A Note on the Tax Rate Implicit in Contributions to Pay-as-you-go Public Pension Systems

Abstract

This is a paper about the (wage) tax implicit in contributions to pay-as-you- go pension systems. I begin by addressing the implicit life-cycle tax rate. It is shown that a popular rule of thumb for back of the envelope computations of the proportion of pension contributions constituting a tax is flawed. In a highly stylised model, however, simple algebra suffices to compute implicit tax rates, and the results tally well with existing estimates. I then turn to the implicit tax on current wages created by paygo pension systems. Intuition, formal analysis and numerical examples are provided to show that this tax rate is likely to fall through-out a contributor's working life, and that it may in fact become negative. I explain asymmetries between the growth of per capita wages and population growth, which combine to constitute the aggregate rate of return on paygo contributions.