||1995|2000|2005|2010|2015|2020|2025|2030|2035|2040|2045|2050|
|---|---|---|---|---|---|---|---|---|---|---|---|---|
|**Pension (RMB 10 billion, in**<br>**1995 yuan)**|||||||||||||
|Revenue|8.5|17.9|19.6|20.5|21.1|21.1|24.8|29.1|34.4|40.8|47.4|53.7|
|Expenditure|8.5|17.3|22.1|27.3|32.6|38.1|44.8|52.3|61.4|74.7|90.9|109.0|
|Annual balance|0.0|0.6|-2.5|-6.8|-11.5|-17.0|-20.0|-23.2|-27.1|-34.0|-43.5|-55.3|
|Accumulated reserve|0.0|3.3|0.6|-20.6|-63.7|-131.8|-222.0|-328.4|-451.2|-598.7|-787.1|-1027.3|
|Balanced contribution rate (%)|25.0|23.3|27.2|31.2|34.5|37.7|35.8|34.3|33.3|33.4|34.2|35.1|
|(with 85 percent compliance rate)|||||||||||||
|System dependency ratio (%)|25.6|28.3|35.6|43.7|52.9|64.0|67.3|68.7|70.5|74.2|77.4|79.2|
|IPD (RMB lObillion in 1995<br>|293.7|632.8|758.4|870.5|990.3|1111.8|1397.9|1731.4|2136.1|2616.6|3159.7|3713.9|
|yuan)<br>IPD as share ofGDP(%)|48.8|71.1|60.1|49.7|41.6|35.1|33.9|32.9|32.5|32.6|33.0|33.1|

Source: Authors.

. The source for these two variables is 1994-95 World Bank 1994b.

It is thus necessary to increase payroll tax rates to maintain the financial viability of the pension system. However, the balanced contribution rate would have to increase from 23.3 percent in 2000 to 37.7 percent in 2020. After this peak the contribution rate will decline but still remain as high as around 35 percent. There is no doubt that the high contribution rates for the pension system will seriously depress investment and reduce the economic growth rate. The results of the baseline calibration confirm that the current PAYGO system is not financially sustainable.

Based on a termination hypothesis and baseline assumptions, implicit pension debt (IPD) would be as high as 71 percent of annual GDP if the current system were terminated in 2000. That is, if pension coverage and benefit do not change over time, the stock of IPD will increase rapidly. However, because the wage growth rate is lower than the assumed GDP growth rate, IPD as a percent age of GDP declines even though its absolute value continues to increase and reaches a very high level (RMB 37,139 billion in 2050).

# **_Policy changes under current pension system_**

If the current pension system in China is not sustainable, the question arises: Could we solve the problem by raising the retirement age (which would reduce the system dependency ratio) and expanding program coverage (which would increase the pooling size of contribution funds) to all SOEs and urban nonstate sectors - and without any fundamental reform of the current pension system?

**Expanding pension system coverage.** In experiment 1.1, the PAYGO coverage in all state-owned enterprises, the urban nonstate sectors and the non-individual sector gradually increase to 100 percent between 1995 and 2005. The pension fund annual balances in the baseline and in experiments 1.1-1.3 are shown in Figure 3. Because the base of the pension system is enlarged, the pension fund will show a surplus in its annual balance during the first few years. The financial situation of the pension system will improve compared with the baseline between 2000 and 2035. However, expanding program coverage worsens the financial situation in the long run, because of a rapidly aging. The annual balance of the pension declines and shows a deficit of as much as RMB766.2 billion by 2050 (exp 1.1). If the pension system is not reformed, it will become a huge direct financial liability for the government, affecting its fiscal sustainability.

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