Working Paper: NBER ID: w12859
Authors: Francisco J. Gomes; Laurence J. Kotlikoff; Luis M. Viceira
Abstract: Governments are known for procrastinating when it comes to resolving painful policy problems. Whatever the political motives for waiting to decide, procrastination distorts economic decisions relative to what would arise with early policy resolution. In so doing, it engenders excess burden. This paper posits, calibrates, and simulates a life cycle model with earnings, lifespan, investment return, and future policy uncertainty. It then measures the excess burden from delayed resolution of policy uncertainty. The first uncertain policy we consider concerns the level of future Social Security benefits. Specifically, we examine how an agent would respond to learning in advance whether she will experience a major Social Security benefit cut starting at age 65. We show that having to wait to learn materially affects consumption, saving, and portfolio decisions. It also reduces welfare. Indeed, we show that the excess burden of government indecision can, in this instance, range as high as 0.6 percent of the agent's economic resources. This is a significant distortion in of itself. It's also significant when compared to other distortions measured in the literature. The second uncertain policy we consider concerns marginal tax rates. We obtain similar results once we adjust for the impact of tax rates on income.
Keywords: government indecision; excess burden; social security benefits; tax rates
JEL Codes: H21; H55; H6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government indecision regarding future social security benefits (H55) | Excess burden on agents (D62) |
| Delay in learning about social security benefits (H55) | Materially affects consumption, saving, and portfolio decisions (E21) |
| Government indecision (H19) | Welfare loss due to government indecision (D69) |
| Indecision regarding tax policy (H29) | Economic distortions and welfare losses (D69) |
| Degree of risk aversion (D81) | Welfare losses due to delayed resolution of uncertainty (D89) |