The Choice of the Life Cycle Earnings Profile for Long-run Fiscal Policy Simulations
Life cycle earnings profiles describe the change in the income level of private households over the course of their working life. Considering the broad differentiation between households, an aggregation into stylised types of households pays off when estimating a wage function or computing the present value of life time income. Typically the life cycle earnings profile shows a hump-shaped pattern, with a steep increase in earnings during the first years after entering the work force, a peak within the last third of the working life and a slight decline in the years immediately before retirement. This shape can be explained by the human capital approach but applies more or less exclusively to households with continuous participation in the labour force. Variations in individual participation, the amount of part-time work, and the average income per unit of time spent on work are the main determinants of individual household income. Thus if any of these factors varies systematically over the life time we will be confronted with non-constant life cycle earnings profiles. Combined with demographic change, this implies that the average income of households will change over time. In this case the long-run impact of changes in policy measures related to actual income (e.g., revenues from income tax or social security contributions) will be sensitive with respect to changes in the demographic composition of the labour force. The distribution of the average monthly contribution base for social security payments over age groups can be interpreted as a life cycle earnings profile for simulation purposes. This distribution represents a cross-section over all participants in the labour market covered by mandatory social insurance in a particular year. The income is corrected for hiring and firing during the month but not for part time work. Thus it provides an accurate measure of average earnings for a given age group by considering all variations in the earnings level and in the amount of part-time work within that age group. For simulations outside the social security system, the upper limit for the contribution base has to be taken into account. Otherwise approximately 11 percent of the income (in the case of employees) will be lost.
Die Wahl des Lebenseinkommensverlaufes für langfristige fiskalpolitische Simulationen; The Choice of the Life Cycle Earnings Profile for Long-run Fiscal Policy Simulations
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