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On financing retirement with an aging population

  • Ellen R. McGrattan
  • Edward C. Prescott

A problem facing the United States and many other countries is how to finance retirement consumption as the number of their workers per retiree falls. Policy analysts are increasingly advocating a move to a savings-for-retirement system. An apparent problem with this move is the shortage of good savings opportunities given the limited ability of government to honor its debt. We find that there is no problem because there is much more productive capital than commonly assumed in macroeconomic modeling. We also find that eliminating capital income taxes will greatly increase savings opportunities and make a savings-for-retirement system feasible with only a modest amount of government debt. The tax policy changes we consider are phased in smoothly and are relatively modest. The switch from a system close to the current U.S. retirement system, which relies heavily on taxing workers’ incomes and making lump-sum transfers to retirees, to one without capital income taxes will increase the welfare of all birth-year cohorts alive today and particularly the welfare of the yet unborn cohorts.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 472.

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Date of creation: 2012
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Handle: RePEc:fip:fedmsr:472
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