Working Paper: NBER ID: w18760
Authors: Ellen R. McGrattan; Edward C. Prescott
Abstract: A problem facing the United States is financing retirement consumption as its population ages. Proposals for switching to a saving-for-retirement system that do not rely on high payroll taxes have been challenged on the grounds that welfare for some cohorts will fall. We show how to devise a transition path from the current U.S. system to a saving-for-retirement system that increases the welfare of all current and future cohorts, with estimates of future gains that are twice as large as those found with typically used macroeconomic models. The gains are large because there is more productive capital than commonly assumed. Furthermore, the gains are amplified if we lower capital taxes in addition to payroll taxes because the value of business equity increases relative to the capital stock. Our quantitative results depend importantly on accounting for differences between actual government tax revenues and what revenues would be if all income were taxed at the income-weighted average marginal tax rates used in our analysis.
Keywords: retirement financing; aging population; welfare gains; tax reform
JEL Codes: E20; G18; H21; H61
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| transitioning from the current US retirement system to a saving-for-retirement system (H55) | enhance the welfare of all birth-year cohorts (I39) |
| eliminating payroll taxes and capital taxes (H29) | welfare gains as high as 25% of lifetime consumption for future cohorts (D15) |
| increase in productive capital stock from 5.8 times GNP to 7.7 times GNP (O47) | allows for financing retirement consumption through savings without taxing labor income (D14) |
| lowering capital taxes (F38) | enhances the value of business equity (G32) |
| capital stock at reproduction cost (E22) | significant factor in welfare gains (D69) |