Econ 208

Marek KapickaLecture 8

Social Security

Roadmap

Government Expenditures A) Data on Govt Expenditures B) Changes in Gov’t Spending in a

frictionless world C) Changes in Gov’t Spending in a

world with frictions D) Social Security

PAYG Young pay SS taxes t Old receive benefits b Balanced budged each period

PAYG introduced in period T

n

bt

NbtN

1

PAYG for Consumers Who Are Old in Period T

PAYG for Consumers Born in Period T and Later

PAYG for Consumers Born in Period T and Later

Change in wealth depends on r and n

Better off if n>r Worse off if n<r

)1)(1(1

11

rn

rnb

r

yy

r

by

n

bywe

Fully Funded Social Security

Essentially a mandated savings program where assets are acquired by the young, with these assets sold in retirement.

Either ineffective or decreases welfare

Fully Funded Social Security When Mandated Retirement Saving Is Binding

What’s missing in the model?Costs of Fully funded social security

Transition costs It is costly to move from PAYG to FF

Commitment Problems Government cannot commit not to pay to

those who haven’t saved. It may be optimal to have PAYG even if .

Moral Hazard Government cannot commit to help

out those who made risky investments and became unlucky

What’s missing in the model?Costs of PAYG: Fertility declines

Social security tax rate Tau and total Fertility Rate TFR. Source: Boldrin, De Nardi, Jones 2005, “Fertility and Social Security”

What’s missing in the model?Costs of PAYG

Distortions of savings Distortions of labor supply (If

distortionary SS taxes) hours work in any given year years worked (choice of retirement

age)

US Social Security

Social Security in the World

US Social Security

Where are we?

1. Introduction: A model with no Government

2. Government Policies1. The Effects of Government Spending2. Government Taxation and Government

Debt

What To Read

Read Today:

DLS, Chapter 13.2,13.4 The Region, Minneapolis Fed: “European

Vacation”, on the web Next time:

The Washington Post:"Where does the Laffer curve bend? "

Today

Government Taxation 1) The data 2) The effects on Labor Supply 3) The effects on Government

Revenue 4) The effects on GDP

Data on US TaxationFederal Government Revenue

Data on US TaxationAverage Marginal Income Taxes

Taxation

Lump-Sum tax vs. Distortive tax Lump sum tax does not depend on

the actions of the consumer With distortive taxation, the

welfare theorems fail Competitive equilibrium is not Pareto

optimal

Why Distortive Taxation? In reality, lump-sum tax is infeasible

Lump sum means everyone pays the same amount but some people have no wealth

If differences among people are taken into account then a distorting tax is the only possibility

What are the effects of a flat tax on Labor Supply? Government Revenue? GDP? Capital Accumulation?

Where we are

Government Taxation 1) The data 2) The effects on Labor Supply 3) The effects on Government

Revenue 4) The effects on GDP

2) The Effects on Labor SupplyAn Example

Utility of a household

Household problem:

1),(

1LCLCU

wLtCts

LC

)1( ..

1max

1

2) The Effects on Labor Supply

Solution:

Labor Supply decreases in the tax rate

1)1(max

1LwLt

L

1

])1[( wtL

The model and the data E. Prescott (2004). “Why Do Americans Work So Much More Than Europeans?

U.S. vs. France

1990’s: French productivity higher, but labor

supply much lower GDP per person lower in France than

in the USA 1970’s:

French productivity lower, but labor supply slightly higher

Ohanian, Raffo, Rogerson: A more comprehensive study

Compare all the OECD countries for 1956-2004 period

How much can we explain by taxes?

Look for alternative explanations as well.

Conclusion: Taxes are the most important factor behind changes in labor supply

Ohanian, Raffo, Rogerson: The data

Ohanian, Raffo, Rogerson: The Results

Ohanian, Raffo, Rogerson: Other Factors

Compute a labor supply wedge:

Our model predicts that the wedge is equal to the tax rate. What if other factors, outside of the model, affect it as well?

Look at measure of employment protection, union density, unemployment benefit replacement rate, duration benefits

Δ𝑡=1 −𝑀𝑅𝑆𝑙 ,𝑐

𝑀 𝑃𝑁

Ohanian, Raffo, Rogerson: Other Factors