Social security, retirement age and optimal income taxation

It is often argued that implicit taxation on continued activity of elderly workers is responsible for the widely observed trend towards early retirement. In a world of laissez-faire or of first-best efficiency, there would be no such implicit taxation. The point of this paper is that, when first-best redistributive instruments are not available, because some variables are not observable, the optimal policy does imply a distortion of the retirement decision. Consequently, the inducement of early retirement may be part of the optimal tax-transfer policy. We consider a model in which individuals differ in their productivity and their capacity to work long and choose both their weekly labor supply and their age of retirement. We characterize the optimal non-linear tax-transfer that maximizes a utilitarian welfare function when weekly earnings and the length of active life are observable while individuals' productivity and health status are not observable.     

The dynamics of inequality and social security in general equilibrium

This paper analyzes the dynamic politico-economic equilibrium of a model where repeated voting on social security and the evolution of household characteristics in general equilibrium are mutually affected over time. In particular, we incorporate within-cohort heterogeneity in a two-period Overlapping-Generation model to capture the intra-generational redistributive effect of social security transfers. Political decision-making is represented by a probabilistic voting à la Lindbeck and Weibull (1987). We analytically characterize the Markov perfect equilibrium, in which social security tax rates are shown to be increasing in wealth inequality. A dynamic interaction between inequality and social security leads to larger social security programs. In a model calibrated to the U.S. economy, the dynamic interaction is shown to be quantitatively important: It accounts for more than half of the social security growth in the dynamics. We also perform some normative analysis, showing that the politico-economic equilibrium outcomes can be fundamentally different from the Ramsey allocation.     

Optimal taxation with endogenously incomplete debt markets

Empirical analyses of labor tax and public debt processes provide prima facie evidence for imperfect government insurance. This paper considers a model in which the government's inability to commit to future policies or to report truthfully its spending needs renders government debt markets endogenously incomplete. A method for solving for optimal fiscal policy under these constraints is developed. Such policy is found to be intermediate between that implied by the complete insurance (Ramsey) model and a model with exogenously incomplete debt markets. In contrast to optimal Ramsey policy, optimal policy in this model is consistent with a variety of stylized fiscal policy facts such as the high persistence of labor tax rates and debt levels and the positive covariance between government spending and the value of government debt sales.     

Social security and risk sharing

In this paper we identify conditions under which the introduction of a pay-as-you-go social security system is ex ante Pareto-improving in a stochastic OLG economy with capital accumulation and land. We argue that these conditions are consistent with realistic specifications of the parameters of the economy. In our model financial markets are complete and competitive equilibria interim Pareto efficient. Therefore, a welfare improvement can only be obtained if agents? welfare is evaluated ex ante, and arises from an improvement in intergenerational risk sharing. We also examine the optimal size of a given social security system as well as its optimal reform.     

Quasi-hyperbolic discounting and social security systems

Hyperbolic discounting has become a common assumption for modeling bounded rationality with respect to individual savings decisions. We examine the effects of hyperbolic discounting on the comparison of alternative social security systems. We show that this form of bounded rationality breaks the equivalence between funded and pay-as-you-go (PAYG) systems established in Sheshinski and Weiss [Sheshinski, E., Weiss, Y., 1981. Uncertainty and optimal social security. Quarterly Journal of Economics 95, 189-206]. Intergenerational transfers within a PAYG economy are usually secured by the social security system and independent of longevity, whereas this is not the case for the funded economy. The savings level under hyperbolic discounting is lower than under exponential discounting [Laibson et al., 1998], but the ratio between the savings level under hyperbolic discounting within a funded economy and a PAYG economy depends on the effectiveness of the commitment devices. It is shown that if individuals are hyperbolic discounters, then in a PAYG economy any change in the mandated level of intergenerational transfers is neutralized by individuals’ voluntary bequests. This does not apply to a funded system.     

Risky human capital and deferred capital income taxation

We study the structure of optimal wedges and capital taxes in a dynamic Mirrlees economy with endogenous distribution of skills. Human capital is a private, stochastic state variable that drives the skill process of each individual. Building on the findings of the labor literature, we construct a tractable life-cycle model of human capital evolution with risky investment and stochastic depreciation. In this setting, we demonstrate the optimality of (a) a human capital premium, i.e., an excess return on human capital relative to physical capital, (b) a large intertemporal wedge early in the life-cycle, and (c) a non-zero intratemporal wedge even at the top of the skill distribution at all dates except the last date in the life-cycle. The main implication for the structure of optimal linear capital taxes is the necessity of deferred taxation of physical capital. The average marginal tax rate on physical capital held in every period is zero in present value. However, expected capital tax payments do not equal zero in every period. Necessarily, agents face negative expected capital tax payments early in the life-cycle and positive expected capital tax payments late in the life-cycle.     

The impact of changing skill levels on optimal nonlinear income taxes

The impact of changing an individual's skill level on the solution to a finite population version of the Mirrlees optimal nonlinear income tax problem with quasilinear-in-leisure preferences is investigated. It is shown that it is possible to sign the directions of change in everyone's optimal consumptions and optimal marginal tax rates in response to such a change.     

The extension of social security coverage in developing countries

We study the dynamic general equilibrium effects of introducing a social pension program to elderly informal sector workers in developing countries who lack formal risk sharing mechanisms against income and longevity risks. To this end, we formulate a stochastic dynamic general equilibrium model that incorporates defining features of developing countries: a large informal sector, private transfers as an informal safety net, and a non-universal social security system. We find that the extension of retirement benefits to informal sector workers results in efficiency losses due to adverse effects on capital accumulation and the allocation of resources across formal and informal sectors. Despite these losses recipients of social pensions experience welfare gains as the positive insurance effects attributed to the extension of a social insurance system dominate. The welfare gains crucially depend on the skill distribution, private intra-family transfers and the specific tax used to finance the expansion.     

Public debt and optimal taxes without commitment

Benhabib and Rustichini [Optimal taxes without commitment, J. Econ. Theory 77 (1997) 231-259] study the properties of optimal capital taxes in economies without commitment and no government debt. They find that capital taxes may be different from zero at steady state. This note shows that, once governments have the possibility of issuing debt and smoothing taxes over time, optimal steady state capital taxes turn out to be zero.     

Differential mortality and social security

Abstract This paper studies the normative problem of redistribution between individuals who differ in their lifespans. We discuss aspects related to the objective function and argue that aversion to multiperiod inequality should be taken into account. Then, we study the properties of the social optimum both with full information and with asymmetric information. We highlight the role of aversion to multiperiod inequality and show that it has substantial consequences on the design of Social Security schemes. In particular, we show that for a low (resp. high) aversion to multiperiod inequality, a negative (resp. positive) implicit tax rate on continued activity is desirable.     

Optimal environmental taxation and enforcement policy

We study the optimal environmental taxation and enforcement policy when (i) the regulator does not know the firms’ abatement costs, (ii) penalties for tax evasion are limited, and (iii) monitoring of pollution is costly. We show that the threat of being audited alter the usual firms’ incentives to over-estimate their abatement costs. In particular, depending on the firms’ abatement costs, the optimal policy may involve over or under-deterrence compared to the full information outcome. We then investigate the properties of a pollution standard. We show that this policy comes close to an environmental tax once the economic incentives of the accompanying enforcement policy are considered.     

Property taxes and dynamic efficiency: A correction

According to Kim and Lee (1997), property taxes as opposed to capital gain taxes and taxes on rent endanger dynamic efficiency. The present paper shows that the choice of the tax base is immaterial. What counts is whether the taxes eliminate the after-tax rent. Empirical evidence suggests that this is not the case.     

Designing social security - a portfolio choice approach

Public social security systems may provide diversification of risks to individuals’ life-time income. Capturing that a pay-as-you-go system (paygo) may be considered as a “quasi-asset”, we study the optimal size of the paygo system as well as the optimal split between funded and unfunded pension saving by means of a theoretical portfolio choice framework. A low-yielding paygo system can benefit individuals if it contributes to hedge other risks to their lifetime resources. Numerical calculations indicate that optimal social security systems should be at least partly paygo financed in many economies. The optimal magnitude of the paygo system depends on the specified risk concept as well as the stochastic properties of stock market returns and implicit paygo-returns.     

Tax competition in federations revisited

We extend Keen and Kotsogiannis (2002, 2004) by considering all-purpose public goods that are beneficial to both producers and consumers. Horizontal externality (resp. vertical externality) exerted by tax competition will not necessarily lead to inefficient outcomes.     

FIRST‐BEST FISCAL POLICY WITH SOCIAL STATUS*

This paper examines the first‐best fiscal policy in a stochastic, infinite‐horizon representative agent model that exhibits consumption‐enhanced as well as wealth‐enhanced social status in the household utility. We show that the first‐best labour tax rate is a positive constant that is used to correct negative consumption externalities. The first‐best tax rate on capital income is also positive in order to overturn agents' status‐seeking capital over‐accumulation. Moreover, we find that in sharp contrast to a conventional automatic stabilizer, the first‐best capital tax rate moves in the opposite direction with shocks to firms' production technology, thus exacerbating the business cycle.     

How Well Does the Australian Aged Pension Provide Social Insurance?

Social security plays an essential role in an economy, but if designed incorrectly, it can distort individuals' labour supply and savings behaviour. We explore how well the Australian means‐tested pension system provides social insurance by changing the settings of the system and calculating the impact on welfare. In order to exclude trivial welfare gains, we keep the cost of the programmes constant. We find that the means‐tested pension system is welfare reducing, but does provide a better outcome than a PAYG system of equivalent cost. We also find that if the benefit amount is held constant, and hence the cost of the pension programme is allowed to vary, a taper rate of 1.0 is optimal. However, once we hold the cost of the programme constant, a universal benefit scheme provides the best welfare outcome.     

Optimal nonlinear income taxation with a finite population

In the standard optimal income taxation problem, tax payments depend only on each consumer's own actions. Piketty [J. Econ. Theory 61 (1993) 23-41] shows that, if one individual's tax schedule depends on others’ actions and the government knows the exact ability distribution, it can implement any undistorted allocation as the unique revelation game outcome. If some individuals misreveal their types, Piketty's mechanism may assign infeasible allocations. We require that tax schedules must balance the government budget for every possible vector of revelations. When individuals reveal their type by simple announcements, all undistorted allocations can be still implemented, even with off-equilibrium feasibility constraints.     

The strategy-proof provision of public goods under congestion and crowding preferences

We examine the strategy-proof provision of excludable public goods when agents care about the number of other consumers. We show that strategy-proof and efficient social choice functions satisfying an outsider independence condition must always assign a fixed number of consumers, regardless of individual desires to participate. A hierarchical rule selects participants and a generalized median rule selects the level of the public good. Under heterogeneity in agents’ views on the optimal number of consumers, strategy-proof, efficient, and outsider independent social choice functions are much more limited and in an important case must be dictatorial.     

The dual nature of public goods and congestion: the role of fiscal policy revisited

Abstract The role of fiscal policy is examined when public goods provide both productive and utility services. In the presence of congestion, the consumption tax is shown to be distortionary. Optimal fiscal policy involves using consumption‐based instruments in conjunction with the income tax. An income tax‐financed increase in government spending dominates both lump‐sum and consumption tax‐financing. Replacing the lump‐sum tax with an income tax to finance a given level of spending dominates introducing an equivalent consumption tax. These results contrast sharply with the literature, where the consumption tax is generally viewed as the least distortionary source of public finance.     

Optimal policy with credibility concerns

This paper considers a reputation model of optimal taxation in which the public is unsure about the government type. A long-lived government can be trustworthy (meaning that it commits to its announced tax rate) or opportunistic (meaning that it retains the ability to change its tax rate after announcing it). Unlike in most prior studies, the committed strategy in this model is optimally chosen by the trustworthy type. We show that this change has significant consequences for the equilibrium dynamics. The optimal committed strategy is found to vary with the time preferences of the two government types, the initial reputation of the government, and the elasticity of household production. This formulation explains differences in policy responses across governments in the face of similar credibility problems.