'-VEL . M-NT : ;IEF Number44 The World Bank November 1994 contributing for them. Pension ben- Red istrib ulton across income efit formulas that give more weight to earnings in the years just before levels I n pay-as-you-go retirement also penalize low- income workers, as compared with Pay-as-you-go pension schemes don't redistribute more educated, higher-income much from the rich to the poor-and some redistribute workers whose earnings rise with age. Such formulas are quite com- the other way mon in developing countries. Financing mechanisms introduce * ay-as-you-go pension against this eventuality. However, another regressive element to most schemes can redistribute the longevity differences between public pension plans. In OECD lifetime income from the rich and poor are predictable, not countries, where coverage is nearly rich to the poor. To achieve this re- random, so the differences in ben- universal, systems are financed distributive objective, the United efits received because of these lon- through payroll taxes rather than States and the Philippines provide gevity differences are expected and general income taxes, and taxable higher wage replacement rates for constitute redistribution rather than earnings are usually capped. In de- 'individuals with lower lifetime insurance. Does society wish to veloping countries, where coverage wages. The Netherlands uses a tlat is sparse, the regressive effect benefit and Switzerland a combina- comes from using general revenues tion of employment-related flat and The well-off live to subsidize pension plans for the progressive earnings-related ben- better-off. Guatemala pays a third efits. Many developing countries longer than the of the costs of its public pension use explicit minimum or maximum plan out of general revenues col- pension levels for the same pur- poor and so collect lected from the entire population pose. None of these mechanisms even though its pension program seems to work as expected.* pensions over a covers less than a third of the popu- 1 -~ * 1lation. Tax deductibility of contri- Why the poor don't benefit l onger penod butions, a common feature of public more than the rich pension plans, also favors higher- Once certain income-specific char- transfer income to the rich because income workers over low-income acteristics of workers are taken into they live longer? We do not know workers. account, public schemes redistrib- whether well-informed citizens and ute little lifetime income to the policymakers would consider this Patterns of redistribution poor. For one thing, the well-off live equitable-yet that is exactly what in industrial countries longer than the poor and so collect many societies do. Considering all these forces of re- pensions over a longer period. Besides drawing a pension over gressive distribution, it is not sur- Many poor people contribute but fewer retirement years, lower- prising that empirical studies for die before they become old enough income workers usually enter the the Netherlands, Sweden, the to collect benefits. labor market earlier because they United Kingdom, and the United People who live longer than aver- leave school earlier. Yet they often States show little if any redistribu- age require larger lifetime incomes fail to accrue much extra pension tion from the lifetime rich to the to maintain their standard of living, credit during these extra contribut- lifetime poor. The public pension and pensions are designed to insure ing years. Germany and Hungary scheme in the Netherlands was grant pension credit to university found to have redistributed income 'For more de-, se World B.k,Averong the Old Agerots students, who thus earn pension primarily from unmarried to mar- (New York Oxford Universitv Press, 1994). benefits during those years without ried individuals, regardless of in- sFIL Fr flnea come. A study of the Swedish sys- ings profiles are even more pro- same proportion of benefits for all tem detected no intragenerational nounced than in OECD countries. income groups, the absolute value redistribution and suggested that Many developing countries have of the transfer is eight times as large the scheme might be regressive if multiple plans that provide more for a high-income worker as it is for mortality differences were taken generous terms to privileged a minimum wage worker (see the into account. Income-related differ- groups of workers with more politi- figure). ences in mortality rates and earn- cal clout. In Brazil, higher-income Misuse of pension fund reserves ings profiles in the United workers have an easier time docu- contributes further to regressive Kingdom offset progressive benefit menting their covered employment, intragenerational transfers. In Ecua- features. In Italy, intragenerational so they are eligible for generous dor and the Philippines, pension redistribution has regional implica- length-of-service-related benefits. fund reserves are lent to high- tions as well. One study found a Civil servants in Egypt and Mexico income workers at negative real pattern of transfers from the poor receive better inflation protection interest rates of as much as 40% a South to the richer North, the result than private sector workers, and in year. In Trinidad and Tobago, well- of steeper age-earnings profiles, Colombia they contribute at a lower off workers borrowed pension longer lifetimes, and a higher old rate than private sector workers, yet reserves for mortgages at below- age dependency ratio in the North. get the same wage replacement rate. market rates. Several studies have looked at In Brazil, Hungary, Turkey, and Not a single study for any coun- the intragenerational effects of the many other countries, white-collar try has presented strong evidence U.S. social security system and workers are more likely than blue- that the public pension scheme has found little or no difference in the collar workers to retire at age 40 or substantially redistributed income rate of return to low- and high- 50, increasing their rate of return from the lifetime rich to the lifetime income workers, particularly after relative to those who continue poor once mortality differences are adjusting for mortality rate differ- working. In Colombia, though all taken into account. In fact, in some ences. Studies have also shown a current retirees receive net transfers countries, the redistribution goes variety of other nontransparent re- that constitute approximately the from the poor to the rich. distributions: from single workers to married couples, from dual to singl wagre-earnerofamles, from. In Colombia, high-income workers get a larger lifetime income single wage-earner famlies, from tase hnlwicm okr women in the work force to other transfer than low-income workers women. Lifetime income transfer (millions of 1992 pesos) Regressive pension schemes 80 High-income worker in developing countries 70 Indirect evidence for developing 70 countries suggests that intra- 60 generational redistribution in pub- 50 lic pension schemes is actually 40 Middle-income worker regressive. Typically, only formal 30 sector workers in urban areas are 20- covered by the plans. The very Low-income worker L poor are usually excluded. Income- 10 related differences in mortality 0 rates, age of entry, and age-earn- Source: World Bank, Averting the Old Age Cnsis (New York: Oxford University Press, 1994). Development Briefs are issued by the World Bank to inform the media, busmess, academic, and govenument policy communities about development policy analyses and results from the Bank's research activties. They aredrawn from the workof individual Bank researchers and do not necessanly represent theviews of theWorld Bankand its membercountnes-and should not thereforebeattnbuted to the World Bank or its affiliates. Briefs are issued penodically by the Research Advisory Staff, Development Economics Vice Presidency, The World Bank, 1818 H Street, NW, Washington, DC 20433. Tel: (202)473-3984, Fax: (202)477-0955 Brefs are not copyrighted and may be reproduced with the appropnate attribution.