Optimal Mix Among PAYGO, EET and Individual Savings

TL;DR

This paper develops a model to determine the optimal mix of pension schemes, including PAYGO, EET, and individual savings, considering demographic changes and participant preferences to maximize overall utility.

Contribution

It introduces a Nash equilibrium framework to optimize pension scheme mixes, extending the Samuelson-Aaron criterion to age-dependent preferences and identifying critical ages affecting outcomes.

Findings

Negative population growth reduces PAYGO attractiveness.

Optimal mix depends on demographic and preference parameters.

The government can influence the mix by adjusting contribution rates.

Abstract

In order to deal with the aging problem, pension system is actively transformed into the funded scheme. However, the funded scheme does not completely replace PAYGO (Pay as You Go) scheme and there exist heterogeneous mixes among PAYGO, EET (Exempt, Exempt, Taxed) and individual savings in different countries. In this paper, we establish the optimal mix by solving a Nash equilibrium between the pension participants and the government. Given the obligatory PAYGO and EET contribution rates, the participants choose the optimal asset allocation of the individual savings and the consumption policies to achieve the objective. The results extend the ``Samuelson-Aaron" criterion to age-dependent preference orderings. And we identify three critical ages to distinguish the multiple outcomes of preference orderings based on heterogeneous characteristic parameters. The government is fully aware of the optimal feedback of the participants. It chooses the optimal PAYGO and EET contribution rates to maximize the overall utility of the participants weighted by each cohort's population. As such, the negative population growth rate leads to the decline of the PAYGO attractiveness as well as the increase of the older cohorts' weight in the government decision-making. The optimal mix is the comprehensive result of the two effects.