Pensions and Retirement Behaviour

This paper employs a lifecycle model to analyse the theoretical effects on an individual's retirement behaviour of pension plans that are not actuarially fair. In addition it examines public and private pension plans in Canada and indicates that income effects are likely to be at least as important as substitution effects and that new plans may have effects which are very different from those of mature plans. In particular, the analysis suggests that empirical evidence drawn from the phase-in period of the Canada Pension Plan (1966-75) is misleading as to the effects of the mature plan on the age of retirement. Regimes de rentes et d&ision de prendre sa retraite. Ce memoire utilise un modele dit du cycle-de-vie pour analyser les effets, au plan theorique, sur la decision de prendre sa retraite du fait qu'un individu participe a un regime de rentes qui n'est pas 'equitable' au plan actuariel (i.e., a un regime pour lequel la valeur presente des contributions n'est pas 6gale a la valeur presente des prestations). De plus le memoire examine les regimes de rentes tant publics que prives au Canada et montre que les effets de revenus sont susceptibles d'&re au moins tout aussi importants que les effets de substitution. I1 appert aussi que les regimes nouveaux peuvent avoir des effets fort diff6rents de ceux des regimes arrives 'a maturation. En particulier, l'analyse suggere que les donnees empiriques tirees de la periode d'introduction et de mise en place du regime de rentes du Canada (1966-75) et les interpretations auxquelles elles ont donne lieu quant a l'effet du r6gime sur l'age de la retraite peuvent fort bien porter 'a faux et ne pas s'appliquer au moment oiu le regime atteint sa maturite. I N T R O D U C T I O N The effects of the demographic bulge known as the baby boom have brought home to economists the importance of anticipating the effects of demographic changes. In Canada and elsewhere there has been much concern about the increasing number of elderly in our population. The concern has focused primarily on the effects of pension plans on savings. More recently, however, Feldstein (1977), Sheshinski (1978) and Kotlikoff (1979a and 1979b) have We would like to thank Frank Denton, Curtis Eaton, John Kennan and the editors and referees of this JOURNAL for comments on earlier versions of this paper. Canadian Journal of Economics I Revue canadienne d'Economique, XIII, no. 3 August / aouit 1980. Printed in Canada / Imprinm au Canada. 0008-4085 / 80 / 0000-0421 $01.50 ? 1980 Canadian Economics Association This content downloaded from 157.55.39.102 on Sun, 25 Dec 2016 06:48:03 UTC All use subject to http://about.jstor.org/terms 422 / J.B. Burbidge and A.L. Robb considered also the effects of such plans on the retirement decision. For this purpose, the authors employ variants of a lifecycle model and treat retirement as a complete withdrawal from the labour force (this is a matter of interpretation in Feldstein's two-period model). Feldstein and, for the most part, Sheshinski examine only 'actuarially fair' plans, that is, pension plans where the present value of contributions equals the present value of benefits. If the individuals knew that a plan was always to be fair, in this sense, it could not, of course, have an effect unless capital markets are imperfect. In the Feldstein and Sheshinski models, however, the individual is presumed to react separately to both the increase in the payroll tax and the pension benefit, because he fails to realize that the two effects are designed so that they always cancel out. The result is to erase any income effects and leave only the substitution effects operative in any comparative static analysis. Kotlikoff, on the other hand, assumes that 'fair' plans have no effects or, alternatively, that individuals realize that the plans are designed such that the effects always cancel out. Since both Kotlikoff and the other authors assume full knowledge of the pension benefits function, the tax rate, the length of life, and so on, it seems reasonable to us to assume, with Kotlikoff, that the individual is capable of realizing that 'fair' plans cannot affect the choice set. In this paper we consider the implications for the retirement age of the introduction of various sorts of 'unfair' pension plans. In so doing, we cover similar material to that examined by Kotlikoff and in part by Sheshinski. But whereas their focus was on steady state capital formation, ours is on the retirement decision of the individual. In the second section we outline a lifecycle model which is sufficiently general to capture the main features of most pension plans, yet is simple enough to admit of a diagrammatic exposition. In the next section we present the analogues of income and price effects. In the fourth section we employ our model to analyse particular public and private pension plans. In so doing, we point out that almost all pension plans are unfair for a particular individual. Two themes which emerge from our analysis are that the income effects of pension plans are at least as important as the substitution effects and that new plans may have effects which are very different from the effects of mature plans. In particular, it is our hypothesis that empirical evidence drawn from the phase-in period of the Canada Pension Plan (1966-75) may be totally misleading as a guide to the long-term effects of the plan on the age of retirement. We summarize our results in the last section.