Distributive Concerns When Substituting a Pay-As-You-Go a Fully Funded Pension System

Salvador Valdés-Prieto


The paper uses a simulation model to quantify the impact on income distribution of the substilution of a progressive social security program that redistributes towards the poor, but isfinanced with the PAYC method, by a neutral social security program thal is funded. We find that if the original PAYC system is large enough to yield benefits with a replacement rate that is at least 40% for the middle income class, and its redistributive impact is limited by the requirement of not yielding benefits for the poor with a replacement rate above 200%, then the proposed substitution helps the poor in the long run, provided that the public debt does not rise by more than 40 percentage points of CDP during the transition. Such a reform allows an increase in the capital stock per worker. so in the long run the poor benefit more through higher real wages than what they lose because of the end of progressive redistribution. In the short run, however, a compensatory program for the poor is needed, because they loose their subsidy before receiving the long run benefit. We show that in most cases the 40 percentage points of CDP that are available from Ihe increase in the public debl are enough to finance a trasfer program that compensates the poor in the sharf run. The paper concludes Ihat concern about the welfare of the poor is unwarranled, both in the short and en the fang run, provided this compensatory program is implemented.

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