## 1. Retirement Incentives in the Slovene Public Pension System

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### Introduction and core questions
- Labor participation in Slovenia is very low compared to Europe, especially among age groups 15–24 and 55–64.
- High welfare spending and generous benefits contribute to fiscal rigidity and a large ratio of nondiscretionary to total expenditures among new EU member states.
- Large positive gap between registered and survey unemployment rates partly reflects benefit-related nonparticipation.
- Low effective retirement age suggests public pension benefits create incentives for early exit.
- Core questions addressed:
  - Does the reformed pension system encourage early retirement?
  - How do marginal effective tax rates (METRs) affect labor participation of low-income individuals?
  - Is there empirical evidence of METRs affecting participation probability?
  - What tax, benefit, and pension reforms could boost participation?
- Structure: Part 1 examines implicit tax of delaying retirement and reform options; Part 2 analyzes METRs, empirical tests for participation effects, and reform options to increase participation.

### Pension system background and design
- 1999 pension reform increased full pensionable ages and introduced penalties for early retirement and bonuses for deferred retirement.
- Retirement allowed as early as age 58 provided minimum qualifying period of 40 years (38 for women); penalties apply if years of service below minimum.
- Benefits are earnings-related; key policy variables:
  - Valorization of wages (linked to pension indexation).
  - Service factor determined by accrual rates, years of service, and penalty/bonus rates.
- Accrual rate schedule:
  - 35 percent for the first 15 years of service.
  - 1.5 percent for every additional year of service.
- Pension base assessed using the 18 best consecutive years (baseline assumption).
- Synthetic net wage corresponds to about 63 percent of gross wage.
- Pension wealth defined as present discounted value of expected future pension benefits conditional on survival; survivor benefits and joint survival probabilities included for married workers.
- Pensions are taxable; personal income tax becomes binding only for those earning above average wage levels, starting at around 150 percent of the average wage (tax schedule in Appendix I).

### Methodology for simulating pension accrual and implicit tax
- Retirement incentive measured via social security wealth accrual: difference in pension wealth from retiring next year versus retiring today.
- Effective implicit tax on deferring retirement from time t to t+1 computed as:
  - Effective implicit tax = (Pension wealth_t+1 + Wage_accrual_t+1 - Wage_t+1) / (Pension wealth_t+1)  (formula structure shown in source).
- Negative pension accrual and positive effective implicit tax indicate strong incentive to exit labor force.
- Peak value measure also used: difference between pension wealth retiring at current date and maximum pension wealth achievable by retiring in the future; optimal retirement when implicit tax turns positive or peak value becomes negative.
- Baseline hypothetical worker:
  - Male joining labor force at age 24, eligible for full pensions at age 63 (phasing in).
  - Wage growth assumptions over 40-year working period: economy-wide average wage growth 5 percent, with real wages growing annually at 2.5 percent and inflation at 2.5 percent, plus seniority increment of 1 percent.
  - Valorization rate in baseline set equal to average economy wage growth; sensitivity test uses alternative valorization of 0.77 percent of wage growth (reflecting 2005 data).
  - Pension assessment period: 18 best consecutive years (assumed last 18 years before retirement under monotonic wage growth).
  - Life expectancy assumption for baseline pension-wealth calculations: worker survives till age 77 (remaining life expectancy for men conditional on survival to age 58).
  - Discount rate in baseline: 3 percent.
  - Pension benefits indexed to nominal wage increases every year in baseline; alternative indexation scenarios considered.

### Simulation results — baseline implicit tax and sensitivities
- Baseline implicit tax for a male earning the average wage, surviving to age 77 (implicit tax by retirement age):
  - Age 58: -34.6
  - Age 59: -21.7
  - Age 60: -9.3
  - Age 61: 2.5
  - Age 62: 13.7
  - Age 63: -5.6
  - Age 64: 12.4
  - Age 65: 28.7
  (All values are in percent and correspond to the series "-34.6-21.7-9.32.513.7-5.612.428.7".)
- Peak-value calculations indicate maximum pension wealth at age 61 in the baseline (age 61 as optimal retirement age).
- Kink at age 63 explained by nonlinearity of penalty/bonus schedule: service factor reduction of 2.35 percent for retiring one year before full pensionable age of 63 versus service factor increase of 4.2 percent for retiring one year after full pensionable age.
- Life-expectancy sensitivity:
  - Increasing remaining life expectancy to 81: implicit tax remains negative until age 64; peak value turns negative only at age 65 (optimal retirement age increases).
  - Life expectancy increases on average by a year every decade (source statement).
- Discount-rate sensitivity:
  - Higher discount rate of 5 percent advances optimal retirement age to about age 60.
  - Lower discount rate of 1 percent makes implicit tax positive at age 62 (encouraging deferral).
- Seniority increment sensitivity:
  - Removing seniority increment pushes optimal retirement age earlier (example: without seniority increment, optimal retirement moves to age 60).
- Case of male with 40 years of service by age 59: little incentive to defer retirement; optimal to retire at age 60 (one year after eligibility) given bonus structure.
- Women (average wages, eligible at age 58 with 35 years service plus purchased 3 years, remaining life expectancy 83):
  - Implicit tax of deferring retirement remains negative up to age 63 (two years beyond full pensionable age).
  - Alternate female life expectancies used: 78 years and 88 years.
- Wage-level heterogeneity:
  - Incentives to retire early particularly strong for low- and high-wage earners.
  - Low-wage earners: minimum pension base (close to 60 percent of average net wage in 2005) is binding, so additional year may not increase pension base; accrual effect weak; wealth effect dominates.
  - High-wage earners: higher pensions push income into higher tax brackets, increasing effective tax on pension and weakening accrual effect; implicit tax of deferral rises when effective tax becomes binding.

### Policy scenario simulations and effects
- Indexation scenarios:
  - Incentives to retire early are strongest under wage indexation and weakest under price indexation.
  - Under price indexation (or reduced wage indexation that lags wage growth), accrual effect dominates and incentives to retire early weaken; optimal retirement can move to age 62.
  - Existing rule: indexation for existing pensioners expected to lag wage growth by 0.065 percent through 2024 (source statement).
- Valorization scenarios:
  - Changing valorization rate does not substantially affect the sign of implicit tax or optimal retirement date in simulations; optimal retirement date remains at age 61 in baseline and alternative valorization scenarios.
  - 2005 implied implicit valorization tax amounted to 0.77 percent of wages (used in sensitivity tests).
- Assessment period:
  - Increasing assessment period from 18 to 25 years does not change the optimal retirement age in simulations.
- Accrual-rate structure:
  - Alternative accrual-rate parameterizations (examples: "Accrual rate (30 + 1.7)", "Accrual rate (25 + 1.9)", "Accrual rate (22.5 + 2)") alter implicit tax profiles and can shift incentives; detailed implicit-tax sequences provided in source tables.
- Raising full pensionable age:
  - Raising statutory full pensionable age (e.g., from 63 to 64) does not ensure higher effective retirement age; simulations show optimal retirement age can remain earlier than statutory age (example: optimal remains at 62, two years ahead of new full pensionable age).
  - Increasing statutory retirement age strengthens the wealth effect (benefits enjoyed for fewer years) and may require complementary parametric changes.

### Key analytical conclusions and pension policy implications
- Under baseline parameters of the 1999 reform, the Slovene pension system provides strong incentives for men to retire early (before full pensionable age of 63), with peak accrual around age 61.
- Incentives are sensitive to life expectancy, discount rates, seniority wages, and wage level.
- Price indexation or reduced wage indexation that lags wages tends to reduce early-retirement incentives.
- Valorization and assessment-period changes have limited impact on sign of implicit tax and optimal retirement date in presented simulations.
- Policy options to raise effective retirement age and restore pension viability should consider:
  - Indexation rules (moving away from full wage indexation reduces early-retirement incentives).
  - Accrual-rate structure and penalty/bonus calibration (more back-loading of accrual rates).
  - Raising statutory full pensionable ages coupled with parametric adjustments.
  - Addressing minimum pension base and tax interactions that create perverse incentives for low- and high-wage earners.

---

### Labor participation, taxation, benefits, and METRs

### Labor participation and tax/benefit background
- Low labor participation concentrated among groups with poor income prospects; unemployment rates higher and employment rates lower than EU-15 peers.
- Contributing factors: lack of qualifications, high labor costs, limited job mobility, and insufficient work incentives.
- Low-income individuals may have high reservation wages due to generous benefits.
- Taxation in Slovenia:
  - Labor taxation among the highest and most progressive in Europe: progressive personal income tax, payroll tax paid by employers, social security contributions.
  - Slovene personal income tax top rate at 50 percent.
  - Planned tax reform objectives: decrease tax pressure, particularly at high end, by reducing rates and flattening schedule; effect on low-wage labor supply depends on interaction with benefits.
- Social benefits and unemployment income replacement:
  - Unemployment Insurance Benefit (UB): taxable, subject to social security contribution, amount 70 percent average monthly earning for first 3 months, 60 percent thereafter; duration 3 to 24 months, most people 6 months.
  - Unemployment Assistance (UA): 80 percent of minimum UB; not subject to PIT or SSC; most people up to 15 months (up to 3 years if old-age pension conditions fulfilled).
  - Guaranteed Minimum Income (GMI): 71 percent of minimum UB; no limit on duration; not subject to PIT or SSC.
  - Child benefits inversely related to income and increase more than proportionally with number of children.
- Main work-incentive problem: difference between minimum UB and UA small; transition from UB to UA can produce a financial windfall and disincentive to work.
- UB duration exceptions: UB could reach 24 months for workers over 55 with insurance periods over 25 years; UA could rise to 3 years if pension conditions fulfilled during this period.

### Marginal Effective Tax Rates (METRs) — definition and key facts
- METR: change in taxes paid and benefits received at different income levels; percentage of an additional dollar earned that is lost through taxes and benefit interactions.
- Current system produces high METRs, particularly at lower end:
  - METRs between minimum UB and UA exceed 100 percent, and top 200 percent in some cases.
  - Most people face METRs in range 30–55 percent when exiting joblessness.
  - METRs particularly high for low-income workers and secondary earners (e.g., spouses), contributing to lower female participation.
- Formula context: METR computed comparing gross income levels y1 and y2, using ty (income tax rate), rssc (social security contribution rate), and b1, b2 (total benefits at income levels y1 and y2).

### Empirical analysis — METRs and joint labor participation
- Data and method:
  - Household Budget Survey used; restricted to families with both spouses active and those with only one active (47 percent of original; around 1700 families).
  - Cross-sectional METRs calculated by comparing observed situation to hypothetical zero family labor income.
  - Probit model estimates probability both spouses participate as function of family income, individual characteristics, and METRs.
- Key econometric findings:
  - A one percentage point increase in METR reduces probability that both spouses participate by 2.8 percent.
  - When controlling for number of household members, probability declines by 3.8 percent per one percentage point increase in METR.
  - Other determinants:
    - Current effective tax rate increases probability of joint participation.
    - Total family income increases probability.
    - Higher education of reference person increases probability.
    - Age of reference person reduces probability.
- Selected regression coefficients (two specifications reported):
  - Current effective tax rate: 0.045 *** (t-stud 2.87) and 0.054 (t-stud 3.32).
  - Marginal effective tax rate: -0.028 *** (t-stud -2.79) and -0.038 (t-stud -3.76).
  - Total family income: 0.006 *** (t-stud 7.60) and 0.004 (t-stud 4.78).
  - Age of reference person: -0.016 *** (t-stud -3.43) and -0.023 (t-stud -5.05).
  - Education of reference person: 0.011 (t-stud 0.92) and 0.042 (t-stud 3.40).
  - Number of children: 0.361 *** (t-stud 6.06).
  - Number of household members: 0.418 (t-stud 11.31).
  - Constant: -0.346 (t-stud -1.35) and -1.223 (t-stud -4.49).
  - Observations: 1531 and 1531; Pseudo R2: 0.17 and 0.22.
  - Significance: ***, significant at 1 percent.

### METRs under alternative tax systems and benefit reforms
- Flat tax scenario:
  - Flat tax considered at 20 percent with unchanged benefits.
  - A 20 percent flat tax with unchanged benefits would, in many cases, worsen incentives for low-income individuals because their tax rate would likely increase.
  - METRs for those taking a job would continue to be high, reaching 50 percent for a single individual moving from UA to a job paying the minimum wage.
  - Flat tax would raise average effective tax rates for low-income individuals while reducing those of high-income ones.
- Benefits-side reforms proposed:
  - Leave GMI unchanged (currently amounting to 71 percent of minimum UB).
  - Reduce UA to half the minimum UB from current ratio of 80 percent.
  - Make UA smaller than GMI so UA is regarded as temporary support; prevent opting for higher GMI during statutory duration of UA; consider shortening UA duration.
  - Assume unchanged child benefit.
  - Intended effects: intensify job search, reduce UA recipients, reduce METRs for most people relative to current system and relative to flat tax, eliminate spike between UA and UB.
  - Note: partial equilibrium analysis.
- Three-rate tax system (alternative to flat tax):
  - Proposed rates:
    - 0–minimum wage (42 percent of average wage): 15 percent
    - Minimum wage – 2 average wages: 20 percent
    - Above 2 average wages: 25 percent
  - Additional assumptions:
    - General tax exemption and child tax exemption remain unchanged.
    - All labor incomes subject to social security contributions at current rate 22.1 percent.
  - Rationale and expected outcomes:
    - 15 percent targets taxable income up to minimum wage (slight reduction from 16 percent most now face).
    - Bulk of working population faces 20 percent.
    - Individuals with taxable income at least twice average wage taxed at 25 percent.
    - Three-rate system delivers lower METRs than both current and flat systems up to average wage; beyond that point flat tax produces lower METRs.
    - METRs when taking a job are lower under three-rate than current or flat tax for single individuals without children and married couples where principal earner earns 67 percent of average wage.
    - METRs could remain up to 40 percent in some three-rate cases; careful calibration of other benefits and tax allowances needed.
  - Distributional trade-offs:
    - Three-rate system produces consistently lower average effective tax rates than other systems for most people, except:
      - Individuals receiving UA would face higher effective tax rates (consistent with incentives to seek work).
      - Average effective tax rates would exceed flat tax at some point due to 25 percent top rate; intersection typically happens beyond twice the average wage.
- Specific numeric values preserved from source:
  - UA currently at 80 percent of minimum UB; proposed reduction to half the minimum UB.
  - GMI currently amounting to 71 percent of the minimum UB.
  - Social security contributions assumed at 22.1 percent.
  - Flat tax considered at 20 percent; three-rate system of 15 percent / 20 percent / 25 percent.
  - Minimum wage taken as 42 percent of the average wage for first bracket.
  - Current upper income bracket represents 38½ percent of the average wage.
  - METRs reaching 50 percent for single individual moving from UA to a job paying minimum wage.
  - METRs could remain up to 40 percent in some three-rate cases.
  - Higher effective tax rates around 35 percent would apply only to individuals well off (beyond twice the average wage).
- Calculations assume:
  - (i) single individuals not eligible for UA receive full GMI; and
  - (ii) spouses in families where there is a principal earner do not receive GMI.

### Policy implications for taxes and benefits
- Reforms to improve work incentives should focus on both tax and benefit systems.
- A hypothetical 20 percent flat tax with unchanged benefits would worsen work incentives for individuals with poor income prospects.
- Adopting three fairly low rates of personal income tax coupled with widening the gap between minimum UB and UA would:
  - Lower METRs for most individuals.
  - Increase work incentives.
  - Lower average effective tax rates for most people.
- Careful calibration of other benefits and tax allowances is necessary to reduce remaining high METRs.
- Further work should account for welfare system aspects not directly related to job status, labor demand considerations, and budgetary impacts; current analysis is partial equilibrium.

---

### Appendices (summary of supplied parameters and tables)

### Appendix I — Public pensions system parameters (selected entries)
- Accrual/Penalty/Bonus fragments and headings drawn from source tables; full aligned numeric rows not available in extract.
- Penalty and Bonus Rates: multiple tabulated percentage entries presented in source (fragmented in extract).
- Effective Tax Rate on Pensions: headings present; full numeric entries not available in supplied extract.

### Appendix II — Life expectancy (selected)
- Remaining life expectancy tables provided as function of age for men and women; source: World Bank (2004).
- Examples of life-expectancy-related statements used in sensitivity analysis:
  - Baseline male remaining life expectancy till age 77 (conditional on survival to age 58).
  - Alternative scenarios include remaining life expectancy 81 for males; female scenarios include 78 and 88.

### Appendix III — Taxation and benefits related to job status (selected)
- Social security contributions apply to gross wages at rate 22.1 percent for employees and 16.1 percent for employers.
- Payroll tax being phased out (totally by 2009) beginning with 20 percent reduction effective January 1, 2006.
- Labor income taxation: child allowance roughly 14 percent of average wage for first child; declines for subsequent children.
- Benefits related to job status (summary):
  - UB: amount 70 percent average monthly earning for first 3 months, 60 percent thereafter; duration mostly 6 months; subject to PIT and SSC.
  - UA: amount 80 percent of minimum UB; duration up to 15 months for most people; not subject to PIT or SSC.
  - GMI: amount 71 percent of minimum UB; no duration limit; not subject to PIT or SSC.

*Source: _wp06298 - 1. Retirement Incentives in the Slovene Public Pension System (pages 23–32).*

### 1. Retirement Incentives in the Slovene Public Pension System.........................................23

### 1. Retirement Incentives in the Slovene Public Pension System.........................................23

### Implicit Tax of Deferring Retiring at Various Wage Levels ...........................................24
- Section title indicates analysis of the implicit tax associated with deferring retirement across wage levels.
- Content location: page 24.

### Marginal Effective Tax Rates for Selected Individuals ...................................................25
- Section title indicates computation and presentation of marginal effective tax rates for selected individual profiles.
- Content location: page 25.

### Marginal Effective Tax Rates Faced When Taking Up a Job from Joblessness .............26
- Section title indicates analysis of marginal effective tax rates relevant to persons transitioning from joblessness to employment.
- Content location: page 26.

### Average Effective Tax Rates for Selected Individuals ....................................................27
- Section title indicates presentation of average effective tax rates for selected individual profiles.
- Content location: page 27.

### Appendices
- I. Public Pensions System Parameters.................................................................................30
  - Appendix covering public pension system parameters.
  - Content location: page 30.
- II. Life Expectancy ...............................................................................................................31
  - Appendix covering life expectancy data.
  - Content location: page 31.
- III. Taxation and Benefits Related to Job Status....................................................................32
  - Appendix covering taxation and benefits related to job status.
  - Content location: page 32.

*Source: _wp06298 - 1. Retirement Incentives in the Slovene Public Pension System (pages 23–32).*

### References..............................................................................................................

### _wp06298 - References..............................................................................................................

### Introduction
- Labor participation in Slovenia is very low compared to Europe, especially among the very young (15–24) and the oldest working-age groups (55–64).
- A relatively high share of the population with primary education tends to remain outside the labor force, indicating more acute participation problems among low-wage earners.
- High welfare spending and generous benefits contribute to fiscal rigidity and one of the largest ratios of nondiscretionary to total expenditures among the new EU member states.
- Large positive gap between registered and survey unemployment rates partly reflects benefit-related nonparticipation, since registration is a condition for receiving benefits.
- Low effective retirement age suggests public pension benefits create incentives for early exit.
- Paper’s core questions:
  - Does the reformed pension system encourage early retirement?
  - How do marginal effective tax rates (METRs) affect labor participation of low-income individuals?
  - Is there empirical evidence of METRs affecting participation probability?
  - What tax, benefit, and pension reforms could boost participation?
- Structure: Part 1 examines implicit tax of delaying retirement under the public pension system and reform options; Part 2 analyzes METRs, empirical tests for participation effects, and reform options to increase participation.

### Retirement incentives in the public pension system — background and design
- 1999 pension reform increased full pensionable ages and introduced penalties for early retirement and bonuses for deferred retirement; full pensionable ages (selected entries from text table):
  - Men: 58, 60, 63, 65 (minimum qualifying periods listed alongside in the source).
  - Women: 58, 60, 61, 63, etc. (see source text table for exact age/qualifying period mapping).
- Rules allow retirement as early as age 58 provided minimum qualifying period of 40 years (38 for women); penalties apply if years of service below minimum.
- Pension benefits are earnings-related; key policy variables affecting benefits:
  - Valorization of wages (method for assessing wages in pension base) — linked to pension indexation.
  - Service factor determined by accrual rates, years of service, and penalty/bonus rates.
- Accrual rate schedule in the Slovene system:
  - 35 percent for the first 15 years of service.
  - 1.5 percent for every additional year of service.
- Pension base assessment uses the 18 best consecutive years (in the baseline assumption), with pension base calculated as the average of those 18 years (formula given in source).
- Synthetic net wage used in the pension system corresponds to about 63 percent of gross wage.
- Pension wealth defined as present discounted value of expected future pension benefits conditional on survival; survivor benefits and joint survival probabilities included for married workers.
- Pensions are taxable; personal income tax becomes binding only for those earning above average wage levels, starting at around 150 percent of the average wage (tax schedule used in simulations is in Appendix I).

### Methodology for simulating pension accrual and implicit tax
- Retirement incentive measured via social security wealth accrual: difference in pension wealth from retiring next year versus retiring today.
- Effective implicit tax on deferring retirement from time t to t+1 computed as:
  - Effective implicit tax = (Pension wealth_t+1 + Wage_accrual_t+1 - Wage_t+1) / (Pension wealth_t+1)  (formula structure shown in source).
- Negative pension accrual and positive effective implicit tax indicate strong incentive to exit labor force (wealth effect dominates accrual).
- Peak value measure also used: difference between pension wealth retiring at current date and maximum pension wealth achievable by retiring in the future; optimal retirement when implicit tax turns positive or peak value becomes negative.
- Baseline hypothetical worker for simulations:
  - Male joining labor force at age 24, eligible for full pensions at age 63 (phasing in).
  - Wage growth assumptions over 40-year working period: economy-wide average wage growth 5 percent, with real wages growing annually at 2.5 percent and inflation at 2.5 percent, plus seniority increment of 1 percent.
  - Valorization rate in baseline set equal to average economy wage growth (per rules effective since 2005); sensitivity test uses an alternative valorization tax rate of 0.77 percent of wage growth (reflecting 2005 data).
  - Pension assessment period: 18 best consecutive years (assumed to be the last 18 years before retirement under monotonic wage growth).
  - Life expectancy assumption for baseline pension-wealth calculations: worker survives till age 77 (remaining life expectancy for men conditional on survival to age 58).
  - Discount rate in baseline: 3 percent.
  - Pension benefits indexed to nominal wage increases every year in baseline; alternative indexation scenarios considered.

### Simulation results — baseline and sensitivities
- Baseline implicit tax for a male earning the average wage, surviving to age 77 (implicit tax by retirement age):
  - Age 58: -34.6
  - Age 59: -21.7
  - Age 60: -9.3
  - Age 61: 2.5
  - Age 62: 13.7
  - Age 63: -5.6
  - Age 64: 12.4
  - Age 65: 28.7
  (All values are in percent and correspond to the series "-34.6-21.7-9.32.513.7-5.612.428.7" shown in the source.)
- Peak-value calculations indicate maximum pension wealth at age 61 in the baseline (suggesting age 61 as optimal retirement age under baseline).
- Kink at age 63 in implicit tax curve explained by nonlinearity of penalty/bonus schedule: service factor reduction of 2.35 percent for retiring one year before full pensionable age of 63 versus service factor increase of 4.2 percent for retiring one year after full pensionable age.
- Life-expectancy sensitivity:
  - Increasing remaining life expectancy to 81 shifts incentives: implicit tax remains negative until age 64; peak value turns negative only at age 65 (optimal age to retire increases).
  - Life expectancy increases on average by a year every decade (source statement).
- Discount-rate sensitivity:
  - Higher discount rate of 5 percent advances optimal retirement age to about age 60 in simulations.
  - Lower discount rate of 1 percent makes implicit tax positive at age 62 (encouraging deferral).
- Seniority increment sensitivity:
  - Removing seniority increment pushes optimal retirement age earlier (example: without seniority increment, optimal retirement moves to age 60).
- Case of male who has already fulfilled 40 years of service by age 59: little incentive to defer retirement; optimal to retire at age 60 (one year after eligibility) given bonus structure.
- Women: simulations for a woman earning average wages, eligible at age 58 with 35 years service plus purchased 3 years, and remaining life expectancy of 83:
  - Implicit tax of deferring retirement remains negative up to age 63 (two years beyond full pensionable age), indicating less incentive to retire early for women under these assumptions.
  - Alternate female life expectancies used: 78 years (current life expectancy at birth) and 88 years (expected remaining life expectancy in 2050).
- Wage-level heterogeneity:
  - Incentives to retire early are particularly strong for both low- and high-wage earners.
  - Low-wage earners: minimum pension base (close to 60 percent of average net wage in 2005) is binding, so additional year of work may not increase pension base — accrual effect weak — wealth effect dominates, strengthening incentive to retire.
  - High-wage earners: higher pensions push income into higher tax brackets, increasing effective tax on pension and weakening accrual effect; implicit tax of deferral rises when effective tax becomes binding.

### Policy scenario simulations and their effects on retirement incentives
- Pension indexation scenarios:
  - Incentives to retire early are strongest under wage indexation and weakest under price indexation.
  - Under price indexation (or reduced wage indexation that effectively lags wage growth), accrual effect dominates and incentives to retire early weaken; optimal retirement can move to age 62.
  - Existing rule: indexation for existing pensioners expected to lag wage growth by 0.065 percent through 2024 (source statement).
- Valorization (valorization coefficient) scenarios:
  - Changing valorization rate does not substantially affect the sign of implicit tax or the optimal retirement date in simulations; optimal retirement date remains at age 61 in baseline and alternative valorization scenarios.
  - 2005 implied implicit valorization tax amounted to 0.77 percent of wages (used in sensitivity tests).
- Assessment period for pension base:
  - Increasing assessment period from 18 to 25 years does not change the optimal retirement age in simulations (effects on benefit level are larger than effect on additional-year accrual).
- Accrual-rate structure scenarios:
  - Alternative accrual-rate parameterizations (examples in source: "Accrual rate (30 + 1.7)", "Accrual rate (25 + 1.9)", "Accrual rate (22.5 + 2)") alter implicit tax profiles and can shift incentives; table in source lists detailed implicit-tax sequences across ages for these parameterizations.
- Raising full pensionable age:
  - Simulations for higher full pensionable ages (64 and 65) produce alternative implicit-tax sequences; source table provides exact numbers for these scenarios and suggests higher full pensionable ages shift implicit-tax profiles and optimal retirement ages (see table in source for precise values).

### Key analytical conclusions and policy-relevant implications (as presented in the source)
- Under baseline parameters of the 1999 reform, the Slovene pension system provides strong incentives for men to retire early (before full pensionable age of 63), with peak accrual around age 61 in the baseline.
- Incentives to retire early are sensitive to life expectancy, discount rates, seniority wages, and the wage level of the worker.
- Alternative indexation (price indexation or reduced wage indexation that lags wages) tends to reduce incentives for early retirement because the wealth effect of foregoing an extra year of pension is smaller.
- Valorization and assessment-period changes have limited impact on the sign of implicit tax and the optimal retirement date in the simulations presented.
- Policy reforms to raise effective retirement age and restore pension viability should consider:
  - Indexation rules (moving away from full wage indexation reduces early-retirement incentives).
  - Accrual-rate structure and penalties/bonuses calibration.
  - Raising statutory full pensionable ages (with attention to nonlinearity in bonus/penalty schedule).
  - Addressing minimum pension base and tax interactions that create perverse incentives for low- and high-wage earners.

*Source: IMF staff calculations and analysis as presented in the supplied content.*

### 72.5 percent for a man with 40 years of service retiring at age 63—the optimal retirement age

### 72.5 percent for a man with 40 years of service retiring at age 63—the optimal retirement age

### Accrual rates and retirement age
- Back-loading the accrual rate over time could be useful in increasing the effective retirement age.
- Changing the penalty and bonus rates would have a direct impact on the accrual rate, but these changes would have a more significant trade-off in terms of the amount of pension benefit and cost of pension expenditure.
- Example outcome: optimal retirement age found at 62 years in scenarios discussed.

### Increase in full pensionable age
- Raising the statutory full pensionable age does not ensure a higher effective retirement age.
- Scenario described: full pensionable age increases from 63 years to 64 years (with a corresponding increase in the minimum pension-qualifying period).
  - Result: the optimal retirement age remains at 62, still two years ahead of the new full pensionable age.
- Further increases in the full pensionable age did not change the optimal retirement age in the simulations.
- Mechanism: for a given life expectancy, increasing the statutory retirement age strengthens the wealth effect (benefits can be enjoyed for fewer years), suggesting complementary policy review is needed to affect incentives to retire.

### Policy implications (pension system)
- Pension parameters need reform to raise the effective retirement age in light of a large demographic shift.
- Policy tools to consider:
  - Change bonus and penalty rates that directly affect retirement incentives.
  - More back-loading of accrual rates to defer retirement decisions.
  - Prefer wage indexation over price indexation, since retirement incentives weaken more under price indexation than under wage indexation.
  - Increase the assessment period for calculating the pension base to lower pension expenditure significantly without weakening retirement incentives.
- Recommendation: consider these changes even if the statutory retirement age is raised, because early-retirement incentives could undermine efforts to raise the effective retirement age.

### Labor participation and tax and benefit systems in Slovenia — Background
- Low labor participation rates concentrated among groups with poor income prospects; unemployment rates higher and employment rates lower than peers in EU-15.
- Contributing factors: lack of qualifications, high labor costs, limited job mobility and fungibility, and insufficient work incentives.
- Implication: low-income individuals may have high reservation wages due to generous benefits.
- Focus of investigation: role of tax and benefit policies in discouraging labor supply among low-income individuals, a large share of whom may be young workers.

### Taxation in Slovenia
- Labor taxation among the highest and most progressive in Europe, including:
  - Progressive personal income tax.
  - Payroll tax paid by employers.
  - Social security contributions.
- Slovene personal income tax top rate at 50 percent, among the highest in Central Europe.
- Planned tax reform objectives: decrease tax pressure, particularly for workers at the high end of the income distribution, by reducing tax rates and flattening the tax schedule.
  - Note: unclear whether the reform would increase labor supply among low-wage earners; effect depends on how reform affects eligibility and amount of benefits.
- Policy implication: reform tax and benefit systems simultaneously to create proper work incentives and boost labor participation.

### Social benefits
- Social benefits, particularly labor income replacement, are generous.
- Support to jobless individuals:
  - Unemployment insurance benefit (UB) initially (taxable and subject to social security contribution).
  - Unemployment assistance (UA) subsequently when UB runs out (UA free of income taxes and social security contributions).
  - Those who do not qualify for UB/UA may receive a top up to the guaranteed minimum income (GMI).
  - Child benefits inversely related to income and increase more than proportionally with number of children.
- Main work-incentive problem: difference between minimum UB and UA is not large; transition from UB to UA can produce a financial windfall.
- Durations:
  - UB duration for most people limited to 6 months.
  - UA duration 15 months across the board.
  - Footnote: UB duration could reach 24 months for workers over 55 with insurance periods over 25 years; UA duration could rise to 3 years if conditions for old-age pension are fulfilled during this period.
- Consequence: transition from UB to UA creates a strong disincentive to work, reflected in high Marginal Effective Tax Rates (METRs).

### Marginal Effective Tax Rates (METRs) and incentives to work
- METR definition: the change in the combination of taxes paid and benefits received at different income levels; measures the percentage of an additional dollar earned that is lost through taxes and benefit interactions.
- Formula context: METR computed comparing gross income levels y1 and y2, using variables ty (income tax rate), rssc (rate of social security contribution), and b1, b2 (total benefits at income levels y1 and y2).
- Current system produces high METRs, particularly at the lower end of the income distribution.
  - METRs between the minimum UB and UA exceed 100 percent, and top 200 percent in some cases (text chart).
- Most people face METRs in the range of 30-55 percent when exiting joblessness, potentially discouraging low-income workers and secondary earners (e.g., spouses), contributing to lower female participation.
- The combination of progressive tax rates and generous benefits yields high and increasing METRs when exiting joblessness, depending on benefit type, job salary, and family status.

### Empirical analysis — METRs and joint labor participation
- Data and method:
  - Household Budget Survey data used; database restricted to families where both spouses are active and those where only one is active (47 percent of original database; around 1700 families).
  - Cross-sectional data; METRs calculated by comparing observed situation to a hypothetical zero family labor income.
  - Probit model used to estimate probability that both spouses participate as a function of family income, individual characteristics, and METRs.
- Key econometric findings:
  - A one percentage point increase in the METR reduces the probability that both spouses participate by 2.8 percent.
  - When controlling for number of household members (including other dependents), the probability declines by 3.8 percent per one percentage point increase in METR.
  - Other determinants:
    - Current effective tax rate increases probability of joint participation.
    - Total family income increases probability.
    - Higher education of reference person increases probability.
    - Age of reference person reduces probability (older individuals more likely to retire).
- Selected regression coefficients (two specifications reported):
  - Current effective tax rate: 0.045 *** (t-stud 2.87) and 0.054 (t-stud 3.32) in two specifications.
  - Marginal effective tax rate: -0.028 *** (t-stud -2.79) and -0.038 (t-stud -3.76).
  - Total family income: 0.006 *** (t-stud 7.60) and 0.004 (t-stud 4.78).
  - Age of reference person: -0.016 *** (t-stud -3.43) and -0.023 (t-stud -5.05).
  - Education of reference person: 0.011 (t-stud 0.92) and 0.042 (t-stud 3.40).
  - Number of children: 0.361 *** (t-stud 6.06) in one specification.
  - Number of household members (in alternate specification): 0.418 (t-stud 11.31) .
  - Constant: -0.346 (t-stud -1.35) and -1.223 (t-stud -4.49).
  - Observations: 1531 and 1531; Pseudo R2: 0.17 and 0.22.
  - Significance: ***, significant at 1 percent.

### Impact of reforms on work incentives
- Introduction of a flat tax alone would not improve work incentives for low-income workers.
  - Example considered: flat tax of 20 percent.
  - Effect: would significantly improve work incentives for high-income workers by reducing their METRs to around 35 percent from current levels of over 60 percent.
- Implication: distributional impacts and interactions with benefits mean tax reform must be designed alongside benefit reforms to improve incentives for low-wage and secondary earners.

*Source: _wp06298 - 72.5 percent for a man with 40 years of service retiring at age 63—the optimal retirement age*

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### _wp06298 - 0.50 AW0.67 AW0.75 AW1.00 AW1.50 AW2.00 AW2.50 AW3.00 AW3.50 AW4.00 AW4.50 AW5.00 AW

### METRs Under a Flat Tax and Unchanged Benefits
- A 20 percent flat tax with unchanged benefits would, in many cases, worsen incentives for low-income individuals because their tax rate would likely increase.
- METRs for those taking a job would continue to be high, reaching 50 percent for a single individual moving from UA to a job paying the minimum wage.
- The flat tax would raise average effective tax rates for low-income individuals while reducing those of high-income ones.
- Participation for workers with incomes above roughly four times the average wage is already above EU-15 averages; a flat tax is unlikely to significantly boost their activity rate, though it might affect hours worked.
- Source of calculations: IMF staff calculations.

### Reforms to Increase Labor Participation (Benefits-side changes)
- Main source of high METRs among low-income workers is insufficiently large differences between minimum UB, UA, and GMI.
- Proposed benefit-side elements:
  - Leave the GMI unchanged (currently amounting to 71 percent of the minimum UB) because it is linked to the poverty line.
  - Reduce the UA to half the minimum UB from the current ratio of 80 percent.
  - Make UA smaller than GMI so UA is regarded as temporary support; an individual who had exhausted UB would qualify to receive UA and would not be able to opt for the higher GMI during the statutory duration of the UA, which could also be shortened.
  - Assume unchanged child benefit.
- Intended effects:
  - Reduction of UA and the signal that it is not sufficient to live on would intensify job search.
  - Decline in the number of UA recipients (noted to have increased in the face of a decline in overall unemployment).
  - Reduction of METRs for most people relative to the current system and for most low-income individuals relative to the flat tax proposal.
  - Elimination of the spike between the UA and the UB.
  - METRs could be smoothed by adjusting other benefits (such as the child benefit) and/or various tax exemptions, particularly at points where tax rates increase.
- Note: This is described as a partial equilibrium analysis.

### Three-Rate Tax System (Alternative to flat tax)
- Hypothetical three-rate system parameters considered:
  - 0–minimum wage (42 percent of the average wage): 15 percent
  - Minimum wage – 2 average wages: 20 percent
  - Above 2 average wages: 25 percent
- Additional assumptions:
  - The general tax exemption and the child tax exemption remain unchanged.
  - All labor incomes, whether subject to the personal income tax or not, would be subject to social security contributions at the current rate of 22.1 percent.
- Rationale and expected outcomes:
  - A tax rate of 15 percent would target individuals with taxable income up to the minimum wage, representing a slight reduction from the 16 percent most of them face at the moment and cover slightly more people (the current upper income bracket represents 38½ percent of the average wage).
  - The bulk of the working population would face a rate of 20 percent.
  - Individuals with taxable income at least twice the average wage would be taxed at 25 percent.
  - The three-rate system would deliver lower METRs than both the current and flat tax systems in the income range up to the average wage; beyond that point, the flat tax produces lower METRs.
  - The three-rate system would increase incentives to seek work for low-income individuals: METRs when taking a job are lower under the three-rate system than currently or under the flat tax for single individuals without children and married couples where the principal earner earns 67 percent of the average wage.
  - METRs would nevertheless continue to be somewhat high (up to 40 percent in some cases), implying a need for careful calibration of other benefits and tax allowances.
- Distributional trade-offs:
  - The three-rate system produces consistently lower average effective tax rates than the other systems for most people, with two exceptions:
    - Individuals receiving the UA would face higher effective tax rates (consistent with incentives to seek work).
    - Average effective tax rates would outstrip those of the flat tax at some point owing to the higher 25 percent rate; this intersection typically happens well beyond income levels equal to twice the average wage, so higher (around 35 percent) effective tax rates would apply only to individuals who are well off.

### Figures, Evidence, and Quantitative Illustrations
- Figures referenced (IMF staff calculations) include:
  - METRs under current, flat-tax (20 percent, unchanged benefits), and three-rate (15-20-25 percent) systems for selected individual/family types and income levels.
  - METRs faced when taking up a job from inactivity, UA, or UB for single individuals and married couples (principal earner at various multiples of the average wage).
  - Average effective tax rates for selected individuals across income ranges and systems.
  - Retirement incentives and implicit tax measures for the Slovene public pension system across ages and life-expectancy scenarios.
- Specific numeric values preserved from source:
  - UA currently at 80 percent of the minimum UB; proposed reduction to half the minimum UB.
  - GMI currently amounting to 71 percent of the minimum UB.
  - Social security contributions assumed at 22.1 percent.
  - Flat tax considered at 20 percent; alternative three-rate system of 15 percent / 20 percent / 25 percent.
  - Minimum wage taken as 42 percent of the average wage for the first bracket.
  - Current upper income bracket represents 38½ percent of the average wage.
  - METRs reaching 50 percent for a single individual moving from UA to a job paying the minimum wage.
  - METRs could remain up to 40 percent in some three-rate system cases.
  - Higher effective tax rates around 35 percent would apply only to individuals well off (beyond twice the average wage).
- Calculations assume for simplicity:
  - (i) single individuals not eligible for UA receive the full GMI; and
  - (ii) spouses in families where there is a principal earner do not receive the GMI.

### Policy Implications
- Reforms to improve work incentives should focus on both the tax and benefit systems.
- A hypothetical 20 percent flat tax with unchanged benefits would worsen work incentives for individuals with poor income prospects, counteracting the objective of raising labor participation rates and thus potential growth.
- Adopting three fairly low rates of personal income tax coupled with widening the gap between the minimum UB and the UA would:
  - Lower marginal effective tax rates for most individuals.
  - Increase work incentives.
  - Lower average effective tax rates for most people.
- Additional recommended steps and caveats:
  - Careful calibration of other benefits and tax allowances is necessary to reduce remaining high METRs.
  - Further work should account for aspects of the welfare system not directly related to job status, other effects of tax and benefit reforms, labor demand considerations, and the budgetary impact of reforms.
  - The analysis presented reflects a partial equilibrium perspective.

### Conclusion (Labor Participation and Pensions)
- Labor force participation is considerably lower among the elderly population in Slovenia compared to EU-15 countries, reflecting the low full pensionable age under the Slovene pension system.
- Although reforms were introduced to increase the full pensionable age and create incentives to defer retirement, the implicit tax built into the pension system would likely encourage workers, especially men, to leave employment early.
- Incentives to retire early are particularly strong for workers earning at the low and the high ends of the wage spectrum.
- To raise the effective retirement age, parametric changes to the pension system are needed in addition to raising the statutory retirement age; this is crucial to prevent exacerbation of age-related spending pressures as Slovenia undergoes a large demographic shift in coming decades.

*Source: IMF staff calculations and analysis as presented in the document.*

### APPENDIX I. PUBLIC PENSIONS SYSTEM PARAMETERS

### APPENDIX I. PUBLIC PENSIONS SYSTEM PARAMETERS

### Pension system parameter samples (ages and rates)
- MenAgeWomenAge
- 12 percent589 percen t58
- 8.4 percent595.4 percent59
- 5.4 percent602.4 percent60
- 3.0 percent61
- 1.2 percent62
- MenAge
- 3.6 percent64
- 6.0 percent65
- 7.2 percent66
- 3.0 percent1st year
- 2.6 percent 2nd year
- 2.2 percent 3rd year
- 1.8 percent4th year
- Sources: Slovene authorities; and World Bank (2004).

### Penalty and Bonus Rates Under Slovenia's Pension System
- Bonus for extended years of service 
- Bonus for extended years of service after qualification for full pensions (40 years)
- Penalties for insufficient years of service
- 50 percent0.0 percent50 percent
- 100 percent0.0 percent100 percent
- 110 percent1.0 percent109 percent
- 120 percent2.5 percent117 percent
- 130 percent3.8 percent125 percent
- 140 percent5.0 percent133 percent
- 150 percent6.0 percent141 percent
- 160 percent7.0 percent149 percent
- 170 percent7.9 percent157 percent
- 180 percent8.8 percent164 percent
- 190 percent9.4 percent172 percent
- 200 percent10.1 percent180 percent
- Sources: Slovene authorities; and World Bank (2004).

### Effective Tax Rate on Pensions (reported headings)
- Net Pension From Benefit Formula/ Average Net Wage
- Net Pension After Explicit Taxation/ Average Net Wage
- Effective Tax Rate

*Source lines present in the original table; full numeric entries are not available in the supplied extract.*

*Italic line indicating original page number: 31*

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### APPENDIX II. LIFE EXPECTANCY

### Estimated Remaining Life Expectancy as a Function of Age (Years)
- AgeMenWomenAgeMenWomenAgeMenWomen
- 07 2.28 0.13 04 3.65 0.76 01 7.82 2.9
- 17 1.57 9.43 14 2.64 9.76 11 7.12 2.0
- 27 0.57 8.43 24 1.74 8.86 21 6.42 1.2
- 36 9.57 7.43 34 0.74 7.86 31 5.72 0.4
- 46 8.67 6.43 44 9.84 6.86 41 5.01 9.5
- 56 7.67 5.43 54 8.94 5.86 51 4.41 8.7
- 66 6.67 4.43 64 8.04 4.96 61 3.71 7.8
- 76 5.67 3.53 74 7.04 3.96 71 3.11 7.1
- 86 4.67 2.53 84 6.14 2.96 81 2.51 6.3
- 96 3.67 1.53 94 5.24 2.06 91 1.91 5.5
- 10 62.67 0.54 03 4.34 1.07 00 11.31 4.7
- 11 61.66 9.54 13 3.44 0.07 10 11.08 4.0
- 12 60.66 8.54 23 2.44 9.17 20 10.31 3.3
- 13 59.76 7.54 33 1.53 8.17 30 9.71 2.5
- 14 58.76 6.54 43 0.73 7.27 40 9.11 1.8
- 15 57.76 5.54 53 29.83 6.27 50 8.61 1.2
- 16 56.76 4.54 63 28.93 5.37 60 8.11 0.5
- 17 55.86 3.54 73 28.13 4.47 70 7.69 0.9
- 18 54.86 2.52 83 27.23 3.47 80 7.29 0.2
- 19 53.96 1.64 93 26.43 2.57 90 6.78 0.5
- 20 53.06 0.65 03 25.53 1.68 06 6.28 0.0
- 21 52.05 9.65 13 24.73 0.78 15 5.87 0.4
- 22 51.15 8.65 23 23.93 9.88 25 5.46 0.8
- 23 50.25 7.65 33 23.13 8.98 34 4.86 1.2
- 24 49.25 6.65 43 22.32 8.08 44 4.35 5.6
- 25 48.35 5.65 55 21.52 7.28 53 3.85 5.1
- 26 47.45 4.75 66 20.62 6.38 63 3.44 4.7
- 27 46.45 3.75 76 19.92 5.48 73 3.74 4.8
- 28 45.55 2.75 86 19.22 4.68 83 3.54 4.4
- 29 44.55 1.75 96 18.52 3.89 93 3.44 4.1
- Source: World Bank (2004).

*Italic line indicating original page number: 32*

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### APPENDIX III. TAXATION AND BENEFITS RELATED TO JOB STATUS

### Labor income taxation (summary)
- Labor income in Slovenia is subject to personal income and payroll taxes.
- Families with children can deduct a child allowance amounting to roughly 14 percent of the average wage for the first child; this allowance declines at a decreasing rate for subsequent children.
- The payroll tax is paid entirely by the employer. In 2005, the government decided to gradually phase it out (totally by 2009), beginning with a 20 percent reduction in the rates effective January 1, 2006.
- Social security contributions apply to gross wages at the rate of 22.1 percent for employees and 16.1 percent for employers.

### Payroll Tax — Tax Rates 1/
- 0 590.0
- 591423.0
- 1422666.2
- 266+11.8
- 1/ Reduced by 20 percent from January 2006

### Wage brackets (Percent of AW) — Payroll Tax (Minimum taxes)
- 0< 16.70.00  General tax exemption.
- 16.7< 38.50.016
- 38.5< 75.26.233 over income equal to 38.5 percent of AW
- 75.2< 152.218.338 over  income equal to 75.2 percent of AW
- 152.2< 305.847.542 over  income equal to 152.2 percent of AW
- 305.8+112.150 over  income equal to 308.5 percent of AW

### Personal Income Taxes (in percent of average wage) and Tax Rates (In percent)
- Taxable income brackets
- Additional income taxed at (In percent of average wage)(In percent)

*The supplied extract contains headings and fragmented entries for the personal income tax schedule; full aligned numeric rows are not available in the provided content.*

### Benefits related to job status (income replacement when jobless)
- The three main benefits certified by registration in the Employment Service are:
  - Unemployment Insurance Benefit (UB)
    - Conditions: Minimum 12-month contribution period; registration with Employment Service
    - Eligibility: Unemployed
    - Amount: 70 percent average monthly earning for first 3 months, 60 percent thereafter.
    - Duration: 3 to 24 months. For most people, 6 months
    - Tax status: Subject to PIT
    - Social security status: Subject to SSC
    - Type: Insurance based
  - Unemployment Assistance (UA)
    - Conditions: Registration with Employment Service
    - Eligibility: Unemployed. After rights to UB have expired
    - Amount: 80 percent of minimum UB
    - Duration: Most people up to 15 months. Up to 3 years if old-age pension conditions fullfilled during period
    - Tax status: Not subject to PIT
    - Social security status: Not subject to SSC
    - Type: Pure welfare
  - Guaranteed Minimum Income (GMI)
    - Conditions: Registration with Employment Service
    - Eligibility: Income below the GMI topped up.
    - Amount: 71 percent of minimum UB
    - Duration: No limit
    - Tax status: Not subject to PIT
    - Social security status: Not subject to SSC
    - Type: Pure welfare
- Note: Individuals or families with children are eligible to receive child benefits. The child benefit is inversely related to income levels and increases more than proportionally with the number of children.
- The chapter focuses on benefits that affect work decisions directly and are easily tractable for calculating METRs.

- Source: Ministry of Labor and Social Affairs.

*Italic line indicating original page number: 33*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06298.pdf_