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Distributive concerns when replacing a pay-as-you-go system with a fully funded system


  • Valdes-Prieto, Salvador


The author uses a simulation model to quantify the impact on income distribution of having a neutral social security program that is fully funded replace a progressive social security program that redistributes income toward the poor but is financed by a pay-as-you-go method. He finds that if the original pay-as-you-go system is large enough to yield an income replacement rate of at least 40 percent for the middle class and 200 percent for the poor, then the proposed change helps the poor in the long run, so long as public debt does not increase by more than 40 percent of GDP during the transition. Such a reform allows an increase in the capital stock per worker, so in the long run the poor benefit more through higher real wages than they lose because progressive redistribution has ended. In the short run, however, a compensatory program is needed because the poor lose their subsidy before receiving the long-term benefit. In most cases, the 40 percent of GDP available from the increase in public debt is enough to finance a transfer program that compensates the poor in the"short"run (the first 50 years). The author concludes that concern about the welfare of the poor is unwarranted, in both the short and long runs, if the compensatory program is implemented.

Suggested Citation

  • Valdes-Prieto, Salvador, 1994. "Distributive concerns when replacing a pay-as-you-go system with a fully funded system," Policy Research Working Paper Series 1366, The World Bank.
  • Handle: RePEc:wbk:wbrwps:1366

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    References listed on IDEAS

    1. Feldstein, Martin & Liebman, Jeffrey B., 2002. "Social security," Handbook of Public Economics,in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 32, pages 2245-2324 Elsevier.
    2. Breyer, Friedrich & Straub, Martin, 1993. "Welfare effects of unfunded pension systems when labor supply is endogenous," Journal of Public Economics, Elsevier, vol. 50(1), pages 77-91, January.
    3. Frankel, Jeffrey A, 1992. "Measuring International Capital Mobility: A Review," American Economic Review, American Economic Association, vol. 82(2), pages 197-202, May.
    4. Diamond, P. A., 1977. "A framework for social security analysis," Journal of Public Economics, Elsevier, vol. 8(3), pages 275-298, December.
    5. Atkinson, A.B., 1987. "Income maintenance and social insurance," Handbook of Public Economics,in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 2, chapter 13, pages 779-908 Elsevier.
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