Life-cycle General Equilibrium Research Articles

Life cycle analysis of savings accounts with matching contributions

In this study, we examined the macroeconomic effects and welfare implications of the new voluntary saving accounts enacted in Turkey. The most salient features of these accounts include tax advantages, government matching contributions, and the fees levied on returns and contributions. Using an overlapping generations model, we demonstrated that the new saving accounts with no fees eventually raise the capital stock by 29.7% and the net saving rate by 0.50 percentage points. Our long-run analysis yielded two other noteworthy results. First, matching contributions generate stronger saving incentives than the tax advantages. Second, the fees implemented on these accounts curtail higher contributions and hence should be eliminated. The transition analysis revealed that the low- and medium-income young individuals benefit the most during the implementation phase of the plan. In contrast, the old-age high-income group incurred a loss. Hence, a government, with long-run commitment to the current system, can achieve a substantial increase in the capital stock and promote the well-being of the least advantaged group, that is, young and low-income individuals in the economy. • Life-cycle general equilibrium analysis of voluntary savings accounts. • Key features are the match on contributions, tax advantages, and fees collected. • Analyze the welfare effects in the long run and during the transition. • The match on contributions increases savings and capital stock. • The welfare of the young and low-income groups improve during transition.

Financial Frictions and Firm Informality: A General Equilibrium Perspective

Abstract This paper assesses the extent to which financial development and informality are related, and how this relation translates into differences in GDP and TFP across countries. To this end, we develop a quantitative life-cycle general equilibrium model of occupational choice with imperfect tax enforcement, in which informal entrepreneurs have no access to credit and face an endogenous probability of being caught for tax evasion. Our quantitative analysis shows that the degree of financial frictions of a country is crucial in shaping the firm’s incentives to evade taxation, a feature that, in the aggregate, results into a non-linear relationship between financial development and both the size of informality and GDP per capita. We test these model’s predictions with cross-country data and find supporting evidence in favour of both non-linearities.

Life Cycle Models, Heterogeneity of Initial Assets, and Wealth Inequality

Life cycle general equilibrium models with heterogeneous agents have a very hard time reproducing the American wealth distribution. A common assumption made in this literature is that all young adults enter the economy with no initial assets. In this article, we relax this assumption – not supported by the data – and evaluate the ability of an otherwise standard life cycle model to account for the U.S. wealth inequality. The new feature of the model is that agents enter the economy with assets drawn from an initial distribution of assets. We found that heterogeneity with respect to initial wealth is key for this class of models to replicate the data. According to our results, American inequality can be explained almost entirely by the fact that some individuals are lucky enough to be born into wealth, while others are born with few or no assets.

Health care reform or more affordable health care?

This article investigates the impact on the U.S. economy of making health care more affordable. We compare health care cost reductions with the Patient Protection and Affordable Care Act (ACA) using a rich life cycle general equilibrium model with heterogeneous agents. We evaluate a wide range of cost reductions ranging from 0.64% (realistic and feasible) to 29.5% (equivalence with OECD). Our results show that the ACA is more effective in reducing uninsured population than all cost reductions considered. This result holds throughout the life cycle and for the most fragile part of the population: the poorest, the less educated, and those with bad health. Realistic and feasible cost reductions are less welfare improving than the ACA. The increase of welfare induced by the reform is around 7.8 times higher than the increase provided by cost reductions. Besides, the poorer are more benefited than the richer after the reform, while the opposite occurs after cost reductions. Finally, to obtain the same welfare increase of the ACA, medical costs have to decrease by 5.21%, a very hard task. These results provide support for the ACA against opponents who might present cost reductions as alternatives.

On the existence of stable population in life cycle models

A common assumption adopted in life cycle general equilibrium models is that the population is stable at steady state, that is, its relative age distribution becomes constant over time. An open question is whether the demographic assumptions commonly adopted in these models in fact imply that the population becomes stable. In this article we prove the existence of a stable population in a demographic environment where both the age-specific mortality rates and the population growth rate are constant over time, the setup commonly adopted in life cycle general equilibrium models. Hence, the stability of the population do not need to be taken as assumption in these models.

Social security and retirement across the OECD

Employment to population ratios differ markedly across Organization for Economic Cooperation and Development (OECD) countries, especially for people aged over 55 years. In addition, social security features differ markedly across the OECD, particularly with respect to features such as generosity, entitlement ages, and implicit taxes on social security benefits. This study postulates that differences in social security features explain many differences in employment to population ratios at older ages. This conjecture is assessed quantitatively with a life cycle general equilibrium model of retirement. At ages 60–64 years, the correlation between the simulations of this study׳s model and observed data is 0.67. Generosity and implicit taxes are key features to explain the cross-country variation, whereas entitlement age is not.

The effect of social security, health, demography and technology on retirement

This article studies the determinants of the labor force participation of the elderly and investigates the factors that may account for the increase in retirement in the second half of the last century. We develop a lifecycle general equilibrium model with endogenous retirement that embeds Social Security legislation and Medicare. Individuals are ex ante heterogeneous with respect to their preferences for leisure and face uncertainty about labor productivity, health status and out-of-pocket medical expenses. The model is calibrated to the U.S. economy in 2000 and is able to reproduce very closely the retirement behavior of the American population. It reproduces the peaks in the distribution of Social Security applications at ages 62 and 65 and the observed facts that low earners and unhealthy individuals retire earlier. It also matches very closely the increase in retirement from 1950 to 2000. Changes in Social Security policy – which became much more generous – and the introduction of Medicare account for most of the expansion of retirement. In contrast, the isolated impact of the increase in longevity was a delaying of retirement.

Rising Earnings Instability, Portfolio Choice, and Housing Prices

This paper studies the efiects of the U.S. rising earnings inequality between the late 1960s and the mid 1990s on the portfolio allocation and prices of assets. In order to investigate the link, a life-cycle general equilibrium model is constructed where distinct characteristics of the housing asset is explicitly modeled and asset prices are determined in equilibrium. It is shown that the model can produce a 9% rise in the housing price, which is about 40% of the changes in the U.S. data (24%). An increased demand for precautionary savings and the general equilibrium efiect play a crucial role here. A higher earnings volatility induces a higher demand for flnancial assets. As the return of flnancial assets declines due to the general equilibrium efiect, the demand for housing assets increases as well. The paper also examines the efiects of the rising earnings inequality on the aggregate amount of debt. Interestingly, contrary to the U.S. data, the model predicts a decline in the total amount of secured debt. A higher earnings volatility induces a higher amount of debt in complete markets models, but an increased demand for savings for precautionary motive dominates the positive efiect to the amount of debt. The model also shows that incorporating housing assets into the model does not make a signiflcant difierence in the efiect of the rising earnings inequality on the consumption inequality.

Hunting the Unobservables for Optimal Social Security

We study the optimal size of a pay-as-you-go social security program for an economy composed of both permanent-income and hand-to-mouth consumers. While previous work on this topic is framed within a two-period partial equilibrium setup, we study this issue in a life-cycle general equilibrium model. Because this type of welfare analysis depends critically on unobservable preference parameters, we methodically consider all parameterizations of the unobservables that are both feasible and reasonable—all parameterizations that can mimic key features of macro data (feasible) while still being consistent with micro evidence and convention (reasonable). The baseline model predicts that the optimal tax rate is between 6 percent and 15 percent of wage income.

Optimal Tax Combination in an Aging Japan

This paper searches for a desirable tax combination in the coming aging society. It looks at the Japanese tax and social security systems through an extended life-cycle general equilibrium simulation model and evaluates the macroeconomic and welfare effects of alternative tax policies in an aging Japan. Simulation results show that an increase in the rate of tax on consumption and a decrease in the rate of tax on interest income may be a desirable tax combination under conditions of revenue neutrality, because the combination substantially promotes capital formation and brings with it a significant improvement in social welfare.

An Optimal Rate of the National Burden in an Aging Japan

This paper examines an optimal rate of the national burden to establish guidelines for fiscal reform in Japan's graying society. The paper looks at Japanese tax and social security systems through an extended life-cycle general equilibrium simulation model. It explicitly considers the benefits that the government provides to households, which enables us to comprehensively evaluate the balance between benefits and burdens. Simulation results show that an optimal rate of the national burden is high when households put a great utility weight on the benefits coming from public services, and that it is low when the degree of publicness of government expenditure is high. The results also suggest that an optimal rate of the national burden would rise as Japan ages and may exceed 50% during the rapid aging of its population.

Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax

America's aging coupled with high and growing old-age health and pension benefits augers for much higher payroll taxes, with damaging effects on the U. S. economy. This prognosis is supported by our analysis of a detailed dynamic life-cycle general equilibrium model. The FairTax, which proposes to replace the federal payroll, personal income, corporate income, and estate tax with a progressive consumption tax, offers a potential alternative to this dismal economic future. According to our simulation model, these policy changes would lead to major improvements in the U.S. capital stock, long-run real wages and the well-being of the majority of Americans.

Simulating progressive expenditure taxation in an aging Japan

This paper investigates the quantitative effects of tax reform from progressive labor income taxation toward progressive expenditure taxation on efficiency and equity in Japan, a society with an aging population. To analyze this problem, we employ a comparative steady state simulation approach for an extended life-cycle general equilibrium model of overlapping generations with different lifetime earnings ability. The simulation results suggest some advantages of a new tax system of progressive expenditure taxation.

The Insurance Role of Social Security: Theory and Lessons for Policy Reform

This paper examines the impact of social security on welfare. The provision of social security reduces precautionary savings and encourages early retirement. Consequently, it lowers aggregate capital, employment, output, and consumption. On the other hand, it also provides old age insurance. This trade-off is examined using a life-cycle general equilibrium model. The paper finds that the current U.S. Social Security system can improve welfare even though the levels of aggregate output, employment, capital, and consumption fall relative to their levels without such a system. The welfare gains arise from insurance against living much longer than expected.

The Insurance Role of Social Security: Theory and Lessons for Policy Reform

This paper examines the impact of social security on welfare. The provision of social security reduces precautionary savings and encourages early retirement. Consequently, it lowers aggregate capital, employment, output, and consumption. On the other hand, it also provides old age insurance. This trade-off is examined using a life-cycle general equilibrium model. The paper finds that the current U.S. Social Security system can improve welfare even though the levels of aggregate output, employment, capital, and consumption fall relative to their levels without such a system. The welfare gains arise from insurance against living much longer than expected.

Rent Control and General Equilibrium

This paper develops a life cycle general equilibrium model of rent control. Households choose between renter and owner profiles based on utility maximization. Owners have a lower user cost of capital, but must save for a downpayment to purchase a house. Rent control results in low-quality housing being built, but no shortage in the number of units. The model predicts a decline in the utility of all households, including renters. This result is in contrast to previous work on rent control which has found benefits accruing to occupants of rent-controlled apartments. One explanation is found in the difficulty of measuring quality in the data used by others. The model demonstrates endogenous incentives for rent control regulations to weaken over time since the utility of all three groups of households (renters, middle-income owners, and high-income owners) is reduced by rent control.

Capital income taxation in a two-commodity life cycle model: The role of factor intensity and asset capitalization effects

This paper discusses the impact of changes in capital income taxation in a two-commodity life cycle general equilibrium growth model. In contrast to the Solow-Swan one-commodity framework which has been used in previous life cycle policy simulation [Summers (1981), Auerbach et al. (1983), Auerbath and Kotlikoff (1983, 1987)], we use a two-commodity Uzawa (1961, 1963) type model.’ Consumption and capital goods are separately identitied, with an endogenously determined relative price between them. As a result, both asset capitalization effects (changes in the relative price of capital and consumption goods) and factor intensity effects across sectors are captured.’ Calculations with the model suggest that both of these effects