External Effects of the Pension System in the Context of the Welfare State


== Abstract ==

<p>This article presents results from various studies conducted by the authors, in collaboration with other researchers, aimed at measuring the external effects generated by the existence of an intergenerational transfer system, such as the pension system, and the welfare state as a whole. The primary reason for the presence of this externality is that the pension system, financed on a pay-as-you-go (PAYG) basis through social contributions, socializes the intergenerational contract and thus provides insurance against not having children. This characteristic extends to other welfare state programs, which implicitly are also financed via PAYG. As a result, the children of some citizens, raised largely with private resources, generate a positive externality for those who do not have children. That is, the taxes paid by these children once they reach adulthood support the welfare state programs for all people, regardless of whether they had children or not. This external effect has been analyzed in the theoretical literature on intergenerational transfers, primarily within the framework of dynamic macroeconomic models of overlapping generations, in which individuals, in addition to making savings decisions, also make the decision to have children.</p>

<p>The possibility of measuring the magnitude of the externality generated by being a parent for society as a whole ultimately depends on the availability of data. In this regard, National Transfer Accounts (NTA) represent an innovative source of information by offering a comprehensive estimate of public and private intergenerational transfers that take place at a given point in time. While initially these estimates were only broken down by age, they already revealed the strong bias of welfare state policies in favour of the elderly, a key element when considering the external effects. In this paper, we describe this method and the extensions developed to measure these external effects, showing an illustration for Spain compared with three other countries. Specifically, the results of a dynamic microsimulation model incorporating NTA estimates disaggregated by sex, family type, and educational level are presented. This allows for the simulation of transfers received throughout the life cycle via the family and the welfare state, providing a quantification of the magnitude of the externality generated by having children, in the presence of a pay-as-you-go welfare state. The results indicate that parents, regardless of their educational level, make more family transfers. Specifically, they receive about half the amount of net family transfers over their lifetime compared to those who have not had children. The welfare state does not compensate for these differences with public transfers. Therefore, the externality is considerable.</p>

<p>These results are crucial for the debate on pension system reform, suggesting that such reform should be considered within the broader framework of welfare state programs, that is, the set of intergenerational public transfers going forward (aimed at children) and backward (targeted at the elderly). The recent measures adopted in the Spanish pension system, focused on increasing contributions and avoiding pension adjustments, will contribute to shifting the burden of adjustment onto the generations active during the retirement of the baby boomers, further increasing the current bias of the welfare state toward the elderly. As a result, the children of the baby boomers will face the challenge of continuing to finance the entitlements acquired by their parents within the pay-as-you-go pension system, while also maintaining fertility and the costs of policies aimed at children (education and family policies), which are key to ensuring equity and also to paying for future pension transfers.</p>



== Full document ==
<pdf>Media:Abio_et_al_2024b_9176_93.External Effects of the Pension System.pdf</pdf>