Working Paper: CEPR ID: DP4864
Authors: Philippe de Donder; Jean Hindriks
Abstract: We study the political economy of social insurance in a world where individuals differ in both income and risk. Social insurance is financed through distortionary taxation and redistributes across income and risk. Individuals vote on social insurance that they can complement with insurance bought on the private market. Private insurance is actuarially fair but suffers from adverse selection, which results in a screening equilibrium with partial coverage.The equilibrium social insurance is the result of an electoral competition game where parties maximize the utility of their members. We calculate the equilibrium social insurance offered by the two parties as well as their equilibrium membership, and study how the equilibrium outcome is affected by electoral uncertainty, distortions from taxation, risk aversion and the distribution of risk and income. We then calibrate the model to US data from the PSID survey. Lastly, we study how the political demand for social insurance is affected by the possibility to redistribute through income taxation.
Keywords: Adverse Selection; Political Economy; Redistribution; Social Insurance
JEL Codes: H23; H50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| electoral uncertainty (K16) | policy divergence (F68) |
| risk aversion (D81) | support for social insurance (H55) |
| lower income and higher risk (I32) | more social insurance (H55) |
| redistribution through taxation (H23) | lower social insurance coverage rate (J32) |