Myopia, Education, and Optimal Social Security

Abstract

A potential role of social security is to protect individuals who have accumulated little or no assets for retirement. Yet, this type of social safety net could reduce human capital formation by making the life-cycle financial rewards from education less attractive. For example, social security tax rates are correlated negatively with tertiary educational attainment across OECD countries. We construct a continuous-time overlapping-generations model with endogenous school duration that can account for this correlation, and we use the model to compute the social security tax rate that maximizes steady-state social welfare in general equilibrium. Social security in the model provides protection for retirees who arrive at retirement with no assets, and it can also redistribute wealth toward those with low earnings, but the program distorts the level of human and physical capital accumulation. In the presence of these characteristics, the social security tax rate that maximizes steady-state welfare is approximately 10%, which is about half of the average rate of 21% across the OECD. This result is robust to whether the social security program is redistributive or earnings-based.