Working Paper: CEPR ID: DP6245
Authors: Martin Gonzalezeiras; Dirk Niepelt
Abstract: We analyze the effect of the projected demographic transition on the political support for social security, and equilibrium outcomes. Embedding a probabilistic-voting setup of electoral competition in the Diamond (1965) OLG model, we find that intergenerational transfers arise in the absence of altruism, commitment, or trigger strategies. Closed-form solutions predict population ageing to lead to higher social security tax rates, a rising share of pensions in GDP, but eventually lower social security benefits per retiree. The response of equilibrium tax rates to demographic shocks reduces old-age consumption risk. Calibrated to match features of the U.S. economy, the model suggests that, in response to the projected demographic transition, social security tax rates will gradually increase to 16 percent; other policies that distort labour supply will become less important; and in contrast with frequently voiced fears, labour supply therefore will rise.
Keywords: labour supply; Markov perfect equilibrium; probabilistic voting; saving; social security
JEL Codes: E62; H55
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| population aging (J11) | higher social security tax rates (H55) |
| population aging (J11) | increase in demand for social security benefits (H55) |
| higher social security tax rates (H55) | decline in social security benefits per retiree (H55) |
| demographic shocks (J11) | adjustment of equilibrium tax rates (H29) |
| adjustment of equilibrium tax rates (H29) | distribution of consumption risk among different age cohorts (D15) |
| higher social security tax rates (H55) | increase in labor supply (J20) |
| political support for social security (H55) | reflects broader societal interests (Z18) |