Should Public Retirement Plans be Fully
Funded?
Private versus public risk sharing: Should governments provide
reinsurance?
Intergenerational risk sharing and fiscal policy
The Sustainability of Fiscal Policy in the United States
Optimal Private Responses to Demographic Trends: Savings,
Bequests, and International Mobility
Abstract: The paper examines the implications of population
ageing in an environment of increasingly mobile capital and
labor. I first present three benchmark models for world savings,
capital-output ratios and returns to capital, and then examine
their relevance for the world economy and their policy
implications.
The mechanics of capital deepening triggered
by declining birth rates are presented in a Solow-Swan model
with exogenous saving. The role of retirement savings is
examined in a stylized overlapping-generations model with
life-cycle savers. A dynastic model with altruism towards
children highlights the interaction of savings with bequests and
spending on children.
All three models are calibrated to the world
economy with particular attention to the G-20. The models yield
different conclusions largely due to their different assumptions
about bequests. While Solow-Swan and life-cycle models suggest
rising capital-labor ratios, rising capital-output ratios, and a
secular decline in returns on capital, the dynastic model
predicts declining savings rates, a declining share of bequests
in aggregate wealth, and a stationary world return on capital.
A substantial share of world capital is due
to bequests rather than life-cycle savings. This raises doubts
about the life-cycle model as tool for demographic projections.
The projected decline in bequests also raises questions about
bequests reaching a lower bound where life-cycle reasoning would
become applicable. I argue that constraints on bequests are
likely “soft” (non-binding) for as long as retirees can
successfully lobby for growing public transfers (serving as
negative bequests). Increasing capital and labor mobility are
relevant in this context because increasing cross-country tax
competition would impose increasingly stringent bounds on
transfers and hence on aggregate bequests. While developed
countries may be close to such bounds, bequests and dynastic
reasoning remain important for savings in developing countries
and hence for world-wide demographic projections.
Who Bears What Risk? An Intergenerational Perspective
Abstract: Many governments promise pension and medical benefits
to their elderly citizens. As the world is aging, the burden of
retiree benefits is becoming painfully obvious. Uncertainty
about the future makes planning for retiree benefits even more
difficult. Who will suffer or gain financially if the future
differs from what we expect? We face, for example, tremendous
uncertainty about the speed of technical progress, about medical
cost, and about trends in fertility and longevity. Government
policy determines not only the level of taxes and benefits, but
also who bears the risk of unexpected changes.
Traditional retirement programs largely
exempt retirees from sharing risk. By making fixed,
unconditional promises, they necessarily impose a more than
proportional risk on younger cohorts and on future generations.
The paper examines the impact of alternative tax, pension, and
health care policies on different cohorts. How do existing
policies shift risk across cohorts? Are there conditions under
which such policies might be appropriate in the interest of
general welfare? Is there scope for better policies, and in
which direction? The analysis focuses on the United States and
covers the main fundamental sources of risk—productivity,
fertility, longevity, health, and asset valuation.
Voting over Non-Linear Taxes in a Stylized Representative
Democracy
Abstract: We derive median-voter results and study the shape of
redistributional taxes when voters elect a candidate who imposes
taxes to maximize own utility. Under general conditions, a
median-productivity candidate is a Condorcet winner. The imposed
tax function is nonlinear, may place high marginal rates on very
low incomes, and may have an interval of negative marginal rates
below the income of the winning candidate. Marginal rates are
positive throughout, however, if non-redistributional spending
or altruism toward the poor are great enough.
Will Social Security and Medicare Remain Viable as the U.S. Population is Aging? An Update
Download Paper (April 2003)
Abstract: This updated and shortened version of my 1998
Carnegie-Rochester conference paper (Carnegie-Rochester
Conference Series on Public Policy 50, June 1999, 1-53)
re-examines the viability of social security on the basis of
current fiscal and economic projections. The answer remains
unchanged: Yes, subject to concerns about Medicare cost and
potentially self-confirming skepticism. The argument is based on
intertemporal cost-benefit tradeoffs in a median voter setting.
For a variety of assumptions, I find that social security should
retain majority support because voters of median-age (about 45)
can expect benefits that exceed future contribution in present
value. The case for viability is even stonger than in my
previous study because of lower interest rates and deflated
stock market expectations.
Retirement Savings in an Aging Society: A Case for Innovative
Government Debt Management
Working paper: Download pdf file (June 2001)
Abstract: Aging societies will have to rely increasingly on
private savings to finance retirement. The natural savings
vehicles, stocks and bonds, are unfortunately lacking key
risk-sharing features that are built into public retirement.
Innovative government debt management can address this problem.
The optimal policy supplies retirees with securities that share
the financial risks of aggregate productivity, asset valuation,
and demographic shocks across generations. As the population
ages, state-contingent government bonds are a better risk
sharing tools than pensions, which become too costly, or
taxation, which raises time-consistency problems. Wage-indexed
and longevity-indexed bonds in particular yield unambiguous
efficiency improvements. To the extent that public pensions
remain important, plans with wage-indexed defined benefits seem
preferable to defined contributions or price-indexed plans.
Capital income taxes and pension trust funds can play a
supporting role for risk sharing.
Working paper: Download pdf file (January 2002)
Abstract: The paper examines alternative options for managing public debt and public assets in a government balance sheet framework that includes the Treasury, the Federal Reserve, and social security. Even after September 11, U.S. fiscal policy is on a trajectory to accumulate substantial “uncommitted funds.” The paper examines how such funds should be invested. I conclude that high-quality fixed-income securities are the best benchmark and that social security is the most appropriate government asset manager. The analysis of policy alternatives reveals a trilemma between maintaining a liquid Treasury market, minimizing rent-seeking, and facilitating intergenerational risk sharing. Policies exist that attain any two of these objective, but not all three simultaneously.
Prepared for presentation at the Conference on Declining Treasury Debt, Federal Reserve Bank of Cleveland, Oct.25-26, 2001.
Working paper (February 1999): Download pdf file
Abstract: As the U.S. population ages, the growing retiree-worker ratio increases the burden of public retirement systems. Is it efficient to maintain a defined-benefit social security system? Should PAYGO benefits be reduced and private retirement savings be encouraged? The paper examines these questions in a neoclassical growth model with overlapping generations and demographic uncertainty. In case of shocks to the birth rate, I find that a defined-benefits social security system is more efficient ex-ante than a defined-contribution or privatized system. This is because small cohorts generally enjoy favorable wage and interest rate movements. They are in the labor force when the capital-labor ratio is high and they earn capital income when the capital-labor ratio is low. A defined benefit system helps to offset the effect of these factor price movements by imposing higher taxes on small cohorts. Neither defined-benefits nor its main alternatives are fully efficient, however, because they all fail to adjust current retiree benefits in response to anticipated future demographic changes. In case of changes in life-expectancy, the efficient policy response depends on the predictability of deaths at the individual level and on the availability of annuities. Reduced benefits can be efficient if annuities markets are missing and the mortality change is such that accidental bequests decline, but not otherwise
Should the Social Security Trust Fund hold Equities? An
Intergenerational Welfare Analysis
Unpublished Technical Appendix: Download Appendix
Working paper (March 1999): Download Paper
Abstract: In a stochastic economy with overlapping generations, fiscal policy affects the allocation of aggregate risks. The paper shows how to compute the welfare effects of marginal policy changes that shift risk across cohorts, in general and for an application to social security equity investments. I estimate the relevant correlations between macroeconomic shocks and equity returns from 1874-1996 U.S. data, calibrate the model, and find positive welfare effects for equity investments. Since stock returns are positively correlated with social securityís wage-indexed benefit obligations, equity investments would also help to stabilize the payroll tax rate.
Will Social Security and Medicare Remain Viable as the U.S.
Population is Aging?
Abstract: Yes, subject to concerns about Medicare cost and potentially self-confirming skepticism. The U.S. social security system (broadly defined, including Medicare) faces significant financial problems as the result of an aging population. But demographic change is also likely to raise savings, increase wages, and reduce interest rates. Viewed in this context, the fiscal problems of retirement insurance seem overrated. A more serious issue is the rapid growth of Medicare spending. Up to a point, a growing GDP-share of medical spending is an efficient response to an aging population. But Medicare growth might be excessive due to moral hazard problems. Except for this caveat, social security is almost certainly economically viable. To examine the political viability of social security, I focus on intertemporal cost-benefit tradeoffs in a median voter setting. For a variety of assumptions, I find that social security will retain majority support. I also discuss the role of altruism, redistribution, and multi-dimensional voting and find that they provide additional voter support for social security.
Fiscal Policy and the Mehra-Prescott Puzzle: On the Welfare
Implications of Budget Deficits when Real Interest Rates are Low
Unpublished Technical Appendix: Download Appendix
Working paper (December 1997): Download Working Paper
Abstract: Historically, average real returns on U.S. government
debt have been far below the rate of economic growth, allowing
the U.S. government to roll over its debt at a rather low cost.
At the same time, the rate of return on capital has generally
been above the growth rate, suggesting that the U.S. economy is
dynamically efficient. The paper shows that the welfare
implications of budget deficits in this scenario depend
critically on why interest rates have been so low. If the
government can offer low returns on its debt because of some
unique ability to create default-free claims, persistent primary
budget deficits may be unproblematic. But if low interest rates
are due to high risk aversion, policies that exploit the low
cost of government debt to run frequent budget deficits will
impose significant risks on future taxpayers. In essence, safe
government debt is safe for the debt holders, but it is very
risky for the taxpayers who are implicitly taking a short
position in the safe security.
Unpublished Technical Appendix: Download
Appendix
[Includes the proof I promised to make available upon request.]
Working paper (February 1998): Download Working Paper (pdf) Download Tables&Figures (pdf)
Abstract: How do governments react to the accumulation of debt?
Do they take corrective measures or do let the debt grow?
Whereas standard time series test cannot reject a unit root in
the U.S. debt-GDP ratio, this paper provides evidence of
corrective action: The U.S. primary surplus is an increasing
function of the debt-GDP ratio. The debt-GDP ratio displays
mean-reversion if one controls for war-time spending and for
cyclical fluctuations. The positive response of the primary
surplus to changes in debt also shows that U.S. fiscal policy is
satisfying an intertemporal budget constraint.
Working paper (July 1997): Download Working Paper (pdf)
Abstract: The paper starts with a review of the principles of
pay-as-you-go social security and of the recent Social Security
Advisory Council's reform proposals. Then I derive a number of
neutrality results for social security and comment on the
effects of inter-generational redistribution and
intergenerational risk-shifting implied by alternative reform
measures. The final section compares alternative policy options
in the context of changing demographics in the context of a
simple calibrated overlapping generations model.
Working paper (March 1996): Download Working Paper (pdf)
Abstract: This notes explains how results from the optimal tax
literature can be used to derive an optimal debt structure, with
application to maturity and price-indexation issues relevant for
the UK.
Article published in: The Economic Journal 102, May 1992, pp.
588-597.
Here is the working
paper
version (March 1990) with technical appendix that's reference in
the article. When using material from the appendix, please
reference the article.