Pareto Efficient Pay-as-You-Go Pension Systems with Multi-Period Lives.

This paper employs a three-period-overlapping generations model to discuss intergenerational (in-)efficiency of a PAYG system when labor supply is endogenous. Four main results will be derived. First, a pension system is (constrained) efficient if the existing system itself and reforms are restricted to guarantee that benefits are proportional to contributions in present value terms. Second, the result does not carry over to other pension systems where the benefits of a retiree are proportional to weighted individual contributions. Third, if the actual PAYG scheme is not a second-best-optimum for some generations, a welfare improving reform is possible provided that the government is not restricted to systems with partial equivalence of contributions and benefits in present value terms. A Pareto-improving transition from the PAYG system to a fully funded system might become feasible provided that the change in the pension scheme is accompanied by an adequate compensating redistribution among generations. Fourth, partial equivalence in present value terms, which requires uniform benefit-adjusted taxation of labor income, does not ensure intergenerational efficiency in all circumstances. However, if uniform benefit-adjusted taxation were optimal, a pension system like the German PAYG system would not be intergenerationally efficient since it misses partial equivalence in present value terms.