Pensions for Whom? Redistribution of Public Pension with an Endogenous Income-Longevity Gradient

Abstract

A vast literature on public pensions shows that pay-as-you-go schemes may be preferable to funded schemes despite arguments of return dominance. A heavily cited reason for this is redistribution. One aspect that is rarely considered, however, is that the positive correlation between income and longevity may mitigate or even reverse redistribution. Augmenting a standard, heterogeneous-agent life cycle model with endogenous survival, we conduct a positive experiment and show that pension policy might not always be an ideal policy instrument to help the disadvantaged. In fact, we find that public pensions may sometimes redistribute funds from the disadvantaged to the middle class. This is especially true if there are threshold effects in survival and/or confounded factors in income and health. Mitigated or reversed redistribution combined with choice distortions of borrowing-constrained individuals implies that public pensions may render the lower class worse off in welfare terms.

Keywords: Inequality, health inequality, income-longevity gradient, public policy, public pensions, overlapping generations