An Inter-temporal General Equilibrium Analysis of the Australian Age Pension

This paper develops a computable general equilibrium model with overlapping generations [OLG] to analyse the behavioural, welfare and macroeconomic implications of the following hypothetical changes to the age pension means test: (i) abolition of the means test, (ii) 50 percent reduction in the income taper rate and (iii) removal of the labour earnings from the income test. The model features intra-generational heterogeneity and essential aspects of Australia’s retirement income policy. We show that all three hypothetical pension policy changes have a signi…cant behavioural impact on middle-income households at older ages while lowand high-income households are almost entirely a¤ected through general equilibrium impacts on the gross wage rate and the consumption tax rate. As a result of all the three policy changes, middle-income generations work longer hours at older ages and postpone their full retirement. Thus, the model implies that the existing means-tested age pension represents a disincentive for some older Australians to work. The most e¤ective of these age pension policy changes to increase the labour supply of some older Australians is the removal of labour earnings from the income test while the means test abolition delivers larger retirement consumption and welfare gains. The macroeconomic simulation results indicate that the means test abolition would raise the government costs on age pension substantially relative to the costs resulting from the other two pension policy changes. Keywords: Retirement, pension reform, dynamic OLG model JEL clasi…cation: H55, J26, C68. This research was supported by a grant from the Australian Research Council and the National Health and Medical Research Council under the Ageing Well, Ageing Productively strategic initiative program. We gratefully acknowledge the comments by Chung Tran, Garry Barret and John Piggott on an earlier draft of this paper.