Sustaining Social Security
2004 (English)Report (Other academic)
This paper analyzes the sustainability of intergenerational transfers in politico-economic equililbrium. We argue that these transfers arise naturally in a Markov perfect equilibrium in the fundamental state variables. In contrast to earlier literature, our explanation does not resort to altruism, commitment, or trigger strategies but rests on the incentive for young households to monopolize capital accumulation, as pointed out by Kotlikoff and Rosenthal (1990). Since transfers to the old are instrumental in that respect, the vote-maximizing platform under electoral competition sustains a large social security system. Introducing fully rational voters and probabilistic voting in the standard Diamond (1965) OLG model, we find that transfers in politico-economic equilibrium are too high relative to the social optimum. Standard functional form assumptions yield analytical solutions for both the Ramsey and the probabilistic voting case. Under realistic parameter values, the model predicts a social security tax rate of 12 percent, as compared to a Ramsey tax rate of 3.5 percent. Other predictions of the model are also consistent with the data. Analytical solutions for the case with endogenous labor supply and tax distortions show the results of the model to be robust.
Place, publisher, year, edition, pages
Stockholm: IIES , 2004. , 34 p.
Seminar Paper / Institute for International Economic Studies, Stockholm University. (Online), ISSN 1653-610X ; 731
social security, intergenerational transfers, Markov perfect equilibrium, probabilistic voting, aggregate saving, aggregate labor supply
IdentifiersURN: urn:nbn:se:su:diva-42123OAI: oai:DiVA.org:su-42123DiVA: diva2:343990