The political economy of contributive pensions in developing countries

This paper sheds light on the role of public institutions as a way to reduce tax evasion through a close link between payroll taxation and pension bene ts. We use a political economy model in which agents have the possibility to hide part of their earnings in order to avoid taxation and, where the public system is more Teffi cient in providing annuitized pension bene ts than the private sector. We show that in the absence of evasion costs, agents are indi erent to the tax rate level as they can always perfectly adapt compliance so as to face their preferred e ective tax rate. There is unanimity in favour of the maximum tax rate and, the public pension system is found to be partially contributive in order to increase tax compliance and thus the resources collected, which in turn, enable higher redistribution toward the worst-o agents. When evasion costs are introduced, perfect substitutability between compliance and taxation breaks down. At the majority voting equilibrium, individuals at the bottom of the income distribution who are in favor of more redistribution, and those at the top who want to transfer more resources to the old age, form a coalition against middle-income agents, in favour of high tax rates. In addition to the previous tax base
argument, the optimal level of the Bismarkian pillar is now chosen so as to account for political support.