DP5914 Designing a Linear Pension Scheme with Forced Savings and Wage Heterogeneity

Author(s): Helmuth Cremer , Philippe De Donder , Darío Maldonado , Pierre Pestieau

Publication Date: October 2006

Keyword(s): social security , myopia , dual-self model

JEL(s): D91 , H55

Programme Areas: Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP5914.asp.asp

This paper studies the optimal linear pension scheme when society consists of rational and myopic individuals. Myopic individuals have, ex ante, a strong preference for the present even though, ex post, they would regret not to have saved enough. While rational and myopic persons share the same ex post intertemporal preferences, only the rational agents make their savings decisions according to these preferences. Individuals are also distinguished by their productivity. The social objective is “paternalistic”: the utilitarian welfare function depends on ex post utilities. We examine how the presence of myopic individuals affects both the size of the pension system and the degree of redistribution it operates. The relationship between proportion of myopic individuals and characteristics of the pension system turns out to be much more complex than one would have conjectured. Neither the impact on the level of pensions nor the effect on their redistributive degree are unambiguous. Nevertheless, we show that under some plausible assumptions adding myopic individuals increases the level of pension benefits and leads to a shift from a flat or even targeted scheme to a partially contributory one. However, we also provide an example where the degree of redistribution is not a monotonic function of the proportion of myopic individuals.