Economy-wide effects of means-tested pensions: The case of Australia

The Australian age pension is non-contributory, funded through general tax revenues and means tested against pensioners’ private resources. This paper examines the economy-wide implications of policy changes to the means test and access age of the age pension. To this end, we applied an overlapping generations model stylised to the Australian economy, with the capacity to investigate tightening the existing means test (by increasing the taper rate at which the pension is withdrawn) and increasing the pension access age. The simulation results indicate that tightening the taper rate combined with lower income tax rates increases per capita labour supply, assets and long run welfare but reduces the welfare of current generations who have their pension cut. However, the welfare losses to current generations are shown to be mitigated by increasing the taper rate gradually over the next decade. Such reform results in a significant reduction in overall pension expenditures and has more equitable distributional implications compared to increasing the pension access age. We also show that population ageing further strengthens the case for means testing public pensions.