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Effects of Taxes and Safety Net Pensions on life-cycle Labor Supply, Savings and Human Capital: the Case of Australia

Financial independence

Fedor Iskhakov and Michael Keane

We structurally estimate a life-cycle model of consumption, labor supply and retirement, using data from the Australian HILDA panel. We use the model to evaluate effects of Australia’s Age Pension system and income tax policy on labor supply, consumption and retirement. Our model accounts for human capital, savings, uninsurable wage risk and credit constraints. We account for “bunching" of hours by assuming a discrete set of hours levels, and we investigate labor supply on both the intensive and extensive margins. Our model allows us to quantify the effects of anticipated and unanticipated tax and pension policy changes at different points of the life-cycle. Our results imply that Australia’s Age Pension system as currently designed is poorly targeted. Our simulations suggest that a doubling of taper rates, combined with a 5.9% reduction of income tax rates, would be budget neutral and Pareto improving.