Unfunded Social Security Research Articles

Social security, bequests, and social comparisons

AbstractWe examine the long‐run impact of unfunded social security on capital stock and wealth inequality in an overlapping generations (OLG) model where newborn individuals differ in their inheritance. In our model, individuals' decisions are subject to social comparisons, which can lead to overspending on personal consumption and result in zero bequests left within poor families. In this scenario, unfunded social security increases long‐run wealth inequality by redistributing wealth from poor to rich families, who always leave bequests. However, it increases long‐run capital stock, too. We also show that when none or all of the families leave bequests in the long run, our model predicts negative and neutral effects of social security on capital accumulation, in line with the standard OLG models of Diamond and Barro. Thus, our results emphasize the need to account for heterogeneity in bequest behavior in the analysis of social security.

Vague Pension Future: Empirical Evidence from the Israeli Radical Privatized Market

We examine the future benefits of the Israeli privatized pension system, which is considered as a model of transition to funded pension systems worldwide. This research is based on an extensive database obtained from one of the largest traditional private funds in the market. The results paint a concerning picture regarding the adequacy of benefits and quality of life in old age. Israel’s radical privatized pension model signals a warning to other nations. We show that, even with high returns, most individuals cannot handle the magnitude of financial and labor risks accumulated during their career and retirement. We recommend more balanced government intervention as well as the use of risk-sharing mechanisms such as providing minimum pension guarantee and strengthening the unfunded social security pillar.

Growth and Welfare Implications of Mortality Differentials in Unfunded Social Security Systems

Several recent studies have examined the steady-state welfare implications of mortality differentials within unfunded Social Security systems, concluding that these differentials undermine the progressivity of the system and make society worse-off relative to alternative public pension schemes. This study is the first to systematically investigate the long-run implications of mortality inequality within the U.S. Social Security system. Utilizing an OLG endogenous growth model of the U.S. economy, I compare the current pay-as-you-go (PAYG) system to versions of the model without either mortality differentials or income inequality. I find that the assumption of mortality homogeneity biases the equilibrium growth rate and welfare analysis. The PAYG system is also compared to a fully funded system based on capital subsidies. The model predicts that PAYG suppresses growth and that, for a given range of subsidy rates, the fully funded system Pareto dominates PAYG in both the medium-run and the long-run.

Is an unfunded social security system good or bad for growth? A theoretical analysis of social security systems financed by VAT

AbstractThis study investigates how unfunded public pensions financed by value added tax (VAT), as discussed in Japan, affect economic growth and whether payroll tax (PT) or VAT is the more growth‐friendly tax structure for financing public pensions. We examine these issues using overlapping generations models with parental altruism and find that a public pension system financed by VAT may increase economic growth when bequests are operative. By contrast, when bequests are inoperative, public pensions hinder growth unless agents are sufficiently patient. Finally, public pensions financed by VAT are more growth‐friendly than those financed by PT.

Like Father, Like Son: Inheriting and Bequeathing

Abstract This paper incorporates indirect reciprocal behavior in the context of bequeathing decisions into an otherwise standard OLG model. We provide conditions for the existence of a unique steady state with operative bequests. Contrary to standard OLG models, we show that taking into account such behavioral interactions allows one to rationalize both an increasing and U-shaped pattern of the inheritance to GDP ratio over time, consistent with recent empirical evidence. Moreover, the model predicts a nonlinear (U-shaped) relationship between the size of an unfunded social security program and the long-run stock of per capita capital, which in turn provides a novel explanation of the inconclusive empirical findings on the relationship between social security, savings and long-run growth. Ricardian equivalence is shown to hold in a special case of the model.

An actuarial balance sheet of the Swiss old‐age pension scheme

AbstractFollowing the recent update of the international System of National Accounts (2008 SNA), internationally comparable estimates of accrued‐to‐date pension liabilities (ADL) of unfunded social security pension schemes will soon be available in the supplementary table to the National Accounts. Against this background, this article analyzes the medium‐term sustainability of the Swiss old‐age pension scheme (Alters‐ und Hinterlassenenversicherung – AHV). This is achieved by estimating a “Swedish” actuarial balance sheet, which compares pension liabilities with the explicit and implicit assets of the pension scheme. Our results show that the current financing of the AHV is unsustainable, with about 30 per cent of the liabilities not backed by corresponding assets. In order to close this financing gap either the contribution rate should rise from 8.4 per cent to 12 per cent or all pension liabilities should be cut by about 38 per cent.

Like Father, Like Son: Inheriting and Bequeathing

Empirical evidence suggests that parents who have themselves inherited from their own parents are more likely to leave an estate to their children even after controlling for income, wealth and education. This implies an indirect reciprocal behavior between three generations by transmitting the attitude towards bequeathing from one generation to the next. We incorporate such an intergenerational chain into an overlapping generations model and show that the economy might be characterized by multiple steady states involving poverty traps. Individuals will not leave bequests unless per capita income levels exceed a threshold level. In such a situation, an unfunded social security security programme may help to overcome poverty by providing additional old age income out of which to bequeath.

Aging, social security design, and capital accumulation

This paper analyzes the impact of aging on capital accumulation and welfare in a country with a sizable unfunded social security system. Using a two-period overlapping generation model with endogenous retirement decisions, the paper shows that the type of aging and the type of unfunded social security system are important in understanding this impact. The analysis compares two types of demographic changes, declining fertility and increasing longevity; three types of pensions, defined contributions, defined benefits, and defined annuities; as well as mandatory and optimal retirement systems to investigate the differences in implications of aging.

Editorial: Should We Treat Aging as a Disease? Academic, Pharmaceutical, Healthcare Policy, and Pension Fund Perspectives.

Editorial: Should We Treat Aging as a Disease? Academic, Pharmaceutical, Healthcare Policy, and Pension Fund Perspectives.

Aging, Social Security Design, and Capital Accumulation

This paper analyzes the impact of aging on capital accumulation and welfare in a country with a sizable unfunded social security system. Using a two-period overlapping generation model with potentially endogenous retirement decisions, the paper shows that the type of aging, i.e. declining fertility or increasing longevity, and the type of unfunded social security system, i.e. defined contributions or defined benefits, are important in understanding this impact. Moreover, the analysis provides a refinement to common policy recommendations that favor eliminating mandatory early retirement regulations in aging societies: aging leads to a greater increase in welfare when it is driven by an increasing longevity and the retirement age is unregulated. In comparison, when aging is driven by a decreasing fertility rate, a mandatory retirement system fosters more savings and, thus, income and welfare, in a closed economy with unfunded pension system based on defined contributions.

Aging, Social Security Design, and Capital Accumulation

This paper analyzes the impact of aging on capital accumulation and welfare in a country with a sizable unfunded social security system. Using a two-period overlapping generation model with potentially endogenous retirement decisions, the paper shows that the type of aging, i.e. declining fertility or increasing longevity, and the type of unfunded social security system, i.e. defined contributions or defined benefits, are important in understanding this impact. Moreover, the analysis provides a refinement to common policy recommendations that favor eliminating mandatory early retirement regulations in aging societies: aging leads to a greater increase in welfare when it is driven by an increasing longevity and the retirement age is unregulated. In comparison, when aging is driven by a decreasing fertility rate, a mandatory retirement system fosters more savings and, thus, income and welfare, in a closed economy with unfunded pension system based on defined contributions.

Family Expansion and Capital Accumulation of a Dynasty

We consider a unified framework that combines two strands of previous literature on overlapping generations growth models of endogenous fertility and savings: one strand incorporating two-period lived agents with life-cycle utility functions and the other strand incorporating one period lived agents with dynastic utility functions. In this framework, we study the long-run effects of unfunded social security on fertility and savings. We provide complete characterization of optimal path in terms of the life-cycle felicity index and the degree of altruism towards all the future offsprings, exhibiting either monotonicity of the standard growth model, fluctuations of the Easterlin (1987) hypothesis or convergence in finite period.

Longer Life and Higher Fertility in an OLG Economy with Production

This paper investigates the effect of a change in life expectancy (i.e., longevity) on fertility in a standard OLG economy. The main result is that, in contrast with other papers, an increase in the longevity rate may increase the fertility rate as well. It is shown that such a result holds when the cost of rearing children in terms of goods and services (rather than in terms of forgone wages) matters. In particular, such a result depends on the relative “strength” of the capital in the technology as compared with the “strength” of the parsimony. Moreover it is shown, again in contrast with other papers, that with an unfunded social security system it is more likely that a longer life may increase the fertility. The latter result is even more likely in the presence of child subsidy policies, which are widespread in developed countries. In conclusion, we argue that in countries having a population with a high longevity, a high capital share, a large unfunded social security, and child subsidy policies (such as Italy), a further increase of longevity may increase fertility in the long run and thus partially alleviate the peril of the so-called “demographic bomb.”

Should We Refinance Unfunded Social Security?

Within a continuous‐time overlapping generations model, featuring endogenous intensive margin of the labour supply and retirement decision, we analyse the issue of passing the burden of payroll revenues onto consumption or capital. We find that large long‐run welfare gains occur when pension benefits are refinanced by consumption taxes. However, the transition to the new steady state is very painful for a large fraction of existing cohorts. On the other hand, the capital base is too small to sustain pension benefits but could be made larger if capital taxes are raised. Yet that would entail significant welfare losses.

A NOTE ON SOCIAL SECURITY WELFARE WITH SELF-CONTROL PROBLEMS

We develop an overlapping-generations model for a closed economy with uncertainty on labor income and mortality risk to show that unfunded social security programs may increase welfare in economies where agents are affected by self-control problems à la Gul and Pesendorfer (2001, Econometrica 69, 1403). We depart from the existing literature by setting the agent's preference parameters to match target levels of macro-variables observed in the real U.S. economy. In our approach, economies with tempted and nontempted agents are indistinguishable in terms of aggregate consumption, labor, and saving behavior when social security provides a replacement rate of 40% (as in the United States). This situation makes agents bear costly self-control problems over more years. Our simulations indicate that social security improves welfare with degrees of temptation equal to 11% or higher. A social security program with a replacement rate of 40% finds support for degrees of temptation not lower than 15%.

On the Implications of Two-Sided Altruism in Human Capital Based OLG Model

This article summarizes some propositions regarding economic dynamics and implications of two-sided altruism, on the basis of the human-capital-based OLG model of Ehrlich and Lui (1991), with application of a modified, fertility-endogenized definition of linearly separable two-sided altruism by Abel (1987) and Altig and Davis (1993). Some properties in both transition processes and steady states, the effects of unfunded social security on an equilibrium path, and the implications in the context of so called the Samaritan’s dilemma and the Recardian equivalence are also analyzed. Finally some policy implications are summarized. Our calibration results and analyses show that (1) the combination of altruism toward parents and children is crucial for determining a threshold level of initial human capital and education technology in a transition process (stagnant to growth or growth to stagnant) with an irreversible hysteresis aspect, (2) a regular recursive induction approach might still cause inefficiency in terms of an ex-post Pareto optimality criterion as of two periods later, even if strategic effects for after children (two generations later) are appropriately taken account of, and (3) unfunded social security, which involves actuarially fair insurance as well as certainty premium transfer, might not affect either saving or critical values for regime change so drastically.

Conspicuous consumption and generation replacement in a model of perpetual youth

This paper investigates household decisions in an overlapping generations model in which individual utility depends on a weighted average of consumption of one's peers. In contrast to representative agent economies, the consumption externality generally affects savings and growth rates. The effects critically depend on the rate at which labor productivity changes with age. For a high (low) rate, the externality lowers ( raises) the steady state propensity to consume out of total wealth. The optimal allocation can be decentralized by a (reverse) unfunded social security system if the rate of labor productivity decline is high (low). In contrast to discrete time OLG models, the optimal steady state capital income tax is zero, in spite of the externality.

On Sustainable Pay‐as‐You‐Go Contribution Rules

AbstractAn unfunded social security system faces the major risk, sometimes referred to as “political risk,” that future generations do not agree to contribute as much as expected. In order to account properly for this risk, the paper considers a political process in which the support to the system is asked from each new born generation. The analysis is conducted in an overlapping generations economy that is subject to macroeconomic shocks. As a consequence, the political support varies with the evolution of the economy. The impact of various factors—intragenerational redistribution, risk aversion, financial markets, governmental debt—on the political sustainability of a pay‐as‐you‐go system is discussed.

Conspicuous Consumption and Overlapping Generations

This paper investigates household decisions, and optimal taxation in an overlapping generations model in which individual utility depends on a weighted average of consumption of ones peers - a keeping up with the Joneses'' consumption externality. In contrast to representative agent economies, the consumption externality generally affects steady state savings and growth rates. The nature of the externality's impact, however, critically depends on the rate at which labor productivity declines with age. For a (strongly enough) declining labor productivity (or when people gradually retire), the consumption externality lowers the steady state propensity to consume out of total wealth. The opposite holds for a constant labor productivity. The optimal allocation can be decentralized by a (reverse) unfunded social security system if the rate of labor productivity decline is high (low). In contrast to previous results, the optimal steady state capital income tax is zero, in spite of the consumption externality.

A Life-Cycle Analysis of Social Security with Housing

This paper incorporates two features of housing in a life-cycle analysis of social security: housing as a durable good and housing market frictions. We find that with housing as a durable good, unfunded social security substantially crowds out housing consumption throughout the life cycle. By contrast, aggregate non-durable consumption is higher when social security is present, although it is postponed until late in life. Moreover, in the presence of housing market frictions, social security lowers the aggregate home ownership rate and reduces the average size of owner-occupied housing. The effects of social security on housing position, furthermore, exhibit substantial heterogeneity across households of different income levels.