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This paper studies the effect of income (wealth) inequality on interpersonal trust. We propose a theoretical framework that links trust, trustworthiness and inequality. The key feature is that agents do not necessarily observe the entire income distribution but base their assessment on reference groups (i.e. they might hold a biased view of reality). In this framework the negative impact of inequality on interpersonal trust is related to the individual-specific perception of inequality. This has important implications for the empirical analyses since researchers typically do not observe perceptions but only objective measures of inequality (e.g. the Gini coefficient). We show that the use of the latter is appropriate only under restrictive assumptions and in general will result in an underestimation of the true effect. An unbiased estimate of the effect of inequality on trust can be obtained with a measure of individual-specific perceptions of inequality. Survey data support our framework. Perceptions of higher inequality exert a strong negative effect on trust. Supplementary Information The online version contains supplementary material available at (10.1007/s10888-021-09490-x).

This paper studies how the rates of deduction for early retirement have to be determined in pay-as-you-go (PAYG) systems in order to keep their budget stable. The derivation of these deductions requires the use of a multiperiod intertemporal budget constraint that involves assumptions about the retirement behavior of past, present, and future cohorts. In general, it is not possible to calculate budget-neutral deductions from the budget constraint of a single individual who retires before the target retirement age—an approach that dominates the related literature. Only for specific cases one can use this second approach but then one has to adjust the discount rate to the assumption about collective retirement. If there is only one deviating individual, then the right choice is the market interest rate while for a stationary retirement distribution it is the internal rate of return of the PAYG system. In this case, the necessary deductions are lower than under the standard approach. This is also true for retirement ages that fluctuate randomly around a stationary distribution. Various long-run developments (e.g., increases in life expectancy or permanent changes in the average retirement age) might cause challenges for the sustainability of the pension system. These developments, however, can only be dealt with by adequate adjustments to the basic pension formulas and not by the use of deduction rates.

In this paper, I study how pay-as-you-go pension systems of the notional defined contribution type can be designed such that they remain financially stable in the presence of increasing life expectancy. For this to happen three crucial parameters must be set in an appropriate way: the notional interest rate, the adjustment rate and the annuity conversion factor. I show that there exist two main approaches to implement a stable system. The first uses period-specific annuitization and indexation rates that correct for labor force increases, which are only due to rises in the retirement age which are necessary to ‘neutralize’ the increase in life expectancy. The second approach uses cohort-specific annuitization and indexation rates that are larger than in a stationary situation. This is due to the fact that a continuously increasing life expectancy leads to higher internal rates of return that can be passed on via the indexation.

Subjective views of the extent of inequality and preferences for redistribution depend on how people perceive the true income (wealth) distribution. We present a novel formal framework in which individuals look at reference groups when guessing the extent of inequality and derive its implications for four dimensions of inequality perceptions. First, we show that the presence of reference groups that put more weight on the own income class leads low (high) income individuals to overestimate (underestimate) their own position. Second, the framework implies that subjective estimates of the average income increases with the own income position. Third, it predicts that people in different income deciles will assess the "distributional shape" of society (e.g. pyramid or diamond) differently. Fourth, the subjective extent of inequality is lower for high-income individuals. While the previous literature has treated these aspects of inequality separately, our model demonstrates that they are connected and follow from a unified framework of reference group formation. This allows us to study these and to reconcile conflicting findings from the literature. We confront these predictions with survey data from 40 countries and find strong support for the model.

In this paper I study the impact of increasing longevity on pay-as-you-go pension systems. First, I show that increasing longevity increases the internal rate of return. The size of the effect differs for different policy regimes. It is higher for the case where the retirement age is increased to keep the system in balance than for the case where the necessary adjustment is achieved by reducing pension benefits. Second, I study optimally chosen retirement decisions and I show that the socially optimal policy involves a shorter working life than the private optimum. The social optimum can be implemented by the use of a PAYG system that combines an actuarial and a flat pension.