A means-tested pension system has a distinct feature that tailors the level of pension benefits according to individual economic status. In the context of population aging with widening gaps in life expectancies, this feature generates an automatic adjustment mechanism that (i) mitigates the pressing fiscal cost of an old-age public pension program (fiscal stabilization device) and (ii) redistributes pension benefits to those in need with shorter life expectancies (redistributive device).
To evaluate this automatic adjustment mechanism, we employ an overlapping generations model with population aging. Our results indicate that this novel mechanism plays an important role in containing the adverse effects of population aging on the fiscal costs and enhancing the progressivity of a pension system. More pronounced aging scenarios further strengthen the role of this mechanism. A well-designed means test rule can create a sufficiently strong automatic mechanism to keep public pensions sustainable.