Scienza delle finanze 3/ed Harvey S. Rosen, Ted Gayer Copyright © 2010- The McGraw-Hill Companies srl Pension system in Italy Public and mandatory system.

Scienza delle finanze 3/edHarvey S. Rosen, Ted Gayer Copyright © 2010- The McGraw-Hill Companies srl

Pension system in Italy

Public and mandatory system


definitions

Old age pensions are granted to people who have stopped working b/se of age limits whilst seniority pensions are granted to those workers who have reached a certain number of years of contributions.

Disability pensions are intended for people who have been injured in an accident and are no longer able to carry out the work that ensured their income.

Pensions for survivors go to those who, even if they have not been employed, have been linked by family ties to workers who have died.


Social pensions are for people who have no means of support, regardless of whether they have worked or not.

The first two categories of pensions perform the function of social security / insurance, while the other two can be considered forms of welfare (assistance) intervention.


Total expenditure for social protection in Italy in % of GDP and in % of primary current expenditure


A bit of history….The first social benefits provided in Italy and elsewhere in

Europe were “mutuals” (=mutual protection) created by specific categories of workers.

With the spread of industry and with the formation of the working class, the social security system has gradually become mandatory and managed by public institutions.

Lagging behind the rest of Europe, old age and disability pensions were introduced for the first time in Italy in 1864, and used only for state employees.


A bit of history…..

In 1919, these institutions became mandatory for private dependent workers while pensions for the survivors were introduced only in 1939, in favor of these same workers.

Between the 50's and 60's mandatory retirement has been extended to all categories of workers (craftsmen, salesman, trade sector, etc ...) and at the end of the '70s social pensions were introduced.

Remember from last times: what are the implications on the budget balance of involving more people into p-a-y-g sytem?


Remember from last times: what are the implications on the budget

balance of involving more people into p-a-y-g sytem?

Nb * B = t * Nw * w or B = t * (Nw/Nb) * w


More history ….

The growth of social spending that was recorded until the end of the '70s is explained by the gradual extension of the intervention to larger groups of workers and populations, while the reasons for the growing deficits that occurred during the 80s and early 90s are due: to the method of financing of social security institutions, macroeconomic trends and the changing structure of the population.

This has formed a substantial pension debt, which is, it has become more and more significant the difference between the present value of pension benefits that the state has undertaken to pay and the present value of the social contributions that will be paid to the public budget.


More history ….

With the primary aim to curb spending, the Italian pension system has been radically changed with the reforms Amato (d.lgvo 503/92) and Dini (Law 335/95).

More recently, work on this subject have been made under the first Prodi government (Art. 59, Law 449/97) the second Berlusconi government (Law 243/2004)


Pension systems classified according to:

1) The method of financing: a) capitalization / funded; b) pay as you go.

2) The criteria for the definition of performance: a) defined contribution; b) defined benefits


FROM LAST TIME

funded and pay as you go

About the financing arrangements, the revenue of public social security contributions paid by workers and employers can be used in different ways depending on whether the funding system is unfunded or funded.

In the PAYG system the tax revenue collected in each period finances pensions provided during the same period, that is, the working generation pays the pensions of those who have ceased to work.

In funded systems, contributions from employees are invested in the capital market and, at retirement, the pension is equal to the contributions paid increased the rate of return prevailing on the mkt.


Funded and pay as you go We use an overlapping generations model to understand on which variables are

dependent the two systems.

We assume a society with only two generations: young people ( Nt + 1) born at t+1,

and the elderly (Nt).

Each generation lives only two periods (during the first it works, while the second is retired).

The population grows at rate n. Young people receive a salary S and pay a contribution rate c.

Labour productivity grows at a constant rate m, which is reflected entirely on wages.

The mkt interest rate is r and is constant for the entire period.

The wage bill at the end of period t is: Nt * St

Total contributions at the end of period t is equal to: C*St*Nt

It should be remembered, finally, that (error below: n instead of m!)

1 11 e 1t t t tS S n N N m


Pr = Pro capite pension in a pay as you go

Pc= Pro capite pension in a funded

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comparison

From a simple comparison of the two equations which indicate the pension per capita in the two systems, it can be seen that, for a given contribution rate c, the two systems are equivalent only if the interest rate is equal to the sum of the rate of productivity growth and the rate

of employment growth, rounded up to m · n.


Defined benefits and defined contributions(PAYG)

Pension systems can be distinguished depending on the criteria used to define pension benefits, which can be calculated by reference either to the employee's wages or paid contributions.

In the first case, we talk about defined benefits (wage based) system and wages considered to define the pension may be the one received at the last period of his working life or an average of what he earned throughout theirhis working life

Regardless of the method of calculation, the idea behind the first system is that the state will ensure to retirees a standard of consumption similar to that enjoyed during the period in which he worked.


Defined contributions

In the second case, the system is by defined contributions and public intervention aims to bind individuals to a compulsory saving ahead of time of inactivity

The rate of return on savings is not the market rate, such as in funded systems, but is defined by the law beforehand


Defined contributions and wages

In Italy, until the early '90s, the social security system was one of defined benefits and characterized not only by a massive pension liabilities, but also marked by huge differences in treatment between categories of workers (employees and self-employed) and between sectors of 'economy (industry, agriculture and services).

Also, for a long period of time, it has been made a wrong use of certain benefits: seniority and disability pensions were used in place of unemployment benefits to manage downturns in the business cycle and the evolution of production .


From the distribution point of view, the amount of pension costs is such that the effects on income distribution are certainly comparable to those produced by the tax system.

In general terms, we can say that all public pension systems are based on some pact between generations and the most delicate aspect of the reforms is the fact that this should be redefined and we change the agreement between the employee and the elderly and the role of the state as guarantor of this agreement.

Transitional generation!!! See previous lesson!!!


In a PAYG DEFINED CONTRIBUTION SYSTEM transfers of resources between generations are determined by the difference between the rate of return of contributions that the State guarantees to pensioners and the performance of financial markets:

if the rate of return of contributions exceeds the market, then is the young generation which transfers resources to the elderly and vice versa when the remuneration paid is less than that of the market.

In the PAYG system, the analysis is a bit 'more complex and to understand the transfer of resources between generations is to be used a concept of equilibrium tax rate.


In the PAYG system the equilibrium tax rate is the following:

NtPt = c St+1 · Nt+1

which says current total benefits = to total current revenues

We will develop this equilibrium conditions for the following possible arrangements between generations:

=> the rate of substitution between salary and pension is fixed;


equilibrio di aliquotal' è 11

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ottiene si ,equilibrio di condizione nella osostituend

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neretribuzio ultimadell' epercentual una è pensione La

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Pension is a fixed percentage K of the last salary (replacement ratio)

C is the equilibrium tax rate and by substituting we single it out (last line)


. ed variabilinelle mutamenti dai ainfluenzat ènon anziani degli pensione La

giovani. i obenefician ne e diminuisce cresce se

giovani dai sopportato è onerel' e cresce scende, se

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nm

cm

cn

knm

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As before, with a fixed rate of substitution pension to wage P with little t is given and not influenced by changes in m and n!

Therefore if n declines, c must increase(young pay)if m increases, c can decline (young gain)


problems before reforms of the ’90s

The problematic features of the Italian pension system before the reforms of the 90s

•Extensive use of deniority pensions (the so-called baby pensions).Improper use of disability pensions.

•Marked differences (for insured benefits and required contributions) between categories, sectors, workers and self-employed (the so-called "contribution jungle ").

•It was a system payg defined benefit with fixed rate of substitution (the pension was a fixed proportion of the average wage of the last years of work).

• As the rate of population growth and the productivity of today are greatly reduced compared to the values in the '70s, could be kept in balance only by increasing the contribution rate.


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:o)considerat abbiamo che primo (il tipodel era igenerazion tra

patto di e ntofinanziame di sistema questocon che Ricordare

Recall that with such a system, the generational Pact was formulated as below


Amato Reform

Main changes

Retirement age increased ( 60 to 65 anni for men, 55 to 60 for women) (with a minimum of 20 years of contributions for old age pension) 35 years for seniority pensions

Replacement ratio

Indexation only to prices not anymore wages


Amato defined benefits

The pensionable salary is the average salary for all taxable years in which the employee has contributed to pension system, referring to the entire working life, excluding from the average those less than 20%, with a ceiling (1/5)

In doing this the average wage earned in different years, are harmonised over time with a calculation that takes into account the compounding rate of inflation plus 1% for each year.

The new pension arrangements has been applied to those who entered the labor market in 1994, did not affect those already retired at the time were only modestly and those who were already in business.

No GRADUALITY!


Dini Reform defined contribution

Full application to those who entered job mkt in 1996.

For those at 1 January 1996 had already entered the labor market, but have less than 18 years of contributions will be applied pro-rata system, whereby a part of the pension is calculated by the fixed benefits some by the fixed contribution system (therefore often also referred to as the mixed system).

For those ho had more than 18 years of contribution at 3 december 1995 the old system is mantained

GRADUALITY????


Dini reform

Rate of capitalisation mobile average 5 years nominal GDP


Latest intervention

Harmonising treatment

Increasing retirement age

Increasing number of years of contribution


Gli interventi più recenti

In altre parole, nel 2008 i lavoratori dipendenti sono potuti andare in pensione con 58 anni di età e 35 di versamenti. Per gli autonomi erano invece richiesti 59 anni di età. Dal 1 luglio 2009 è invece scattato un meccanismo di quote, con il quale si terrà conto della somma dell’età anagrafica e degli anni di versamenti, ancorato a un’età minima e ai 35 anni di contributi.

Per esempio, per i lavoratori dipendenti, si partirà con quota 95, con almeno 59 anni di età: ciò significa che potranno andare in pensione coloro che avranno 59 anni di età e 36 di contributi (36 + 59 = 95), oppure 60 anni di età e 35 di contributi e così via. Tale quota aumenterà a 96 dal 1 gennaio 2011 e di un altro punto fino al 2013.


Test your

Macrosostenibility new system after Dini by using the formula

Pro capite pension in a pay as you go system

Derive/veryfy/check/explain:

• pro- capite pension and pension expenditure increase with GDP

• contrary to the fixed benefits system, financing disequilibria cannot be corrected by increasing the tax rate: why?

• being a pay as you go system still subject to demographic changes: explain.


Replacement rates per gender

Scienza delle finanze 3/ed Harvey S. Rosen, Ted Gayer Copyright © 2010- The McGraw-Hill Companies srl Pension system in Italy Public and mandatory system.

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