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The Dynamics of Inequality and Social Security in General Equilibrium

  • Zheng Song

    (Fudan University)

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. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2011.05.001
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 14 (2011)
Issue (Month): 4 (October)
Pages: 613-635

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Handle: RePEc:red:issued:09-145
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