Social Security and Retirement in Italy

This paper analyzes the incentives provided by the Italian Social Security System (SS) to supply labor. Italy is an interesting example in this context as: (1) fertility rates are very low while life expectancy has improved dramatically over the past decades; (2) the SS Program is extremely generous to retirees by providing very high replacement rates; (3) virtually all retirement income is in the form of SS benefits; (4) the existence of an early retirement provision, which attracts no actuarial penalty, greatly distorts choices in favor of early retirement. This paper addresses the above issue by first documenting the stylized facts of the labor market and the SS provisions. A simulation model is then developed to better understand the incentive effects of SS on current cohorts of retirees. This model proposes two measures for incentives: the accrual rate (i.e. the percentage change in Social Security Wealth) from postponing retirement and the implicit tax/subsidy (via SS entitlements) on potential earnings from working an additional year. The simulation results show that the Italian SS Program provides a strong incentive to retire early and the age-implicit tax profile fits very closely with the estimated hazards out of the labor force. Additional evidence of the existence of behavioral responses to SS policy changes lends further support to the view that old age insurance arrangements have an influence on labor supply decisions.