The hidden side of old age social protection: The impact of taxes on pensioners’ living standards in Europe

Abstract

The complex interactions between the pension and the tax system remain understudied. We analyse how personal income tax systems of European countries contribute to fulfilling the two main objectives of pensions systems, notably safeguarding living standards after retirement and preventing old age poverty. We construct a hypothetical dataset that allows us to calculate the counterfactual tax burden of pensioners should their income be treated as employment income, rather than pension income. This allows to study to what extent the differential tax treatment of pensions complies with principles of horizontal and vertical equity and to what extent it impacts on poverty outcomes. We find that tax treatment of pension incomes differs substantially across countries. In most countries, the tax burden on pension income is lower than that of employment income, so that differential tax treatment contributes to maintenance of living standards of pensioners. This difference in tax burden is, as we demonstrate, not a general finding as it differs across countries as well as over the income distribution. In terms of poverty protection, we find a limited, though mostly positive role of the tax treatment of pensions: in some countries poverty among pensioners would be higher if taxed as employees. Our results emphasize the importance of taking a broader view on pension policies, as focusing only on the side of pension benefits disregards the effect of the tax system.