The Aging Population and the Size of the Welfare State

1. The Aging Population and the Size of the Welfare State Razin, A., E. Sadka, and P. Swagel. 2002. Presented by Amonthep Chawla (Beet)

2. Objective • This paper examines the implication of the rising size of the social security transfer for the welfare state, focusing particularly on the relationship between the aging population and the tax rates and benefits involved in the welfare state

3. 1. Introduction • Stylized Fact: “A negative correlation between the dependency ratio and labor tax rates and the generosity of social transfer”, despite a higher portion of aging population • Political equilibrium is determined as a balance between those who gain (retirees) and those who lose (working age) from a more extensive tax-transfer policy

4. 1. Introduction • Methodology: Using OLG model of intra- and intergenerational transfers and HK model • Finding: with democratic voting, an increase in the dependency ratio can lead to lower taxes or less generous social transfers

5. 2. Tax-Transfer Policy in a Political Economy Equilibrium • OLG model: each generation lives two periods-a working period and a retirement period • First group chooses whether to acquire an education to be skilled workers or remain un skilled • Second group’s consumption is funded by savings and government transfer

6. HK formation • e-time needed to acquire education • Investing e unit of labor time in education • Less skilled labor spend more time-costly • Cutoff level (1-T)w(1-e*) = qw+ e*=1-q-/[(1-T)W]

7. 2. Tax-Transfer Policy in a PEE (Cont) • Total labor supply: L = l(e*)No(1+n)^t • Government budget balance: bNo[(1+n)^t-1 + (1+n)^t] = TwL b=Twl(e*) (1+n)/(2+n) • Young individual BC: C1t +C2t/(1+r) = W (e, Tt, Tt+1, n) • Retiree: C2t-1(e) = St-1(e)(1+r) + b(Tt, n)

8. 2. Tax-Transfer Policy in a PEE Political Economy • “ Median Voter”: The pivot in determining the outcome of majority voting Young • Political Equilibrium tax rate maximizes the lifetime income of a young, a median voter • Political equilibrium tax rate, T, max lifetime income of the median voter To = argmaxW[em(n), T, n] • Tax rate depends on Im vs. Ia • Im <Ia positive tax rate

9. 3. The Dependency Ratio and the Tax Burden in the PEE • dTo/dn = - Bn[To(n), n]/ BT[To(n), n] • BT <0, the sign depends on Bn: If Bn > 0, the increase in n ( lower DR) raises To & b • An increase in the dependency ratio lowers the political equilibrium T and b

10. Reason • Given the median voter is a young skilled worker and the rising population, there is a decline in the amount of tax revenue collected from the median voter that leaks to the retirees. • If median voter is an unskilled worker, a decline in DR (n )raises T and b

11. Meltzer and Richard (1981) • Spread of the right to vote(franchise), which increases the number of voters with rel low income and thus natural incentive to vote for higher taxes and transfer (no. of receivers of SSS vote for higher T and b • If the median voter is not among retiree, rising n may lead to lower T and b • Need empirical studies

12. 4. Evidence • Data: US and 12 European countries (1965-92) to examine the relationship between the dependency ratio and the tax burden and the generosity of social transfers • Dependent vars: labor tax rate and real per capita transfer • Indep vars: dependency ratio, income skewedness, gov’t emp, real GDP growth, openness to trade

13. Results ( table 1) • Labor taxes: • DR has negative effect-solve the ambiguity of the model. 1% increases in DR would lower tax by 0.4% • Larger gov job and more openness T • GDP growth and income skewedness T • Unemp is positive but reverse causality!

14. Results ( table 1) • Transfer: • Higher DR lowers transfers • Higher unemployment lowers transfer but reverse causality!!! need to use instrument variables

15. Conclusion • Determination of the tax burden and generosity of social transfer emphasizes the demand for redistribution by the median voter. (political economy-whether the median voter is a net contributor or net beneficiary of the PAYG SSS) • Privatization: individuals should have their own retirement accounts-lower pressure