DP6245 The Future of Social Security

Author(s): Martin Gonzalez-Eiras, Dirk Niepelt
Publication Date: April 2007
Keyword(s): labour supply, Markov perfect equilibrium, probabilistic voting, saving, social security
JEL(s): E62, H55
Programme Areas: International Macroeconomics, Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6245

We analyze the effect of the projected demographic transition on the political support for social security, and equilibrium outcomes. Embedding a probabilistic-voting setup of electoral competition in the Diamond (1965) OLG model, we find that intergenerational transfers arise in the absence of altruism, commitment, or trigger strategies. Closed-form solutions predict population ageing to lead to higher social security tax rates, a rising share of pensions in GDP, but eventually lower social security benefits per retiree. The response of equilibrium tax rates to demographic shocks reduces old-age consumption risk. Calibrated to match features of the U.S. economy, the model suggests that, in response to the projected demographic transition, social security tax rates will gradually increase to 16 percent; other policies that distort labour supply will become less important; and in contrast with frequently voiced fears, labour supply therefore will rise.