Retirement Financing: An Optimal Reform Approach

Hosseini, Roozbeh and Shourideh, Ali (2016): Retirement Financing: An Optimal Reform Approach.

Abstract

Abstract We study Pareto optimal policy reforms aimed at overhauling retirement financing as an integral part of the tax and transfer system. Our framework for policy analysis is a heterogeneous-agent overlapping-generations model that performs well in matching the aggregate and distributional features of the U.S. economy. We present a test of Pareto optimality that identifies the main source of inefficiency in the status quo policies. Our test suggests that lack of asset subsidies late in life is the main source of inefficiency when annuity markets are incomplete. We solve for Pareto optimal policy reforms and show that earnings tax reforms cannot yield efficiency gains. On the other hand, progressive asset subsidies provide a powerful tool for Pareto optimal reforms. We implement our Pareto optimal policy reform in an economy that features demographic change. The reform reduces the present discounted value of net resources consumed by each generation by about 5 percent in the steady state. These gains amount to a one-time lump-sum transfer to the initial generation equal to 9 percent of the GDP.

• Item Type: MPRA Paper
• Language: English
• Keywords: Retirement, Optimal Taxation, Social Security
• Subjects: E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H21 - Efficiency ; Optimal Taxation; H - Public Economics > H5 - National Government Expenditures and Related Policies > H55 - Social Security and Public Pensions

References

ALES, L., R. HOSSEINI, AND L. E. JONES (2014): “Is There" Too Much" Inequality in Health Spending Across Income Groups?” Unpublished.

ALTIG, D., A. J. AUERBACH, L. J. KOTLIKOFF, K. A. SMETTERS, AND J. WALLISER (2001): “Simulating fundamental tax reform in the United States,” American Economic Review, 91, 574–595.

AMERIKS, J., A. CAPLIN, S. LAUFER, AND S. VAN NIEUWERBURGH (2011): “The joy of giving or assisted living? Using strategic surveys to separate public care aversion from bequest motives,” The journal of finance, 66, 519–561.

ATKINSON, A. B. AND J. E. STIGLITZ (1976): “The design of tax structure: direct versus indirect taxation,” Journal of public Economics, 6, 55–75.

AUTEN, G. AND D. JOULFAIAN (1996): “Charitable contributions and intergenerational transfers,” Journal of Public Economics, 59, 55–68.

BADEL, A. AND M. HUGGETT (2014): “Taxing top earners: a human capital perspective,” Federal Reserve Bank of St. Louis Working Paper Series.

BELL, F. C. AND M. L. MILLER (2005): “Life Tables for the United States Social Security Area 1900–2100,” Actuarial Study 120, Social Security Administration.

BELLOFATTO, A. A. (2015): “Wealth Taxation and Life Expectancy,” Unpublished.

BENARTZI, S., A. PREVITERO, AND R. H. THALER (2011): “Annuitization puzzles,” The Journal of Economic Perspectives, 143–164.

BLANDIN, A. (2015): “Reforming Social Security: The Earnings Cap and Endogenous Human Capital,” Unpublished.

BROWN, J. R. (2001): “Private Pensions, Mortality Risk, and The Decision to Annuitize,” Journal of Public Economics, 82, 29–62.

CAGETTI, M. AND M. DE NARDI (2009): “Estate Taxation, Entrepreneurship, and Wealth,” American Economic Review, 99, 85–111.

CALIENDO, F. N., N. L. GUO, AND R. HOSSEINI (2014): “Social security is NOT a substitute for annuity markets,” Review of Economic Dynamics, 17, 739–755.

CASTANEDA, A., J. DÍAZ-GIMÉNEZ, AND J.-V. RÍOS-RULL (2003): “Accounting for the US earnings and wealth inequality,” Journal of Political Economy, 111, 818–857.

CONESA, J. C. AND D. KRUEGER (2006): “On the optimal progressivity of the income tax code,” Journal of Monetary Economics, 53, 1425–1450.

CRISTIA, J. P. (2009): “Rising mortality and life expectancy differentials by lifetime earnings in the United States,” Journal of Health Economics, 28, 984–995.

DE NARDI, M. (2004): “Wealth inequality and intergenerational links,” The Review of Economic Studies, 71, 743–768.

DE NARDI, M. AND F. YANG (forthcoming): “Wealth inequality, family background, and estate taxation,” Journal of Monetary Economics.

DIAMOND, P. (1998): “Optimal Income Taxation: An Example with a U-Shaped Pattern of Optimal Marginal Tax Rates,” American Economic Review, 88, 83–95.

DUGGAN, J. E., R. GILLINGHAM, AND J. S. GREENLEES (2007): “Mortality and lifetime income: evidence from US social security records,” .

EINAV, L., A. FINKELSTEIN, AND P. SCHRIMPF (2010): “Optimal mandates and the welfare cost of asymmetric information: Evidence from the uk annuity market,” Econometrica, 78, 1031–1092.

FARHI, E. AND I. WERNING (2012): “Capital taxation: Quantitative explorations of the inverse Euler equation,” Journal of Political Economy, 120, 398–445.

——— (2013): “Insurance and Taxation over the Life Cycle,” The Review of Economic Studies, 80, 596–635.

FUKUSHIMA, K. (2011): “Quantifying the welfare gains from flexible dynamic income tax systems,” manuscript.

GALE, W. G. AND J. K. SCHOLZ (1994): “Intergenerational transfers and the accumulation of wealth,” The Journal of Economic Perspectives, 145–160.

GOLOSOV, M., N. KOCHERLAKOTA, AND A. TSYVINSKI (2003): “Optimal Indirect and Capital Taxation,” Review of Economic Studies, 70, 569–587.

GOLOSOV, M., M. TROSHKIN, AND A. TSYVINSKI (forthcoming): “Redistribution and social insurance,” American Economic Review.

GOLOSOV, M., M. TROSHKIN, A. TSYVINSKI, AND M. WEINZIERL (2013): “Preference heterogeneity and optimal capital income taxation,” Journal of Public Economics, 97, 160– 175.

GOLOSOV, M. AND A. TSYVINSKI (2006): “Designing Optimal Disability Insurance: A Case for Asset Testing,” Journal of Political Economy, 114, 257–269.

HEATHCOTE, J., F. PERRI, AND G. L. VIOLANTE (2010): “Unequal we stand: An empirical analysis of economic inequality in the United States, 1967–2006,” Review of Economic dynamics, 13, 15–51.

HEATHCOTE, J., K. STORESLETTEN, AND G. L. VIOLANTE (2014): “Optimal tax progressivity: An analytical framework,” Tech. rep., National Bureau of Economic Research.

HEATHCOTE, J. AND H. TSUJIYAMA (2015): “Optimal Income Taxation: Mirrlees Meets Ramsey,” Research Department Staff Report 507.

HONG, J. AND J.-V. RÍOS-RULL (2007): “Social Security, Life Insurance and Annuities for Families,” Journal of Monetary Economics, 54, 118–40.

HORIUCHI, S. AND A. J. COALE (1982): “A simple equation for estimating the expectation of life at old ages,” Population Studies, 36, 317–326.

HOSSEINI, R. (2015): “Adverse Selection in the Annuity Market and the Role for Social Security,” Journal of Political Economy, 123, 941–984.

HUBBARD, R. G. AND K. L. JUDD (1987): “Social Security and Individual Welfare: Precautionary Saving, Borrowing Constraints, and the Payroll Tax,” American Economic Review, 77, 630–46.

HUGGETT, M. AND J. C. PARRA (2010): “How Well Does the U.S. Social Insurance System Provide Social Insurance?” Journal of Political Economy, 118, 76–112.

HUGGETT, M. AND G. VENTURA (1999): “On the distributional effects of social security reform,” Review of Economic Dynamics, 2, 498–531.

HURD, M. AND J. P. SMITH (2002): “Expected bequests and their distribution,” Tech. rep., National Bureau of Economic Research.

˙IMROHOROGLU ˇ , A., S. ˙IMROHOROGLU ˇ , AND D. H. JOINES (1995): “A Life Cycle Analysis of Social Security,” Economic Theory, 6, 83–114.

KITAO, S. (2014): “Sustainable Social Security: Four Options,” Review of Economic Dynamics, 17, 756–779.

KOCHERLAKOTA, N. R. (2010): The New Dynamic Public Finance, Princeton University Press.

LUCAS, R. E. AND N. L. STOKEY (1983): “Optimal fiscal and monetary policy in an economy without capital,” Journal of monetary Economics, 12, 55–93.

MCDANIEL, C. (2007): “Average tax rates on consumption, investment, labor and capital in the OECD 1950-2003.” Arizona State University.

MCGRATTAN, E. R. AND E. C. PRESCOTT (2013): “On financing retirement with an aging population,” Tech. rep., National Bureau of Economic Research.

MIRRLEES, J. (1971): “An Exploration in the Theory of Optimum Income Taxation,” Review of Economic Studies, 38, 175–208.

NISHIYAMA, S. AND K. SMETTERS (2007): “Does Social Security Privatization Produce Efficiency Gains?” Quarterly Journal of Economics, 122, 1677–1719.

PASHCHENKO, S. (2013): “Accounting for Non-Annuitization,” Journal of Public Economics, 98, 53–67.

PIKETTY, T. AND E. SAEZ (2013): “A theory of optimal inheritance taxation,” Econometrica, 81, 1851–1886.

PIKETTY, T., E. SAEZ, AND S. STANTCHEVA (2014): “Optimal Taxation of Top Incomes: A Tale of Three Elasticities,” American Economic Journal: Economic Policy [Internet], 6, 230–271.

POTERBA, J. M. (2014): “Retirement security in an aging population,” The American Economic Review, 104, 1–30.

REED, W. J. AND M. JORGENSEN (2004): “The double Pareto-lognormal distribution–a new parametric model for size distributions,” Communications in Statistics-Theory and Methods, 33, 1733–1753.

ROGOT, E., P. D. SORLIE, AND N. J. JOHNSON (1992): “Life Expectancy by Employment Status, Income, and Education in the National Longitudinal Mortality Study,” Public Health Reports, 104, 457–461.

SAEZ, E. (2001): “Using Elasticities to Derive Optimal Income Tax Rates,” Review of Economic Studies, 68, 205–229.

——— (2002): “The desirability of commodity taxation under non-linear income taxation and heterogeneous tastes,” Journal of Public Economics, 83, 217–230.

SHOURIDEH, A. AND M. TROSHKIN (2015): “Providing Efficient Incentives to Work: Retirement Ages and the Pension System,” Available at SSRN 2062355.

SIEGEL, J. J. AND D. G. COXE (2002): Stocks for the long run, vol. 3, McGraw-Hill New York.

TUOMALA, M. (1990): Optimal Income Tax and Redistribution, Oxford University Press.

WALDRON, H. (2013): “Mortality Differentials by Lifetime Earnings Decile: Implications for Evaluations of Proposed Social Security Law Changes,” Social Security Bulletin, 73.

WEINZIERL, M. (2011): “The Surprising Power of Age-Dependent Taxes,” Review of Economic Studies, 78, 1490–1518.

WERNING, I. (2007): “Pareto Efficient Income Taxation,” Massachusetts Institute of Technology, Manuscript, 44, 45.

WOO, L. AND D. BUCHHOLZ (2006): “Subsidies for Assets: A New Look at the Federal Budget,” in Assets Learning Conference – A Lifetime of Assets, sponsored by the Federal Reserve and CFED.