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Optimal fiscal policy in the design of Social Security reforms

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  • Juan Carlos Conesa
  • Carlos Garriga

Abstract

The quantitative macroeconomics literature has documented that in the basic Overlapping Generations model a privatization of the social security system, going from a Pay-As-You-Go to a Fully Funded system, generates large long run welfare gains at the cost of substantial welfare losses for initial generations. We propose an alternative to previous literature. In this paper we maximize over the entire policy space, following the optimal fiscal policy approach, rather than comparing alternative policy paths one to one. That is, policies are chosen as part of the optimal design of a social security privatization in a Pareto improving way. The government decides endogenously how to finance the implicit social security liabilities and compensate the initial generations alive during the transition. In contrast with previous analysis the resulting allocation, by construction, lies on the constrained Pareto frontier. We find that the optimal design of reforms exhibits sizeable welfare gains, arising because of the reduction in labor supply distortions. In contrast, the welfare gains coming from the reduction of savings distortions are relatively small.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2007-035.

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Date of creation: 2007
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Publication status: Published in International Economic Review, February 2008, 49(1), pp. 291-318
Handle: RePEc:fip:fedlwp:2007-035

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Keywords: Fiscal policy ; Social security;

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References

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  1. Homburg, Stefan, 2014. "The Efficiency of Unfunded Pension Schemes," Hannover Economic Papers (HEP) dp-523, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  2. Krüger, Dirk & Kubler, Felix, 2005. "Pareto Improving Social Security Reform when Financial Markets Are Incomplete," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5039, C.E.P.R. Discussion Papers.
  3. Juan C. Conesa & Dirk Krueger, 2004. "Taxing Capital: Not a Bad Idea After All," 2004 Meeting Papers 403, Society for Economic Dynamics.
  4. Mendoza, Enrique G. & Razin, Assaf & Tesar, Linda L., 1994. "Effective tax rates in macroeconomics: Cross-country estimates of tax rates on factor incomes and consumption," Journal of Monetary Economics, Elsevier, Elsevier, vol. 34(3), pages 297-323, December.
  5. Andres Erosa & Martin Gervais, 2000. "Optimal taxation in life-cycle economies," Working Paper, Federal Reserve Bank of Richmond 00-02, Federal Reserve Bank of Richmond.
  6. Boldrin, Michele & Montes, Ana, 2002. "The Intergenerational State: Education and Pensions," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3275, C.E.P.R. Discussion Papers.
  7. Thomas F. Cooley & Jorge Soares, 1999. "A Positive Theory of Social Security Based on Reputation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 107(1), pages 135-160, February.
  8. Juan C. Conesa & Dirk Krueger, 1999. "Social Security Reform with Heterogeneous Agents," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(4), pages 757-795, October.
  9. Hansen, G D, 1993. "The Cyclical and Secular Behaviour of the Labour Input: Comparing Efficiency Units and Hours Worked," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 8(1), pages 71-80, Jan.-Marc.
  10. Luisa Fuster & Ayse Imrohoroglu & Selahattin Imrohoroglu, 2003. "A welfare analysis of social security in a dynastic framework," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(4), pages 1247-1274, November.
  11. Martin Feldstein & Andrew Samwick, 1996. "The Transition Path in Privatizing Social Security," NBER Working Papers 5761, National Bureau of Economic Research, Inc.
  12. Martin Feldstein, 1995. "Would Privatizing Social Security Raise Economic Welfare?," NBER Working Papers 5281, National Bureau of Economic Research, Inc.
  13. Gale, David, 1973. "Pure exchange equilibrium of dynamic economic models," Journal of Economic Theory, Elsevier, vol. 6(1), pages 12-36, February.
  14. Lorenzo Forni, 2005. "Social Security as Markov Equilibrium in OLG Models," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(1), pages 178-194, January.
  15. Conesa, Juan Carlos & Garriga, Carlos, 2003. "Status Quo Problem In Social Security Reforms," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 7(05), pages 691-710, November.
  16. Feldstein, Martin S, 1985. "The Optimal Level of Social Security Benefits," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(2), pages 303-20, May.
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Blog mentions

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  1. Branislav Žúdel autorom Kriteka: Nerušme dôchodkovú reformu
    by Kriteko in Kritická ekonómia on 2010-12-20 08:14:14
  2. Social security reform is possible
    by Economic Logician in Economic Logic on 2008-04-08 00:04:00
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