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GDP growth rate Share of payroll in GDP Level of economic activity of population Birth rate Net migration Inflation rate Unemployment rate Interest rate Contribution rate (tax rate for UST) Pension system parameters (such as e.g., collection ratio) Retirement age The model employs a module principle based on the following sequence of calculations applied to each group of contributors and pensioners. Estimating the number of contributors and pensioners;

Estimating the average size of salaries and pensions;

Estimating the flows of pension contributions and benefits;

Balancing revenues and expenditures of the pension system;

Determining the key performance characteristics of the pension system, such as a replacement rate, etc.

To estimate the number of contributors, all employees in the economy are divided into three groups: (i) regular employees; (ii) those who benefit from the reduced UST rates, including self-employed; and (iii) delinquent taxpayers.

The number of pensioners in the model is determined using the Stock method, where share matrixes are defined for each type of pensioner, as well as for each age and sex group.

Then, to determine the number of pensioners in a particular group one has to multiply the population number in each age and sex group (defined by the existing demographic projections) by a respective value in the share matrix.

The size of pension benefit for each group of pensioners is determined based upon the overall amount of UST collection, the number of pensioners in each pension group, types of pension benefits established for these groups, as well as upon the adopted pension indexation rules. The level of administrative costs in the system is considered to be constant at 2 percent of the total annual PAYG benefits.

The NDC benefit is determined as accumulated notional individual fund divided by the annuitization factor that reflects the remaining life expectancy of the cohort and the notional interest rate. The annuitization factor is gradually increasing between 2002 and from 12 to 19. The initial notional individual fund for those who are enrolled in the system in 2002 is equivalent of the average monthly pension of 830 Rbl.

The overall inflow of revenues to the pension system is determined by the number and structure of contributors, average UST rates, as well as by the following factors:

Collection rate (currently amounts to 0.96);

The model considers two groups of contributors (regular employees and those who are eligible for reduced UST rates) and four groups of pensioners: old-age pensioners, disability pensioners, survival pensioners and early retirement pensioners.

Nature of the wage distribution relative to the regression scale of the existing UST rates; this factor is reflected in the model by the introduction of a separate coefficient of regressivity (currently amounts to 0.94);

Exemption rate for UST that reflects the average reduction in effective UST rate for contributors due to the existing legal benefits for particular groups of taxpayers, such as those who pay a single agricultural tax (currently amounts to 0.94) Average working life period is estimated as 30-35 years.

The indexation of benefits in the model is based on current legislation: the base pension is indexed with average inflation, while the NDC portion of the benefit is indexed based on the growth rate of the pension fund collections per beneficiary (which on average exceeds the inflation rate due to the growth in real wages).

The model calculations were undertaken without feedback, i.e., even if the pension system balance starts to accumulate considerable surpluses, the model does not provide for an automatic change in the rules of pension indexation. The logic behind such an approach is in focusing the analysis on what outcomes various indexation rules may generate (in terms of both the pension system balance and average replacement rate) if kept intact for a considerable period of time.

In addition to this, however, the model generates an alternative estimate for the replacement rate, which is the rate that could be attained at a zero balance of the pension system. To get this estimate in the model all current surpluses in the system are distributed among the groups of beneficiaries proportionally to their NDC pensions. This alternative estimate reflects a potential maximum pension benefit that could be funded by utilizing all collected funds (i.e., without running surpluses), but at the same time without creating debts in the pension system. In Chapter 4 we call this indicator of the maximum potential pension benefit as an affordable replacement rate, and this is an indicator that represents the core to our analysis. In other words, we are especially interested in understanding for each particular scenario how much the pension system could afford to pay. It is assumed that if in the longer term the selected indexation rules proved to be too restrictive (as they seem to be now), they could be adjusted to allow for a full pay-out of available pension funds.

While statistical data required for building a full quantitative model of the link between the pension contribution rate and the taxable base for UST were unavailable, a numeric experiment was undertaken, which allowed estimating sensitivity of the basic pension system parameters to the cuts in contribution rate.

ANNEX 4.MAIN SIMULATION RESULTS FOR THE PENSION REFORM ANALYSIS Table A4.1. Total affordable replacement rate, % Scenarios 2003 2004 2005 2006 2007 2008 2009 2010 2020 2030 2040 Group I: Base scenarios 11: low growth, slow reforms 33.6 33.2 32.5 31.7 31.4 31.0 30.5 30.0 25.3 24.4 24.6 23.12: low growth, advanced reforms 34.0 33.9 33.6 33.2 33.1 32.9 32.7 32.2 27.7 26.4 26.0 24.13: high growth, slow reforms 33.6 33.2 32.5 31.7 31.4 31.0 30.6 30.0 25.5 24.6 24.7 23.14: high growth, advanced reforms 34.3 34.2 33.8 33.4 33.4 33.2 33.1 32.8 28.9 27.8 27.1 25.Group II. With the UST reform (cuts in the pension contribution rates) 22: low growth 34.0 34.6 29.1 28.6 28.5 28.3 28.1 27.6 23.7 22.7 22.7 21.24: high growth 34.3 34.9 29.3 28.8 28.7 28.6 28.5 28.2 24.7 23.8 23.6 22.Group III. With the UST reform and increase in the retirement age 32: low growth 34.0 34.6 29.1 30.3 30.4 32.2 32.0 33.8 35.5 33.0 34.6 32.34: high growth 34.3 34.9 29.3 30.5 30.6 32.6 32.5 34.4 37.1 34.8 36.3 34.Group IV. UST reform, an increase in the retirement age and cuts in privileges 42: low growth 35.3 35.7 29.8 31.1 31.2 33.1 32.8 34.6 36.4 33.8 35.5 33.44: high growth 35.6 36.0 30.0 31.3 31.4 33.4 33.3 35.3 38.0 35.7 37.3 35.Table A4.2. Affordable average replacement rate in the pay-as-you-go pillar, % Scenarios 2003 2004 2005 2006 2007 2008 2009 2010 2020 2030 2040 Group I: Base scenarios 11: low growth, slow reforms 33.6 33.2 32.5 31.7 31.4 31.0 30.5 30.0 24.2 21.8 19.5 16.12: low growth, advanced reforms 34.0 33.9 33.6 33.2 33.1 32.9 32.7 32.2 26.5 23.8 21.5 18.13: high growth, slow reforms 33.6 33.2 32.5 31.7 31.4 31.0 30.6 30.0 24.6 22.1 19.9 16.14: high growth, advanced reforms 34.3 34.2 33.8 33.4 33.4 33.2 33.1 32.8 27.8 25.3 22.8 19.Group II. With the UST reform (cuts in the pension contribution rates) 22: low growth 34.0 34.6 29.1 28.6 28.5 28.3 28.1 27.6 22.6 20.2 18.2 15.24: high growth 34.3 34.9 29.3 28.8 28.7 28.6 28.5 28.2 23.6 21.4 19.3 16.Group III. With the UST reform and increase in the retirement age 32: low growth 34.0 34.6 29.1 30.3 30.4 32.2 32.0 33.8 34.1 31.1 29.7 25.34: high growth 34.3 34.9 29.3 30.5 30.6 32.6 32.5 34.4 35.7 33.0 31.6 27.Group IV. UST reform, an increase in the retirement age and cuts in privileges 42: low growth 35.3 35.7 29.8 31.1 31.2 33.1 32.8 34.6 34.9 31.8 30.4 26.44: high growth 35.6 36.0 30.0 31.3 31.4 33.4 33.3 35.3 36.5 33.8 32.3 27. Table A4.3. Affordable average replacement rate in the fully funded pillar, % Scenarios 2003 2004 2005 2006 2007 2008 2009 2010 2020 2030 2040 Group I: Base scenarios 11: low growth, slow reforms 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.1 2.7 5.0 6.12: low growth, advanced reforms 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.2 2.6 4.6 6.13: high growth, slow reforms 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.0 2.5 4.8 6.14: high growth, advanced reforms 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.1 2.5 4.3 5.Group II. With the UST reform (cuts in the pension contribution rates) 22: low growth 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.1 2.5 4.5 6.24: high growth 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.1 2.4 4.2 5.Group III. With the UST reform and increase in the retirement age 32: low growth 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.4 1.9 4.9 7.34: high growth 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.4 1.8 4.7 7.Group IV. UST reform, an increase in the retirement age and cuts in privileges 42: low growth 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.5 2.0 5.1 7.44: high growth 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.4 1.9 4.9 7.Table A4.4. Overall affordable average replacement rate adjusted for the personal income tax (13%), % Scenarios 2003 2004 2005 2006 2007 2008 2009 2010 2020 2030 2040 Group I: Base scenarios 11: low growth, slow reforms 38.6 38.1 37.3 36.5 36.1 35.6 35.1 34.4 29.1 28.1 28.3 27.12: low growth, advanced reforms 39.1 39.0 38.6 38.2 38.1 37.9 37.6 37.0 31.8 30.4 29.9 28.38.6 38.1 37.3 36.5 36.1 35.6 35.2 34.5 29.3 28.3 28.4 27.13: high growth, slow reforms 39.5 39.3 38.9 38.4 38.3 38.2 38.1 37.7 33.2 31.9 31.2 29.14: high growth, advanced reforms Group II. With the UST reform (cuts in the pension contribution rates) 39.1 39.8 33.4 32.9 32.8 32.5 32.3 31.8 27.2 26.1 26.1 24.22: low growth 39.5 40.2 33.6 33.1 33.0 32.9 32.7 32.4 28.4 27.4 27.1 25.24: high growth Group III. With the UST reform and increase in the retirement age 39.1 39.8 33.4 34.9 35.0 37.1 36.8 38.8 40.8 37.9 39.8 37.32: low growth 39.5 40.2 33.6 35.1 35.2 37.4 37.3 39.6 42.6 40.0 41.7 39.34: high growth Group IV. UST reform, an increase in the retirement age and cuts in privileges 40.6 41.0 34.3 35.8 35.9 38.0 37.7 39.8 41.8 38.8 40.8 38.42: low growth 40.9 41.3 34.5 36.0 36.1 38.4 38.3 40.6 43.7 41.0 42.8 40.44: high growth Table A4.5. Real overall affordable replacement rate (replacement rate adjusted for the share of informal wages in the total payroll) Scenarios 2003 2004 2005 2006 2007 2008 2009 2010 2020 2030 2040 Group I: Base scenarios 11: low growth, slow reforms 20.16 22.25 23.65 24.59 25.51 26.12 26.52 26.61 24.06 22.99 22.64 21.12: low growth, advanced reforms 20.40 22.78 24.49 25.76 26.95 27.79 28.38 28.59 26.35 24.85 23.99 22.13: high growth, slow reforms 20.16 22.26 23.67 24.61 25.53 26.15 26.56 26.65 24.27 23.15 22.72 21.14: high growth, advanced reforms 20.60 22.97 24.66 25.90 27.13 28.05 28.78 29.16 27.48 26.13 24.98 22.Group II. With the UST reform (cuts in the pension contribution rates) 22: low growth 20.40 23.25 21.18 22.19 23.20 23.89 24.38 24.54 22.52 21.35 20.88 19.24: high growth 20.60 23.44 21.33 22.31 23.35 24.12 24.72 25.02 23.48 22.43 21.69 20.Group III. With the UST reform and increase in the retirement age 32: low growth 20.40 23.25 21.18 23.53 24.73 27.20 27.79 29.99 33.74 31.02 31.88 29.34: high growth 20.60 23.44 21.33 23.66 24.90 27.47 28.18 30.58 35.24 32.76 33.44 30.Group IV. UST reform, an increase in the retirement age and cuts in privileges 42: low growth 21.17 23.95 21.74 24.14 25.37 27.91 28.50 30.76 34.59 31.79 32.71 30.44: high growth 21.37 24.14 21.89 24.27 25.54 28.18 28.90 31.36 36.13 33.57 34.31 31.Table A4.6. Ratio of the overall affordable average pension to the minimum subsistence level, % Scenarios 2003 2004 2005 2006 2007 2008 2009 2010 2020 2030 2040 Group I: Base scenarios 11: low growth, slow reforms 105 105 105 105 105 110 110 110 120 150 185 12: low growth, advanced reforms 105 110 110 115 115 115 115 115 135 200 280 13: high growth, slow reforms 105 110 110 115 115 120 120 125 150 185 240 14: high growth, advanced reforms 105 110 115 120 120 125 125 130 170 265 395 Group II. With the UST reform (cuts in the pension contribution rates) 22: low growth 105 115 100 100 100 105 105 105 130 185 265 24: high growth 105 115 100 105 110 110 115 115 160 250 375 Group III. With the UST reform and increase in the retirement age 32: low growth 105 115 100 105 110 120 120 130 190 270 410 34: high growth 105 115 100 110 115 125 130 145 240 360 580 Group IV. UST reform, an increase in the retirement age and cuts in privileges 42: low growth 110 120 105 110 115 125 125 135 205 285 435 44: high growth 110 120 105 115 120 135 135 150 250 380 610 Table A4.7. Additional funding needed to maintain the replacement rate at 30%, as a share of GDP Scenarios 2003 2004 2005 2006 2007 2008 2009 2010 2020 2030 2040 Group I: Base scenarios 11: low growth, slow reforms -0.60 -0.55 -0.45 -0.30 -0.25 -0.20 -0.10 0.00 1.15 1.55 1.65 2.12: low growth, advanced reforms -0.70 -0.70 -0.65 -0.60 -0.60 -0.55 -0.55 -0.45 0.55 0.90 1.10 1.13: high growth, slow reforms -0.60 -0.55 -0.45 -0.35 -0.25 -0.20 -0.10 0.00 1.10 1.45 1.60 2.14: high growth, advanced reforms -0.75 -0.75 -0.70 -0.65 -0.65 -0.65 -0.60 -0.55 0.25 0.55 0.75 1.Group II. With the UST reform (cuts in the pension contribution rates) 22: low growth -0.70 -0.85 0.20 0.25 0.30 0.35 0.40 0.50 1.70 2.10 2.35 3.24: high growth -0.75 -0.90 0.15 0.25 0.25 0.30 0.30 0.40 1.35 1.70 1.95 2.Group III. With the UST reform and increase in the retirement age 32: low growth -0.70 -0.85 0.20 -0.05 -0.10 -0.40 -0.35 -0.65 -1.00 -0.55 -0.90 -0.34: high growth -0.75 -0.90 0.15 -0.10 -0.10 -0.45 -0.45 -0.80 -1.20 -0.85 -1.15 -0.Group IV. UST reform, an increase in the retirement age and cuts in privileges 42: low growth -0.90 -1.05 0.05 -0.20 -0.25 -0.60 -0.55 -0.85 -1.20 -0.75 -1.10 -0.44: high growth -1.00 -1.10 0.00 -0.25 -0.30 -0.65 -0.65 -0.95 -1.40 -1.05 -1.35 -1.Table A4.8. Average replacement rate in the pay-as-you-go system if the pension indexation rules remain to be based on the currently effective legislation, % Scenarios 2003 2004 2005 2006 2007 2008 2009 2010 2020 2030 2040 Group I: Base scenarios 11: low growth, slow reforms 31.7 30.9 30.0 28.9 28.4 27.8 27.2 26.5 19.2 15.3 12.7 10.12: low growth, advanced reforms 31.8 30.8 29.9 29.1 28.8 28.4 28.0 27.4 19.6 14.7 11.8 9.31.7 30.5 29.2 27.9 27.2 26.4 25.7 24.8 17.5 14.0 11.6 9.13: high growth, slow reforms 14: high growth, advanced reforms 31.7 30.5 29.4 28.3 27.8 27.4 26.9 26.3 18.5 14.0 11.3 9.Group II. With the UST reform (cuts in the pension contribution rates) 22: low growth 31.8 30.7 29.6 28.7 28.4 27.9 27.4 26.8 19.0 14.4 11.9 10.24: high growth 31.7 30.3 29.1 27.9 27.4 26.8 26.3 25.7 18.0 13.9 11.4 9.Group III.

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