Fiscal Implications of Pension Reforms in Italy

Abstract

A pension reform should address a number of issues. One important aspect is the financial soundness of the system, particularly in the light of the legacy that we leave to future generations. Policy makers should also address economic efficiency at two levels: no waste of resources for a given contribution rate (or for a given benefit level), and no distortions of individual choices (or at least minimize distortions). The main distortions associated with a pension system or with its reform have to do with saving and labor supply behavior. Italy has seen a flurry of reforms during the 1990s, and economists and policy makers are still struggling to assess the results and the long-term effects of these reforms. Many analysts argue that the overall design of the recent Italian reforms is probably a good one, and yet more steps need to be taken to speed up the reform process and reap the benefits which, due the adverse demographic trends, could easily evaporate. In this paper, we contribute to the current debate on the Italian pension system by analyzing the impact of social security reforms, in terms of both budgetary implications and distributional effects. This is done by simulating the effects of three hypothetical reforms, plus the effects of the 1995-reform of the Italian pension system (the so-called Dini reform). Our approach relies on the use of a semi-structural econometric model to predict retirement probabilities under different policy scenarios, so as to properly take into account the behavioral effects of the reforms. On the basis of the estimated retirement model, we develop a complete accounting exercise which includes not only changes in gross future benefits due to policy changes, but also changes in social security contributions, income taxes and value added taxes. Thus, our results provide not only estimates of the workers' gains or losses, but also an exhaustive evaluation of the gains and losses for the government budget. We find that the reforms, particularly the Dini reform (once fully phased in), have a substantial impact on individuals' retirement decisions and their net social security wealth, as well as substantial gains for the government finances.