COMPLIANCE RISK AND PENSION SUSTAINABILITY: A POLICY FRONTIER APPROACH
COMPLIANCE RISK AND PENSION SUSTAINABILITY: A POLICY FRONTIER APPROACH

Summary/Abstract: This paper analyses the fiscal and structural implications of a "compliance shock" - a sudden decline in social security contributions - within pay-as-you-go (PAYG) pension systems. We characterise this phenomenon as an immediate budget shock rather than a demographic one, demonstrating that because the ratio of contributors to retirees remains fixed on impact, benefits must fall immediately unless policy intervenes. Our findings reveal that demographic instruments, such as raising the retirement age, are insufficient for short-term stabilisation because they only gradually alter the balance only gradually. Consequently, maintaining benefit stability requires a front-loaded response through contribution rates. We identify a precise policy trade-off frontier between higher contributions and tighter retirement criteria. Under realistic adjustment costs, we show that the optimal long-term response is a hybrid policy mix rather than an extreme reliance on a single instrument. However, statutory contribution caps can render benefit protection infeasible, making retirement-age increases a necessity rather than a choice, especially as future demographic ageing intensifies. Our calibration suggests that these shocks generate economically significant pressures, with the timing and sequencing of reforms determined by the relative costs of each policy tool. Regardless of the specific pension philosophy (Bismarckian or Beveridgean), the underlying fiscal mechanics remain consistent. We conclude that pension systems should internalise compliance risk by adopting automatic balancing mechanisms. By replacing ad hoc crisis management with predictable state-contingent adjustments, policymakers can better stabilise expectations and ensure long-term institutional resilience.

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