Means Testing of Public Pensions: The Case of Australia

The Australian age pension is noncontributory, funded through general tax revenues and means tested against pensioners’ private resources, including labor earnings. This paper constructs an overlapping generations (OLG) model of the Australian economy to examine the economy-wide implications of several counterfactual experiments in the means testing of the age pension. These experiments include policy changes that both relax and tighten the existing means test. We also consider a policy change that only exempts labor earnings from the means testing. Our simulation results indicate that tightening the existing means test, combined with lower income tax rates, leads to higher labor supply, domestic assets, and consumption per capita, as well as to welfare gains in the long run, while labor earnings exemptions from the means testing have largely positive effects on labor supply at older ages. Population aging is shown to further strengthen the case for the pension means testing.