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Coping with Rational Prodigals: A Theory of Social Security and Savings Subsidies

  • STEFAN HOMBURG

The rational prodigality argument, which often serves to justify social security, is considered in a second-best tax framework with endogenous labour supply. Rational prodigality renders the familiar policies time-inconsistent. I analyse time-consistent policies and show that a wage tax suffices to rule out prodigality as a rational strategy. However, by using savings subsidies the solution can be improved upon. The subsidies are shown to be decreasing in income. A social security system with increasing contributions is not needed in either case. Copyright (c) The London School of Economics and Political Science 2006.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1468-0335.2006.00447.x
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Article provided by London School of Economics and Political Science in its journal Economica.

Volume (Year): 73 (2006)
Issue (Month): 289 (02)
Pages: 47-58

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Handle: RePEc:bla:econom:v:73:y:2006:i:289:p:47-58
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  1. Casey B. Mulligan & Xavier Sala-i-Martin, 1999. "Social security in theory and practice (II): Efficiency theories, narrative theories and implications for reform," Economics Working Papers 385, Department of Economics and Business, Universitat Pompeu Fabra.
  2. Varian, Hal R., 1980. "Redistributive taxation as social insurance," Journal of Public Economics, Elsevier, vol. 14(1), pages 49-68, August.
  3. Lindbeck, Assar & Weibull, Jorgen W, 1988. "Altruism and Time Consistency: The Economics of Fait Accompli," Journal of Political Economy, University of Chicago Press, vol. 96(6), pages 1165-82, December.
  4. Steven Matthews & John Moore, 1985. "Monopoly Provision of Quality and Warranties: An Exploration in the Theory of Multidimensional Screening," Discussion Papers 661, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Stefan Homburg, 2001. "The Optimal Income Tax: Restatement and Extensions," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 58(4), pages 363-395, November.
  6. Homburg, Stefan, 2000. "Compulsory savings in the welfare state," Journal of Public Economics, Elsevier, vol. 77(2), pages 233-239, August.
  7. Kai A. Konrad & Gert Wagner, 2000. "Reform of the Public Pension System in Germany," Discussion Papers of DIW Berlin 200, DIW Berlin, German Institute for Economic Research.
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