The pensions challenge

Financing retirement was the theme in the latest in a new series of online public discussions, “Ask the economists”. Held in April, OECD experts fielded a dozen questions from readers in Canada, France, Germany, Korea, the UK and the US, as well as the World Bank, about issues such as taxation, equity, early retirement, life expectancy, mortality-linked debt, the role of savings in stocks and real estate, and private versus public provision. The following are just a few extracts from the debate.

Q. Currently income taxation in most countries is quite modest on pension incomes and, as it is politically very hazardous to decrease pensions, shifting to consumption taxation is a way to make pensions less generous by stealth. Is this a plausible interpretation and do you as economists for the OECD have a clear view on the efficiency and equity issues involved by this shift and its intergenerational impact? Patrick Broullard, France

A. There has been a global shift to consumption taxes, not only in Europe. (…) Savings are a means to future consumption, and so consumption taxes will be paid in the future when the (saved) money is spent. So a shift to consumption taxes may increase the tax burden on pensioners, but when the change is fully in place, they will have paid less in income taxes when they were working.

Many countries do, indeed, offer tax concessions to older people, meaning that the effective burden of income tax on pensions is small. However, it is difficult to justify the fact that a pensioner on the same income as a worker pays less in tax. (…) In the 16 OECD countries that have had major pension reforms since 1990, benefits for a worker entering the labour market today are, on average, 25% lower than they would have been without reform. This dwarfs the effect on pensioners of the shift from income to consumption taxes.

Q. Do individuals understand the need to save for retirement and how best to do that? Ingeborg Scheven, Germany

A. Surveys across OECD countries and worldwide consistently show alarmingly low levels of financial literacy in general and understanding of the need and importance of saving for retirement in particular. For example, surveys in the US have shown that four out of ten workers are not putting any money aside for retirement, while a report in New Zealand found that many individuals are either “unwilling or not able” to save enough for retirement, with around 30% of households spending more than they earn. 71% of respondents in a Japanese survey had no knowledge about investment in equities and bonds, and in Canada, respondents considered choosing the right investments for a retirement savings plan more stressful than going to the dentist!

Though measuring the impact of financial education is challenging, programmes can play a role in improving individuals’ understanding of the changing pension environment, of the need to save and how to invest. For example, in Germany providing information on pension entitlements has been found to play a significant role in additional planning for retirement. (…)

Q. Which country has the best pension system? Andrew Clark, UK

A. This is a tricky question. There are many elements of OECD countries’ pension systems that work well and can serve as “best practice”. But there is no single model that can or should be applied in every country. OECD pension systems developed gradually and were strongly influenced by each country’s economy, societal values and cultural norms. What works well in Switzerland or Sweden will not necessarily be the best solution for Mexico or Japan.

It also depends on the criteria one uses to assess the best system. Is it the system that offers the highest pension replacement rates? In this respect, the earnings-related pension systems in Greece and Luxembourg would be the best but they would score much lower on financial sustainability. Or is it the system that is most targeted towards the poor? With these criteria, the universal flat-rate pension schemes of Ireland and New Zealand or the basic pension in the UK would score highest. Another criterion could be diversification of retirement income source. On this count, Sweden would score the highest since pensioners there receive benefits from five different pension system components, funded and pay-as-you-go, defined-benefit and defined-contribution, public and private. Having the best of all worlds will require determining the various objectives of the pension system. (…) The OECD tries to contribute to this through its work on public and private pensions.

The full text of “The pensions challenge - financing retirement” and previous “Ask the economists” can be found at www.oecd.org/asktheeconomists

Visit www.oecd.org/insurance

©OECD Observer No. 261 May 2007