Uncertainty and Optimal Social Security Systems
This paper examines the annuity aspect of social security within the framework of an overlapping-generations model. The duration of life is assumed to be uncertain. Under a fully funded system, demand for social security is determined by each generation so as to maximize expected lifetime utility, taking into account the welfare of future generations. Under a pay-as-you-go system with intergenerational transfers, demand for retirement benefits by the working population takes into account taxes paid by descendants. It is shown that the two modes of finance are equivalent in terms of all real aggregates. Effects of changes in expected lifetime and in the birth rate are analyzed. Starting at the optimal level, a compulsory balanced increase in social security taxes and benefits is shown to increase short-run savings.
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