Reforming China’s public pension system: Fiscal sustainability and the challenge of formality-based inequality

This paper examines the design of China’s public pension system, addressing two major challenges: fiscal unsustainability caused by population aging and significant pension disparities between formal and informal workers. Using a dynamic quantitative model with long-run macro and demographic trends, we assess the effects of the ongoing reforms and offer several options to deepen the reform: indexing pension benefits solely to the CPI, raising the resident pensions, and replacing pension financing from payroll tax with consumption tax. Our findings indicate that the delayed retirement policy announced in September 2024 could substantially mitigate fiscal deficits in the coming decades. Among the options evaluated, raising resident pension alleviates the formality-based pension inequality but increases fiscal burden; altering benefit indexation or the tax base for pension financing enhances both fiscal sustainability and welfare outcomes; the effects of consumption tax are particularly pronounced in the long run. • The paper studies impact of China’s pension reforms on fiscal budget and inequality. • The paper builds a dynamic model with long-run macro and demographic trends. • The 2024 delayed retirement policy significantly reduces long-term pension deficits. • Indexing pension benefits only to CPI lowers deficits and improves welfare outcomes. • Financing pensions through consumption taxes strengthens fiscal and welfare results.