Should Public Retirement Plans be Fully Funded?
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.