Trade-offs in means tested pension design

Abstract

The means-testing of age pension programs allows governments to control the receipt of pension benefits (extensive margin) and the benefit level (intensive margin). We investigate how the presence of the extensive margin influences the trade-off between protecting the poorer elderly and the economic costs of distorting incentives to work and save of young individuals. The means-test effect via the extensive margin improves the insurance aspect but introduces opposing impacts on incentives that potentially have ambiguous welfare outcomes. We characterize combinations of the maximum pension benefit and taper rate that balance the negative incentive effects and positive insurance effects.