Econ 208 Marek Kapicka Lecture 8 Social Security

Roadmap Government Expenditures A) Data on Govt Expenditures B) Changes in Gov’t Spending in a frictionless world C) Changes in Gov’t Spending in a world with frictions D) Social Security

PAYG Young pay SS taxes t Old receive benefits b Balanced budged each period PAYG introduced in period T

PAYG for Consumers Who Are Old in Period T

PAYG for Consumers Born in Period T and Later

Change in wealth depends on r and n Better off if n>r Worse off if n<r

Fully Funded Social Security 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

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 Distortions of savings Distortions of labor supply (If distortionary SS taxes) 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. Introduction: A model with no Government 2. Government Policies 1. The Effects of Government Spending 2. Government Taxation and Government Debt

What To Read Read Today: DLS, Chapter 13.2,13.4 The Region, Minneapolis Fed: “European Vacation”, on the web Next time: The Washington Post:"Where does the Laffer curve bend? "

Today Government Taxation 1) The data 2) The effects on Labor Supply 3) The effects on Government Revenue 4) The 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 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? In reality, lump-sum tax is infeasible 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 Labor Supply? Government Revenue? GDP? Capital Accumulation?

Where we are Government Taxation 1) The data 2) The effects on Labor Supply 3) The effects on Government Revenue 4) The effects on GDP

2) The Effects on Labor Supply An Example Utility of a household Household problem:

2) The Effects on Labor Supply Solution: 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 1990’s: French productivity higher, but labor supply much lower GDP per person lower in France than in the USA 1970’s: French productivity lower, but labor supply slightly higher

Ohanian, Raffo, Rogerson: A more comprehensive study Compare all the OECD countries for 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 Compute a labor supply wedge: 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