An excerpt from the upcoming "Recent Economic Developments (139)" that will soon be published: Implementation of Mandatory Pension Saving and Its Effect on Wage
An excerpt from the upcoming "Recent Economic Developments (139)" that will soon be published: Implementation of Mandatory Pension Saving and Its Effect on Wage.
Mandatory pension saving was applied to all employees and employers in Israel in 2008. It was a gradual process: In 2008, employees and employers were required to contribute a combined 1.7 percent of wage (up to the national average wage) and the rate rose incrementally to 11.5 percent in 2014 and ensuing years. Before the arrangement went into effect, in 2007, some 60 percent of employees (and their employers) made pension contributions; by 2012, this rate had risen to 80 percent. During this period, the proportion of pension savers among employees who had not been saving in 2007—a large majority of whom belonged to the lower portion of the wage distribution—attained parity with that of employees who had been saving in 2007.
Studies on the mandatory pension saving arrangement found that the arrangement has been detrimental to many employees who had not been allocating funds for a pension before it was implemented. This is because the arrangement reduces their wages in years when their expenses were high and their income (adjusted to household size) is low, while adding to their pension income at an age when their income would be relatively high to begin with. It is possible, however, that the arrangement benefits workers by requiring their employers to contribute to their pensions at the rate of 6 percent of their wage. This contribution amounts to a wage supplement that may mitigate the damage caused by the employee’s compulsory contributions, meaning that, all told, the arrangement might improve employees’ welfare. Such an improvement, however, may take place only if employers do not offset the supplement of their contributions at the expense of their employees’ wages.
In this overview, we examine whether, and to what extent, the risk of an impairment to wage among the main group affected by compulsory pension saving—workers who had not made pension contributions before the arrangement went into effect—became real. To do this, the change in their wages in the five years following the introduction of the arrangement is compared with the change in the wages of workers who had been making pension contributions prior to the arrangement. The results of the analysis, which controlled for employees’ characteristics and changes in the economic and institutional environment that may have affected changes in the wage differences between the groups, indicate that the arrangement slowed the rate of increase in the wages of employees who had not been saving for pension in 2007, before the arrangement went into effect. The rate of the deceleration, relative to the increase in the wages of workers who had been making pension contributions in 2007, resembles the rate of increase in employers’ pension contributions. In other words, the employees bore the vast majority of the burden that the mandatory pension saving arrangement had created—certainly, when accounting for the part of the burden originating in their own contributions. The estimated contribution incidence borne by the employees is somewhat higher than the range reported in the literature—between 50 percent and 80 percent.
The analysis shows that when long-term programs are assimilated into the labor market, a sober assessment of all their implications, including the market’s response to them, should be made. Formal determinations about the apportionment of the burden among different stake-holders may affect the outcomes in the short term, but the programs should also be designed in line with the potential longer term direction of developments, when the economic forces find expression. Absent such processes, the programs may yield results that their initiators had neither anticipated nor intended. The mandatory pension-saving program demonstrates this point: its assimilation induced a much larger share of employees to save for pension purposes but, in contrast to the intent implied by the formal structure of the arrangement, the contribution incidence was ultimately borne by employees and was not shared with their employers.