Transcript Econ 101

Econ 208
Marek Kapicka
Lecture 8
Social Security
Roadmap

Government Expenditures
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A) Data on Govt Expenditures

B) Changes in Gov’t Spending in a
frictionless world
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C) Changes in Gov’t Spending in a world
with frictions
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D) Social Security
PAYG
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
Young pay SS taxes t
Old receive benefits b
Balanced budged each period
N t  Nb
b
t
1 n
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PAYG introduced in period T
PAYG for Consumers Who Are Old in
Period T
PAYG for Consumers Born in Period T
and Later
PAYG for Consumers Born in
Period T and Later

Change in wealth depends on r and n
b
y  b
we  y 

1 n 1 r
y
nr
 y
b
1 r
(1  n)(1  r )
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
Better off if n>r
Worse off if n<r
Fully Funded Social Security
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Essentially a mandated savings program
where assets are acquired by the
young, with these assets sold in
retirement.
Either ineffective or decreases welfare
Fully Funded Social Security When
Mandated Retirement Saving Is Binding
What’s missing in the model?
Costs of Fully funded social security
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Transition costs
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Commitment Problems
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It is costly to move from PAYG to FF
Government cannot commit not to pay to those
who haven’t saved. It may be optimal to have
PAYG even if 𝑛 < 𝑟.
Moral Hazard
 Government cannot commit to help out
those who made risky investments and
became unlucky
What’s missing in the model?
Costs of PAYG: Fertility declines
Social security tax rate Tau and total Fertility Rate TFR.
Source: Boldrin, De Nardi, Jones 2005, “Fertility and Social Security”
What’s missing in the model?
Costs of PAYG
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Distortions of savings
Distortions of labor supply (If
distortionary SS taxes)
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
hours work in any given year
years worked (choice of retirement age)
US Social Security
Social Security in the World
US Social Security
Where are we?
1.
2.
Introduction: A model with no Government
Government Policies
1.
2.
The Effects of Government Spending
Government Taxation and Government Debt
What To Read
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Read
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Today:
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DLS, Chapter 13.2,13.4
The Region, Minneapolis Fed: “European
Vacation”, on the web
Next time:
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The Washington Post:"Where does the Laffer
curve bend? "
Today
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Government Taxation
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1)
2)
3)
4)
The
The
The
The
data
effects on Labor Supply
effects on Government Revenue
effects on GDP
Data on US Taxation
Federal Government Revenue
Data on US Taxation
Average Marginal Income Taxes
Taxation

Lump-Sum tax vs. Distortive tax
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Lump sum tax does not depend on the
actions of the consumer
With distortive taxation, the welfare
theorems fail

Competitive equilibrium is not Pareto
optimal
Why Distortive Taxation?
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In reality, lump-sum tax is infeasible
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Lump sum means everyone pays the same
amount but some people have no wealth
If differences among people are taken into
account then a distorting tax is the only possibility
What are the effects of a flat tax on
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Labor Supply?
Government Revenue?
GDP?
Capital Accumulation?
Where we are
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Government Taxation
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1)
2)
3)
4)
The
The
The
The
data
effects on Labor Supply
effects on Government Revenue
effects on GDP
2) The Effects on Labor Supply
An Example
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Utility of a household
L1
U (C , L)  C 
1 
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Household problem:
1
L
max C 
1 
s.t. C  (1  t ) wL
2) The Effects on Labor Supply
1
L
max(1  t ) wL 
L
1 
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Solution:
1
L  [(1  t ) w]
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
Labor Supply decreases in the tax rate
The model and the data
E. Prescott (2004). “Why Do
Americans Work So Much
More Than Europeans?
U.S. vs. France
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1990’s:
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French productivity higher, but labor
supply much lower
GDP per person lower in France than in the
USA
1970’s:
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French productivity lower, but labor supply
slightly higher
Ohanian, Raffo, Rogerson: A more
comprehensive study
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Compare all the OECD countries for
1956-2004 period
How much can we explain by taxes?
Look for alternative explanations as
well.
Conclusion: Taxes are the most
important factor behind changes in
labor supply
Ohanian, Raffo, Rogerson: The data
Ohanian, Raffo, Rogerson: The
Results
Ohanian, Raffo, Rogerson: Other
Factors
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Compute a labor supply wedge:
Δ𝑡 = 1 −
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𝑀𝑅𝑆𝑙,𝑐
𝑀𝑃𝑁
Our model predicts that the wedge is equal to
the tax rate. What if other factors, outside of
the model, affect it as well?
Look at measure of employment protection,
union density, unemployment benefit
replacement rate, duration benefits
Ohanian, Raffo, Rogerson: Other
Factors