PENSION DESIGN WITH A LARGE INFORMAL LABOR MARKET: EVIDENCE FROM CHILE

This article investigates the fiscal and welfare trade-offs involved in designing a pension system when workers can avoid contributing by working informally. Using a life-cycle model of labor supply and saving decisions, I structurally estimate preferences and earnings opportunities in the formal and informal sectors using data on Chilean households. I find limited support for formal jobs rationing. Instead, mandatory pension contributions significantly encourage informality. Policy experiments show that Chile could lower minimum pension spending by 23%while guaranteeing the same income to retireesif the minimum pension's implicit tax rate was increased to 60%.