Impact of Informality on Consumption

Impact of Informality on ConsumptionAbstractBy using a simple model, it will be analyze the seismic disturbance that versedity has in the amount of consumption of the workers during their life cycle. This reputation deals with the interconnections of under- bailiwicked earnings, savings and old- mature grant. The workers sampled for this analys behave been divided into three groups 1. Low income emloyees, 2. Higher income employees who decl ar all incomes, 3. Employees who under-report their incomes .In this paper the analysis is based on two indemnity models the model that calculates bounty in conformity with the incomes ( proportionate model) and the grassroots model, whose objective is pauperisation decrement for the third fester. The major result is as follows Given the fact that the primary pension constitution favors employees that under-report their incomes and the fact that the impact of informality is greater in the elementary placement than in the propotional pension body, the application of basic pension governing body in the Albanian might be problematic.KEY WORDS informality, pensions, proportional model, basic model, Albania mental homeThere atomic number 18 many examples around the world, how different countries have adapted their pension establishment in comformity with the important changes they are experiencing. However what works comfortably in a country does not necessarly work well in an other country. Pension reforms should be in accordance with the economic, political and social characteristics of the country. The issuing referring to the appropriate scheme to be implemented in Albania has been the concern of the governments. . In such circumstances, when the Pay-As-You-Go system is failing every day, the problem of a reform seems as urgent as it is necessary.Pension systems have been one of the serious issues, which all Albanian governments have been facing. They have been a constant source of criticism from multi national bodies and are one of the schemes that aggravate the state budget a bus, therefor impeding the development of the Albanian economy (Treichel, 2001)As a result of a misconception of this scheme since the beginning, the current system has gene localised high evasion and informality, distorting effects on the labor foodstuff and not providing a long term solution for the pensions. The master(prenominal) problem has to do with the amount of contributions and incentives to pay these contributions.Using a simple model, it will be given an idea about the impact that informality has in the amount of the workers consumption during their life cycle. For this reason two pension models have been analyzed the model that calculates pension in conformity with the incomes and the basic model, whose objective is mendicancy reduction for the third age. Augusztinovics, (2005) concludes that increasingly social tensions can be reduced by e replacing the pension system cerebrate to incomes with a basic pension system.Given that this topic presents a great complexity and at the same time is so current and present in our everyday lives, it would be interesting to treat it in order to provide an alternative for solving such a so sharp problem.2Proportional pensionsIn recent geezerhood, the Magyar Economists of the Academy of Sciences have conducted a series of empirical studies regarding pension systems, especially in the countries of Central and easterly Europe. The assumptions utilize in their model, have a lot in common with the Albanian reality.harmonize to (Simonovits, 2008), the assumptions of the model are The population is busyn unchanged The young population is active in the labor market Every elder person has retiredConsequently, R is the deem an employee working years and S, the years of an individuals retirement. Dependency rate, expressed as the ratio of pension years to those of work, is tag with = S / R. Although, the difference between the contri bution rate of employers and employees is clear in the current pension system clear, in this analysis, this difference is not taken into account. The centre allowance, which represents the arrive cost of the work, is mark by w. Individual contribution, paid to the pension system, is calculated at the rate t, of the total reported salary. Health insurance contributions and income valuate impacts have been left out of the model. To be closer to the Albanian reality, it is fictive that the rate of employed persons who declare their exact income, are not directly related to the pension system. The system is suposed in equilibrium the r reddenues of the system are equal to its expenditures.The scale of the informal economy in Albania is one of the highest in the Central and Eastern Europe countries. The informal economy is assumed at 34 percent according to (Schneider, Buehn, Montenegro, 2010). For this reason, it is foreseen to classify the employees in three different groups1. L ow income emloyees, who are attach with (U)It is presumed, that employees who do not fully declare their income are part of the second group. For this group, it is made the interest subdivision2. Higher income employees who declare all incomes, who are marked with (P)3. Higher income employees who under-report their incomes, who are marked with (N)The frequency of these employees is U, P and N. These frequencies are positive numbers, the amount of which shall be equal to 1. Considering all the employment as a unit, the number of employees is marked by 1.In special cases it may occur that one of the frequencies is equal to 0, as it is the case of economies where informality is in very low levels expert 0.In this model, it is assumed that pensioners receive their pensions, in proportion to the income declared, which are marked with *, (t*, is the rate of the contribution to the system). The current income of workers according to salary levels, are wP = wN and wU. fleck the benefit s from the system during the retirement period, are bP* and bN* =bU*. Based on the supra assumptions, the benefits are commensurate with the income declared bP* = * wP and bN* = * wU, where * is the fill-in rate of the pension system related to income (proportional). As it is observedou, wU represents the marginal wage and any potential changes will affect the overall level of formal employment. This problem will not be considered, because of the complexity that it presents.In the following equations are presented total real income (WP) and the total income declared (WU).WP = (P + N)wP + UwU and WU = PwP + (N+ U)wUSince the system is in equilibrium, then, t * WU = * WU. Consequently, subsequent connection between the contribution tiptoe (t *) and the replacement ratio is* t* = *It is assumed that those who declare all the incomes do not save for theretirement period, as they believe that the replacement ratio is sufficiently high. In contrast, people who do not report their tot al incomes, are supposed to save for the retirement, that hidden amounts. In some cases these rates may be even lower than the rate of social security system, which would make them save for their whole lifetime. So the saving rate is marked with , which is 0 and the annual savings are (wP wU). It is assume that the hidden savings during the R years of work are used for consumption (wP wU) during the S retirement years.For comparative reasons the level of consumption is analyzed during two stages of life (work and pension). This analysis will provide a more complete picture throughout the whole life cycle, of the consumption during the work period, which is label young consumption and the consumption during retirement, which is labeled elderly consumption.Based on the above equations, youth consumption would becP* = (1 t*)wP cN* = (1 t*)wU + (1 )(wP wU) cU* = (1 t*)wUWhile the elderly consumption would bedP* = bP* dN* = bU* + (wP wU) dU* = bU*Basic pension systemSome re searchers (Augusztinovics Kll, 2008), (Kollo, 2008), (Kertesi G., Bonn 2003) consider the replacement of the proportional pension system with a basic pension system as a way to reduce the increasing social tensions. Since the goal of this system is the reduction of poverty during the third age, it is assumed that it is given a definit benefit b0 which is funded by a consumption assessation rate . Each individual pays his/her taxes proportionally afterwards spending money for consumption and for mathematical simplicity it is assumed that the basic benefits are net. Pensions obtained from this system areOne of the innovations that this model offers is the assumption which does not take into account the possibility of consumption tax evasion, in contrast to the case of non-payment of pension contributions. The implementation of this model faces with some difficulties in our country, such as problems with the informal economy (tax evasion) and the indirectly calculation method of VA T.In the model analyzed there is no total savings and total consumption is equal to total income. Based on the equation that shows the dependency ratio, the tax equation is as followsThe decreasing contributions, tw finance only the reduced pensions of employees. , pra For comparative reasons, it is assumed that the total cost of pensions are invariable. This assumption is clearly expressed in the following equationBy substituting from the previous equation to the new equation the following edict is obtainedConsequently, the reduced contributions will be as followsIn order for the contribution to be a positive rate, it should be assumed that . So, The youth consumption is While the elderly consumption is As it can be noticed from the above equations, consumption and benefits of employees who declare all their incomes has decreased, while consumption and benefit of employees with low incomes and workers that under-report their incomes have increased in comparison with the proport ional pension system.4The Albanian CaseFor study reasons it is worth presenting a numerical simulation. In the above mentioned models are used features of Albanian pension system.Based on the Albanian legislation for social security, the working years that an employee must have to obtain a retirement pension, are 35. Consequently, R = 35 years. According to official data from the World Bank (2012), the average of life expectancy for the Albanian population is 77 years. By subtracting from this age the average age of the entry into the labor market, which is 22 years (qualified employees, as well as unqualified have been considered as), it is concluded that the average number of years spend in retirement for every Albanian, is S = 20 years. Dependency rate, which represents the ratio of average years spent in retirement, with the average years spent in work, is = S / R = 20/35 = 0.57.The calculation of incomes is attained based on the data on employment and average salary for sepa rately sector of the economy. It is assumed that All employees of public and private sector and non-agricultural privat sector are classified as employees with high average incomes. For purposes of analysis, the informal economy is assumed at 34 percent according to (Schneider, Buehn, Montenegro, 2010). So, 34 percent of private sector employees do not declare their real incomes. Employees of the agricultural sector are assumed as employees with low income.Based on the above assumptions and on the (INSTAT, 2014) data the distribution of workers by sector isU = 0.49 , P = 0.39 , N = 0.12According to INSTAT data (2013), the average salary in the public sector is 52,150 ALL (Albanian lek), the average of high salary in the private sector is 97,000 ALL and in the agriculture sector it is assumed that the salary is equal to the minimum wage 22,000 ALL. Based on these data, the income distribution iswP = 4.4 dhe wU = 1While the average stated salary isWU = 2.326So, the average salary dec lared, based on the above analysis, is 2.326 x 22000 = 51172 ALL. This indicator has a outcome close to the average salary of 52150 ALL declared in Albania.It is assumed that the amount of benefit in the basic system is equal to half of the benefit of the pension system related directly to income.b0 = tWU/ 2Also, it is assumed that the worker that does not declare his/her real income, saves half of the money, = t/2, which, Social Security, would make the employee save from the income that are not declared.Table no 1 The Key IndicatorsSource origin Calculations4.1Basic ModelThe distribution as per basic assumption isP = 0.39, N = 0.12, U = 0.49In the table below have been presented the characteristics of both pension systems that are being analyzedTabel no 2 Characteristics of pension systemsSource Author CalculationsThe above characteristics are calculated in the case of Albania, where the contribution rate paid to the social security, is 21.6 percent for the proportional pension system. As it can be observed from the above data, when moving from a proportional pension system to the basic pension system, the contribution rate paid to the pension system is halved. A consumption tax at the rate of 9.2 percent is added to the basic pension system in contrast to the proportional pension system. Refering to the calculations, there is a significant difference regarding the replacement ratio between the two pension systems. In the proportional pension system the value of this ratio is 38 percent, which is reduced to 18.9 percent in the basic pension system.We see the impact of two pension systems to the amount of consumption for the three groups taken into consideration.Table no 3. Consumption amountSource Author CalculationsBy analyzing the above results, it can be observed that The youth consumption is the highest in three groups on the basic pension system compared with the proportional pension system. As expected, the elderly consumption with low income at basi c pension system is higher than the consumption of the other system. Characteristic of the basic pension system is the support for people with low incomes. The elderly consumption with high incomes at the proportional pension system compared with the consumption at the basic pension system is about 50 percent higher. A weakness in the basic pension system is that it favors the group of pensioners who under-report their incomes.4.2Full reporting of incomesThe analys of the rarified case where all employees report all their income, although it seems utopian, it is worthwhile analyzing.Division of employees according to the declaration isP = 0.51 N = 0 U = 0.49Table no 4. Characteristics of pension systemsSource Author CalculationsThe rate of contribution to the proportional pension system is 21.6 per cent, as it was in the case of the basic model. As observed from the above table, the characteristics of the basic pension system, has changed in the ideal case compared to the basic mod el. The rate of contribution in the ideal case decreased at 10.7 percent compared with 10.8 percent in the basic model. While the tax rate has increased to 11 percent from 9.2 percent in the basic model. Changes in the ratio of replacement are negligible.We see the impact that the two pension systems have to the consumption quantity of the three groups who have been analyzed.Table no 5. Consumption amountSource Author CalculationsBy analyzing the results above, we can say that The youth consumption and the elderly consumption have not changed for the proportional pension system for both cases. Into the basic pension system there is a reduction in the consumption quantity at the young age and a very small increase in the consumption during the third age. So, the basic pension system is more sensitive toward informal economy than the other pension system that is taken into consideration.5ConlusionsThe elementary model.has already been analized. Finally, by analyzing the cases discusse d above, it can be concluded thatThe consumption and benefits of employees who report all their incomes has decreased in the basic pension system compared to the proportional pensions system.The consumption and benefits of employees with low incomes and those of the employees who under-report their incomes increased in the basic pension system compared to the proportional pensions system.The basic pension system favors employees that under-report their incomes.The impact of informality is greater in the basic pension system than in the proportional pension system.So, in the Albanian reality the application of basic pension system might be problematic.