General Equilibrium Analysis of Fiscal Transfers in an Aging Society

We analyze fiscal transfer policies using a quantitative spatial general equilibrium model given heterogeneous local productivities and amenities, migration of young and elderly population, and inter-regional trade. We confirm that fiscal transfers improve welfare by reducing congestion in urban areas and increasing public services and real wages in rural areas. Contrary to the literature, introducing mobility of elderly population indicates possibility of optimal transfers that enable the central government to accomplish welfare gains without sacrificing national output. We calibrate the model to the Japanese economy and conduct some counterfactual simulations. The results show that Japan's central government's current fiscal transfers improve welfare of young and old population by 17.5% and 20.4%, respectively, compared with a zero-transfer case. However, they reduce national output by 12.5%. If the central government makes the transfers at a uniform rate across regions, it improves welfare of working and old population by 20.3% and 27.2%, respectively, compared with the zero-transfer case, without reducing the national output.