Coping With Rational Prodigals: A Theory Of Social Security And Savings Subsidies
The rational prodigality argument, which often serves to justify social security, is considered in a second-best tax framework with endogenous labor supply. Rational prodigality renders the familiar policies time inconsistent. We analyze time consistent policies and show that a wage tax suffices to rule out prodigality as a rational strategy. However, 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 needed in neither case.
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