Self-Control Preferences and Pension Means Testing

Daniel Wheadon, Gonzalo Castex, George Kudrna and Alan Woodland

Abstract: We investigate the effects of self-control preferences on household life cycle decisions, macroeconomic outcomes, and the roles they play in determining optimal means testing of public old-age pensions. To that end, we develop a stochastic overlapping generations model with heterogeneous households that have Gul-Pesendorfer self-control preferences. First, we show that in economies with higher self-control costs lifetime savings diminish, while labor supply and retirement are postponed to later ages. Hence, the fiscal burden to fund the public pension system increases. Second, we examine the effects of increasing self-control costs in the context of age pension means testing with alternative taper rates at which the pension benefit is withdrawn. We show that there is a negative relationship between self-control costs and taper rates, i.e., populations with higher self-control costs prefer lower taper rates. We find that if self-control costs are sufficiently high, a universal pension with a zero taper rate may be optimal.

Keywords: Self-control preferences, Public pensions, Progressivity, Labor supply, Life-cycle, Stochastic OLG model