Should Public Retirement Pensions Be Means-tested?

The complex matrix of retirement policy trade-offs – encompassing elements of paternalism, market failure, and overlaying incentives in a life-cycle context – have received much attention in the literature. But the issue of whether publicly-funded retirement provision should be means-tested, and if so how, has received limited attention, although it has been highlighted from time to time. This paper examines the economic welfare effects of means testing using a stochastic overlapping generations model calibrated to the UK economy. A labor-leisure choice is incorporated, with multiple individuals differentiated by endowments of effective labor. Our results indicate that a change in the taper rate has implications for both welfare and economic aggregates. In particular, with a second tier pension in place, it is welfare improving to strictly means-test the first pillar. In contrast to much received wisdom, higher taper rates increase social welfare.