APPENDIX I Incentives For Early Retirement
140. The retirement decision depends inter alia on the preference for leisure, health, the net wage rate, and the cost in terms of a decreased pension. When a worker desires to retire early, a pension fund would have to reduce the pension in order to compensate for two factors:
(i) The increase in the expected duration of pension payments. With an average life-expectancy of around 15 years at age 65 and life-expectancy at 64 of 15.95 (the probability of death is assumed equal to 5 percent), a retirement at 64 years of age would increase the expected pension payments by about (15.95/15)-1 = 6.3 percent.
(ii) In addition, in the case of early retirement the wage earner and his employer would pay one year less of pension contributions. In Austria, the value of forgone pension contributions is equal to 22.8 percent of the last year’s gross wage.
141. A pension system that allows for an early retirement without compensating for the loss from (i) and (ii) does in effect “subsidize” early retirement. In addition, the worker’s choice between retirement and work is distorted resulting in a sub-optimal supply of labor. From the viewpoint of the Austrian pension system, the average incremental loss from one year of early retirement (from 65 to 64) can be calculated using the following formula:
where ΔL stands for the incremental loss in schilling terms, w0 is the last salary, and wa is the base reference salary (the “best” 15 years). As a percentage of standard pensions P = (wa*0.80*15), the required pension reduction becomes:
which—assuming w0/wa equal to 1.2—amounts to close to 8½ percent or, in terms of a compensatory reduction in the replacement rate; e.g., a reduction from 80 percent to 73 percent or around 7 percentage points. This compares to a discount of 2 percentage points a year after the 1997 reform.
142. The calculations above are based on an average individual and could underestimate the incentives for early retirement. In addition to the effects discussed above, there might be adverse selection effects arising from the self-selection of workers with relatively short life expectancy: the percentage increase in expected pension payments would thus be larger for these workers than for the average worker and would warrant a larger reduction in the replacement rate in order to remove any incentives for early retirement.
Fougére, Maxime and Marcel Mérette, 1998a, “Economic Dynamics of Population Ageing in Canada: An Analysis with a Computable Overlapping-Generation Model” (unpublished: Department of Finance, Canada).
Fougére, Maxime and Marcel Merette, 1998b, “Population Ageing and Economic Growth in Seven OECD Countries” (unpublished: Department of Finance, Canada).
Hviding, Ketil and Marcel Merette, 1998, “Macroeconomic Effects of Pension Reform in the Context of Ageing Populations: OLG Simulations for Seven OECD Countries”, Economics Department Working Paper, (Paris: OECD).
Jaeger, Albert, 1997, “Alternative Approaches to Pension Security in an Aging Society”, in: Germany - Selected Issues, IMF Staff Country Reports, No. 97/101.
Masson, Paul R., Tamim Bayoumi, and Hossein Samiei, 1995, “International Evidence on the Determinants of Private Savings”, IMF Working Paper, No. 95/51-EA.
Koch, Manfred and Christian Thimann, 1997, “From Generosity to Sustainability: The Austrian Pension System and Options for its Reform”, IMF Working Paper, No. 97/10.
OECD, 1997, “The Macroeconomics of Aging, Pensions and Savings: A Survey”, (unpublished: document for Working Party 1, Economic Policy Committee, ECO/CPE/WP1 (97)10).
OECD, 1998, “The Retirement Decision in OECD Countries”, (unpublished: document for Working Party 1, Economic Policy Committee, ECO/CPE/WP 1(98)3).
Palacios, Robert and Edward Whitehouse, 1998, “The Role of Choice in the Transition to a Funded Pension System” (unpublished: World Bank).
Roseveare, Deborah, Willi Leibfritz, Douglas Fore, and Eckhard Wurzel, 1996, “Ageing Populations, Pension Systems and Government Budgets: Simulations for 20 OECD Countries”, Economics Department Working paper, No. 168, (Paris: OECD).
Rürup, Bert, 1997, “Perspektiven der Pensionsversicherung in Osterreich”, study commissioned by the Austrian Ministry for Labor, Health, and Social Affairs.
Prepared by Ketil Hviding.
Url (1997) estimated the 95 percent confidence limit of the structural budget deficit at 1.25 percent of GDP.
The EU11 comprises all EU countries, except Denmark, Greece, Sweden, and the United Kingdom.
Estimates made at the OECD by Roseveare and others (1996) are in line with the findings in Koch and Thimann (1997). Including only the employee pension system, they estimated that pension expenditures would rise from around 8¾ percent of GDP in 1995 to 14 percent of GDP in 2030. Based on a productivity growth rate of 1½ percent per year and a discount rate of 5 percent of GDP, it was estimated that the net present value (expenditure less contributions) amounted to 93 percent of 1994 GDP.
Although it is difficult to compare the projections in Rürup (1997) with those of Koch and Thimann (1997), the smaller increase in pension expenditure in Rürup (1997) is likely to arise from different labor market assumptions: while Koch and Thimann (1997) assumed constant unemployment and participation rates, Rürup (1997) projected the unemployment rate would fall from 6½ percent in 2000 to 4½ percent in 2030.
This simple assumption was chosen in the absence of any available actuarial study of the civil servant pensions.
See Palacios and Whitehouse (1998) for a discussion of the issue of a voluntary switch to a private pension system.
Tax sheltered saving accounts are currently available in. Austria, but the ceilings are low and depend on the level of income.