such reforms are regressive, effectively redistributing from poorer to richer individuals (Spinnewijn et al. 2022). On average, early retirees have lower consumption, worse health, and lower life expectancy than late retirees. This creates a trade-off between the fiscal gains and equity losses of pension reforms providing financial incentives for later retirement. In navigating this balance, which specific groups of retirees are targeted by reforms is crucial. One of the chapters in the eBook lays out a concrete reform proposal of US Social Security that that aims to address the trade-off between fiscal sustainability and appropriate income support to the vulnerable (Duggan and Olshen 2024).
Another important dimension in which pension systems redistribute is life expectancy. Pension benefits are usually paid in the form of an annuity until death. While this provides insurance against the risk of uncertain longevity, such a system also effectively redistributes from individuals with short life expectancy to those with long life expectancy (Bozio et al. 2024). Empirical studies have documented pronounced and growing differences in life expectancy across socioeconomic groups, including by gender, ethnicity, income, and wealth. As a result of these disparities, better-off individuals with longer life expectancy tend to receive higher lifetime benefit payments. It is important to take into account this regressive tendency within pension systems designing reforms.
Interactions with other social insurance programmes
Pension systems operate in a broader landscape of labour market institutions, where interactions with other policies can play a role. In particular, other social insurance benefits available to non-working individuals may serve as a substitute for old-age pensions. For instance, if a pension reform encourages delayed retirement, more workers may claim unemployment benefits before retiring. Recent empirical evidence confirms that such spillovers exist, particularly onto unemployment and disability insurance (Haller and Staubli 2024). However, the magnitude of these spillovers is generally insufficient to counter the direct effects of pension reforms. Conversely, the design of unemployment and disability insurance programs can influence retirement timing, impacting the pension system.
Six key policy lessons
The concluding chapter of the eBook synthesizes these research insights into six key lessons for retirement policy (Landais and Spinnewijn 2024b):
- Statutory retirement ages are highly effective in impacting retirement behaviour and social security finances; financial retirement incentives have much less impact.
- Cutting pension benefit levels has strong fiscal effects and induces later retirement, but this often comes at a significant welfare cost to affected individuals.
- Pension reforms have some spillover effects on other social insurance programmes, but these are not large enough to counter their direct fiscal effects.
- Reforms that penalise early retirement and reward late retirement can be regressive, exacerbating inequalities between retirees.
- Disparities in life expectancy across socioeconomic groups make pension systems less progressive.
- In addressing the trade-off between fiscal consolidation and distributional concerns, careful targeting of pension reforms is crucial.
Basing future reform efforts on these principles will be essential for creating pension systems that are both financially sound and socially equitable.
References
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