Economic Effects of Raising Basic Pension Benefit

Abstract

The basic pension is the income support program for the elderly whose age is no less than 65 and whose income level is less than 70% among them. Recently, policymakers suggest raising the pension benefit from 300,000 KRW per month to 400,000 KRW per month (33%) to mitigate the high elderly poverty ratio in Korea. This paper quantitatively assesses the long-run economic impacts of raising the basic pension benefit by comparing two steady-state economies. To conduct the quantitative analysis, we build the heterogeneous agent overlapping generation model and calibrate the model to match the current economic status. Then, we simulate the model economy with the inflated benefit and consider various financing methods to support the enlarged program. Because of the generous income support, the life-cycle and precautionary saving motives are weakened, so the aggregate variables drop relative to the benchmark economy. Our results follow. First, the aggregate employment rate falls by 1.7%p and the elderly employment rate by 7%p. Secondly, the aggregate output drops by 3% because of the aggregate capital and labor reduction. Lastly, the before-tax income Gini largely increases, while the after-tax income Gini falls a little. These results quantitatively vary across different financing methods, but they change in the same direction qualitatively.