Fairness of Public Pensions and Old-Age Poverty

Abstract

A crucial parameter for increasing the retirement age is the early-retirement discount of the public pension system. Critics of the present German system argue that the downward adjustment of the pension for early retirees is too small compared with a fair system and thus encourages early retirement. We discuss several notions of fairness of early-retirement provisions and propose a concept called distributive neutrality , which states that the ratio between total benefits and total contributions should not depend systematically on the individual's ability. By applying this concept to the German retirement benefit formula and taking empirically estimated relationships between annual income (as a proxy for ability), life expectancy and retirement age into account, we show that at the present discount rate of 3.6% per year there is redistribution from low to high earners, which, surprisingly, could be attenuated by raising the discount rate.