Implications of Pension Illiteracy for Labor Supply and Redistribution

This paper explores the effects of pension illiteracy on aggregate labor supply and the redistributive performance of public pension systems. I consider an overlapping generations model in continuous time populated with individuals who differ in labor productivity and pension literacy. Agents suffering from pension illiteracy fail to fully account for the structure of the pension system when planning their economic behavior over the life cycle. In particular, I assume that myopic agents treat changes to replacement income as exogenous in the active--retired trade-off and contributions to the pension system as a pure labor income tax. I find that pension illiteracy can negatively impact aggregate labor supply and increase earnings inequality and lifetime income inequality. This suggests that pension illiteracy may limit the efficiency gains of increasing the correlation between individual contributions and benefits, making the equity--efficiency trade-off difficult to characterize in the context of pension reforms.