From PAYG to Funding in Italy: A Feasible Transition?

Abstract

Even after the Amato (1992) and Dini (1995) reforms,1 the Italian pension system is fundamentally based upon a PAYG scheme, the funded component being so far negligible. The system is highly unbalanced (benefits exceed contributions by about 4 per cent of GNP), and its current rules will lead to financial equilibrium only about 2050. This paper argues that a mixed system, consisting of a PAYG scheme and of a complementary fully funded one, can be considered superior to either "pure" extreme, and that, notwithstanding its undeniable difficulties, the transition towards such a system should be pursued in Italy. The argument for a partially funded system is examined in sections 2 and 3, while section 4 assesses the extent of the current imbalance in the Italian PAYG scheme and the size of the burden it imposes on taxpayers. Sections 5 and 6 consider two alternative transition paths to a mixed system. Section 5 assumes no further changes in the present PAYG rules and examines the prospects for a complementary funded scheme, financed by future flows to "severance pay" funds ("Trattamento di Fine Rapporto", or TFR). Section 6 suggests a more innovative scenario where the current payroll tax rates are lowered for new cohorts and the amounts thus made available mandatorily diverted to funding. The aim of sections 5 and 6 is to establish orders of magnitude and to relate the problem to general economic policy. Given the financing assumptions of the new schemes (future TFR flows in section 5 and part of the payroll tax rate for new workers in section 6), both sections necessarily envisage a long and gradual transition process. Section 7 attempts to draw conclusions.