The marginal cost of public funds with an aging population

Abstract

As populations in the United States and other advanced economies grow older, the burden of social security and health care financing is expected to rise markedly. Payroll, income, and other taxes on working populations are projected to rise accordingly. The marginal welfare cost to workers of social security and other public expenditures is analyzed within the context of a two-period life-cycle model. By relaxing separability assumptions that have become common in the literature, the theoretical structure properly incorporates the effect of these public expenditures on labor supply. Comparative statics results indicate that the changing age structure is likely to raise the marginal welfare to workers of social security, education, and other public expenditures. Illustrative calculations for the United States confirm this result, suggesting that the cost to workers of incremental social security benefits may easily double by 2025–2050. The cost of education may also rise significantly. These results imply that political pressure from workers to limit social security and other spending may increase over time.