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The effects of population aging on optimal redistributive taxes in an overlapping generations model

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  • Craig Brett

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Abstract

The impact of population aging on the steady-state solution to an Ordover and Phelps (J. Public Econ. 12:1–26, 1979 ) overlapping generations optimal nonlinear income tax problem with two types of worker and quasilinear-in-leisure preferences is investigated. A decrease in the rate of population growth, which leads to an aging population, increases the relative price of consumption per person in retirement, which tends to decrease optimal consumption for retirees of both skill types. Nevertheless, it is also shown that the optimal marginal income tax rates are independent of the rate of population growth. In addition, the steady-state interest rate unambiguously declines when the rate of population growth declines. Resulting adjustments in production plans have an ambiguous effect on the aggregate wage rate. This article identifies factors contributing to an increase in the aggregate wage when the population ages, namely normality of consumption in retirement, complementarity between capital and labor in production, and a large capital deepening effect relative to the increase in dependency owing to demographic change. Depending on the sign of this wage effect, ambiguities may arise in the direction of change in the optimal steady-state consumption and production plans. However, when the dependency effect is sufficiently strong, it is possible to sign the direction of change in all production and consumption plans. Moreover, regardless of the direction of change in optimal consumption plans, the absolute value of the changes in consumption plans are smaller for low-skilled workers than for high-skilled when utility is time-separable and preferences exhibit decreasing absolute risk aversion. Adopting, instead, a quasilinear-in-consumption specification of preferences sharpens the comparative statics of consumption allocations, but introduces ambiguity into the effect of the rate of population growth on the optimal marginal income tax rate. Copyright Springer Science+Business Media, LLC 2012

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Bibliographic Info

Article provided by Springer in its journal International Tax and Public Finance.

Volume (Year): 19 (2012)
Issue (Month): 6 (December)
Pages: 777-799

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Handle: RePEc:kap:itaxpf:v:19:y:2012:i:6:p:777-799

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Web page: http://www.springerlink.com/link.asp?id=102915

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Keywords: Optimal income taxation; Overlapping generations model; Population aging; D82; H21;

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  1. Myles,Gareth D., 1995. "Public Economics," Cambridge Books, Cambridge University Press, number 9780521497695, November.
  2. BOADWAY, Robin & PESTIEAU, Pierre, . "Tagging and redistributive taxation," CORE Discussion Papers RP -1932, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  3. Craig Brett & John Weymark, 2008. "Optimal Nonlinear Taxation of Income and Savings without Commitment," Vanderbilt University Department of Economics Working Papers 0805, Vanderbilt University Department of Economics.
  4. Susan A. McDaniel, 2003. "Toward Disentangling Policy Implications of Economic and Demographic Changes in Canada's Aging Population," Canadian Public Policy, University of Toronto Press, vol. 29(4), pages 491-509, December.
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  10. David M. Cutler & James M. Poterba & Louise M. Sheiner & Lawrence H. Summers, 1990. "An Aging Society: Opportunity or Challenge?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1), pages 1-74.
  11. Brett, Craig & Weymark, John A., 2008. "The impact of changing skill levels on optimal nonlinear income taxes," Journal of Public Economics, Elsevier, vol. 92(7), pages 1765-1771, July.
  12. HAMILTON, Jonathan & PESTIEAU, Pierre, 2002. "Optimal income taxation and the ability distribution: implications for migration equilibria," CORE Discussion Papers 2002036, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  13. Ordover, J. A. & Phelps, E. S., 1979. "The concept of optimal taxation in the overlapping-generations model of capital and wealth," Journal of Public Economics, Elsevier, vol. 12(1), pages 1-26, August.
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  15. Pirttila, Jukka & Tuomala, Matti, 2001. "On optimal non-linear taxation and public good provision in an overlapping generations economy," Journal of Public Economics, Elsevier, vol. 79(3), pages 485-501, March.
  16. Laurent Simula, 2007. "Optimality conditions and comparative static properties of non-linear income taxes revisited," PSE Working Papers halshs-00588074, HAL.
  17. Craig Brett & John A. Weymark, 2008. "Public Good Provision And The Comparative Statics Of Optimal Nonlinear Income Taxation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 49(1), pages 255-290, 02.
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  19. Meijdam, L. & Verbon, H.A.A., 1995. "Aging and public pensions in an overlapping-generations model," Discussion Paper 1995-38, Tilburg University, Center for Economic Research.
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