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The aging population in Australia threatens the sustainability of the Australian pension system. Projections from the Department of Treasury’s 2015 Intergenerational Report suggest that the number of Australians age 65 and older is projected to double by 2054-55. A key policy response in Australia has been incremental increases in the age at which people can access the Age Pension — six-month unilateral increases in the female pension age every two years to harmonise it with the male pension age of 65 (from July 1995 to July 2014) and further incremental increases for both sexes to raise it to 67 (from July 2017 to July 2023).

A key question is to what extent substitution into alternative welfare payments in response to pension age increases will undo fiscal savings from reduced pension receipts? Economists have warned that future increases in the pension age will shift the burden of the aging population to the Disability Support Pension (DSP), with the potential to increase DSP recipients beyond 1 million. This view is supported by evidence of large substitution effects, as suggested by previous studies. Most concerning, an Australian study by Atalay and Barrett (2015) estimated a 13-23 percentage point increase in the receipt of disability benefits, depending on the age cohort, for every one-year increase in the female retirement age (between 60 and 65) in Australia. However, the study was silent on the impact that this large substitution effect had on fiscal savings.

Estimating fiscal savings from female pension age increases

In a paper published this year in the Economic Record, we use population administrative data of income receipt payments from the Research and Evaluation Database to address this issue. Specifically, we quantify behavioural responses, including substitution effects, and resulting impacts on welfare expenditure from incremental increases in the female pension age. Our econometric approach allows us to estimate causal impacts of incremental increases by comparing outcomes of those close to retirement whose eligibility age has increased to those who, because of the slightly earlier timing of their birth, are unaffected because they are already at their eligibility age (comparison group).

We estimate an annual reduction in welfare expenditure for affected women of 18 per cent for every one-year increase in eligibility age. This large effect is likely to be because many people choose to retire at pension eligibility age (even among self-funded retirees), possibly because it is a signal of a ‘socially acceptable’ age to retire. On average across women affected, we estimate a reduction in the rate of income receipt of 13 percentage points, but that reduction in income receipt increases with the ratcheting up of the pension age. For those who are affected by an increase in the pension age from 61 to 61.5, the reduction in income support receipt is 8 percentage points, whereas for those affected by an increase from 64 to 64.5, the reduction is 18 percentage points. The increasing impact on welfare receipt is because an increasing proportion of people are forced to postpone their retirement as the pension age is ratcheted up.

Like Atalay and Barrett (2015), we estimate a large increase in the receipt of alternative payments among women affected — a 39-percentage point increase. However, of the 39-percentage point increase in alternative payments, only 4.3 percentage points represents ‘active substitution’ or increases from outside of the income support system. Active substitution may occur when people avoid delaying retirement on income support by entering through alternative programs, such as Disability Support Pension or JobSeeker (previously known as NewStart). Most of the substitution effect is ‘mechanical’, that is, people close to retirement age who are already receiving income support (and do not actively substitute) bridge the delay to the Age Pension by extending time on existing payments. Data from the Research and Evaluation Database suggests around 40 per cent of affected women were already receiving income receipt in the lead-up to retirement.

We find no evidence that active substitution increases with incremental increases in the female pension age or that it varies according to opportunities to substitute. For the latter, we estimate that cohorts of single women with access to an extra payment (Widow Allowance) are no more likely to actively substitute than partnered women.

Interestingly, we find that unilateral increases in the female pension age reduced pension receipt of male partners by around 1.2 percentage points, even though they were not directly affected by the change. The likely interpretation is that couples tend to synchronise retirement, so that delaying the female retirement age has led their partners to delay retirement as well.

Implications for future increases on income receipt

For further incremental increases set in train for both sexes, there are some important fiscal implications from our study. All else equal, our results suggest that incremental increases for both sexes are likely to result in larger reductions in welfare expenditure than unilateral increases, and that the reductions will increase as the pension age is ratcheted up because increasing numbers are affected.

However, our results suggest that the extent of savings from pension age increases already in place,  and possibly further increases, will depend on the extent of mechanical substitution or the welfare dependence of older Australians as they enter retirement years. A concern is that any increases in the premature retirement of older Australians on Disability Support Pension or JobSeeker after the COVID-19 crisis will blunt the effect of pension age increases in reigning in welfare expenditure growth associated with an aging population. While it is too early to predict the impacts of the crisis on older workers, it underlines the importance of measures, such as support for retraining, in ensuring that older Australians maintain attachment to work. Our results do not support the need for greater action to reduce active substitution in response to pension age increases, such as tax credits for those close to retirement age affected by the changes.

 

Reference

Oguzoglu, U., Polidano, C. and Vu, H. (2020). Impacts from Delaying Access to Retirement Benefits on Welfare Receipt and Expenditure: Evidence from a Natural Experiment. Economic Record, 96(312), pp. 65-86.

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