Compulsory Savings: Efficiency and Redistribution On the Interaction of Means Tested Basic Income and Public Pensions

In the presence of means tested basic income for old age, households will tend to reduce precautionary savings to an inefficiently low level. We explore how this might serve as a justification for a compulsory public pension system. In a representative agent framework with two income types, compulsory savings are found to be Pareto-improving up to a point. Beyond that point, increases in contribution rates simply result in increasingly regressive (implicit) taxation. Similar results are found for pay-as-you-go pensions. On the basis of our model we argue that the introduction of a funded pension component may help the German pension system to cope with demographic change more efficiently.