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Fiscal Impacts of Korean Public Pension
System: A Generational Accounting
Approach
Young Jun Chun
University of Incheon, Korea
January 2006
Motivation
• High speed of Population Aging in Korea
- Old population proportion:
7.2% (2000) → 23.1% (2030, OECD average)
• Effects of population aging on Public Pensions
budget
- Increase in public pension benefits and contribution revenue
decrease will deteriorate pension budgets
→ Increase in Fiscal Burden of future generations
Motivation
• Budgetary Imbalance of Public
Pensions
- Too generous public pension benefit promised compared with
contribution
Replacement Ratio: 60%(NPS), 70%(OCP)
Contribution Rate: 9%(NPS), 17%(OCP)
※NPS: National Pension
OCP: Occupational Pensions
PCS: Pension for Civil Servants
PPS: Pension for Private School Employees
Motivation
• Short History of Public Pensions
- National Pension (NPS) was introduced in 1988.
Regulatory Pension benefit will be paid from 2008
- Occupational Pensions (OCP) has longer history, but the proportion of Participants
of OCP is small.
Pension for Civil Servants (PCS): introduced in 1960
Pension for Private School Employees (PPS): introduced in 1972.
→ Large amount of contribution revenue without regulatory payment of NPS benefits
results in accumulation of NPS funds.
→ Difficult to evaluate the fiscal impacts of public pension and intergenerational
redistribution effects using cross-sectional distribution of pension contribution and
benefits.
Need a forward-looking approach: i.e. need to project contribution and benefit
distribution by age for future years
Purpose
• Investigate financial sustainability of public pensions
and their intergenerational redistributive Effects
- Generational Accounting Approach to evaluate the
effects of public pensions
- Construct Projection Model for public pensions to
compute the benefit and contribution distribution of
future years
Generational Accounts (GA)
• Present value of net tax payment of
representative individual of generations for
remaining lifetime
- Net tax: tax payment – transfer income
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Traditional Method of computing GA
• Project aggregate values of Taxes and Benefits
• Estimate age*sex distribution using micro-data
• Allocate aggregates across age and sex in each year,
based on the assumption that the age*sex distribution
will not change
• Compute PV of net payment for each cohort
Modification of Method
• Compute age*sex distribution of contributions
and benefits in future years, using projection
models, because the distribution changes
overtime, as the NPS and other public pensions
mature.
Projection (NPS)
• Use National Pension Corporation (NPC)’s 2000 projection of distribution
of the covered population (participants), average income, new benefit
recipients by age*sex*year.
• Modify the distribution of participants and new benefit recipients using
2005 Population Projection of National Statistics Office (NS0).
- Assume that the ratio of the number of participants and new benefit
recipients by age*sex to the relevant population group is the same as that
assumed in NPC’s projection
※ NPC’s projection used 1996 population projection
• Modify average income and average benefit amount of new benefit
recipients, by changing assumptions on macroeconomic variables
• Compute contribution by age*sex, based on the assumption on
participation rate, contribution collection rate, contribution rates.
• Compute the pension benefit recipients by age*sex, taking account of
demographic characteristics
Projection Model (PCS, PPS)
• Use data published statistical yearbook:
- Statistical Yearbook for the PCS
Statistical Yearbook for the PPS
• Distribution of Participants by age*sex*duration of service
- For benchmark year (2004), use data in the statistical
yearbooks
- After benchmark year, compute the distribution, using
distribution of the newly employed, survival rate, retirement
rate by age*sex computed using the data of the statistical
yearbook
Projection Model (PCS, PPS)
• Wage by age*sex*duration of service
- For benchmark year (2004), use data on wage by duration of
service in the statistical yearbooks
- After benchmark year, compute wage using the profile of
benchmark year and the assumption that the wage growth rate
is the same across age groups.
• Distribution of benefit recipients
- For benchmark year (2004), use data on the distribution by
age in the statistical yearbooks
- After benchmark year, compute new benefit recipients by
age*duration of service using retirement rate computed using
the statistical yearbook
Projection Model (PCS, PPS)
• Benefit Amounts
- For benchmark year (2004), use the profile published in the
statistical yearbook
- After benchmark year, compute the benefit amount for new
benefit recipients, and compute weighted average of benefit
amount of the existing benefit recipients and the new benefit
recipients
• Compute contribution by age*sex, using distribution of
participants, computed wage profile, and contribution rate
Findings
• Aggregate Contribution and Benefits
- Aggregate Public Pension Benefits rise up to 17% of GDP in the long run.
- Aggregate Public Pension Contribution Revenue does not exceed 4% of
GDP
- Pension budget turns deficit around 2015, and the magnitude of deficit
reaches up to 13% of GDP, if current policy maintains.
→ Long-term budgetary imbalance
• Public Pension benefit profile changes overtime.
- The Profile becomes flatter as the NPS matures.
Findings
• Current Public Pension system substantially shifts its fiscal
burden to future generations.
- Net payments for all the current generations (alive in 2004) are negative
- The accounts for future generations is positive and its magnitude is very
large.
• Generational Imbalance is more serious for the PCS and the
PPS then for the NPS.
- Fiscal burden shifted to future generations by the PCS (PPS) is 44.5 (8.4%)
of that by the NPS, while the ratio of the number of the PCS (PPS)
participants to that of the NPS is only 7.6% (18%).
Findings
• Net transfers from the public pensions are larger for
male than for female, except for the young age groups
of the PPS participants.
- Korean public pensions covers the income earners and the
proportion of the economically active population is larger for
males.
- The proportion of the female newly employed private school
employee is much larger than the male.
※ number of newly employed (PPS) in 2004
male: 5,176 female: 13,303
Findings
• The required contribution (and benefit) adjustment to
attain long-term budgetary balance is very large.
- Need to raise contribution rate by 127% of current rate, if
adjust in 2010.
- The tax increase is accompanied by the same percentage
decrease in benefits, the required adjustment decreases to 36%.
• The adjustment is delayed until 2020, the adjustment
magnitude of contribution (and benefit) rise to
165%(41%)
Findings
• Changing the assumption on fertility rate, discount
rate, and wage growth rate does not produce
qualitatively different results
• Rise in wage growth rate does not improve the public
finance of the public pensions.
- Rise in wage growth rate increases the magnitude of the
required tax adjustment, because wage growth increases the
benefit amounts.
- The deficit of public pension become larger then the
contribution revenue after 2030. Therefore, the wage growth
raises the deficit.
Summary
• Current public pension policy in Korea is not
sustainable, even though its current budget
maintains surplus and the magnitude of
pension fund is very large.
- The annual budget of public pensions may cause
fiscal illusion, which implies that forward-looking
approaches are needed to evaluate the
intergenerational redistribution
Summary
• Evaluation of intergenerational redistributions based
on cross-sectional distributions may be misleading.
- Need to separate age effects and cohort effects using
panel studies.
- In addition, forward-looking approaches are needed in
order to take account of changing trend of economic
behavior in economies that experience rapid
transition.