Pension Reform, Private Saving, and the Current Account in a Small Open Economy

Is Foreign Direct Investment (FDI) Eroding Corporate Income Taxes?

The macroeconomic implications of a pension reform that substitutes a high-return fully-funded system for a low-return pay-as-you-go system are discussed in an overlapping generations, neoclassical growth model. With forward-looking individuals, a debt-financed reform worsens the current account, while a tax-financed reform leaves the current account unchanged. With myopic individuals, a debt-financed reform leaves the current account unchanged, while a tax-financed reform improves the current account. Hence, tax-financing, which is equivalent to pre-funding, should be the preferred reform strategy in a small open economy with a weak current account position.
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Volume/Issue: Volume 2000 Issue 171
Publication date: October 2000
ISBN: 9781451858495
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Business and Economics , Labor , Economics- Macroeconomics , Public Finance , Taxation - General , WP , current account , rate of return , open economy , pension reform , saving , PAYG pillar , pillar saving , FF pillar , PAYG system , budget constraint , Pension spending , Private savings , Pensions , Payroll tax

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Summary

The macroeconomic implications of a pension reform that substitutes a high-return fully-funded system for a low-return pay-as-you-go system are discussed in an overlapping generations, neoclassical growth model. With forward-looking individuals, a debt-financed reform worsens the current account, while a tax-financed reform leaves the current account unchanged. With myopic individuals, a debt-financed reform leaves the current account unchanged, while a tax-financed reform improves the current account. Hence, tax-financing, which is equivalent to pre-funding, should be the preferred reform strategy in a small open economy with a weak current account position.

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