Download Razin

The Aging Population and the
Size of the Welfare State
Razin, A., E. Sadka,
and P. Swagel. 2002.
Presented by
Amonthep Chawla (Beet)
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
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
1. Introduction


Methodology: Using OLG model of intraand 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
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
HK formation




e-time needed to acquire education
Investing e unit of labor time in
education
Less skilled labor spend more timecostly
Cutoff level
(1-T)w(1-e*) = qw+
e*=1-q-/[(1-T)W]
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)
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
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
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
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
4. Evidence



Data: US and 12 European countries (196592) 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
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!
Results ( table 1)



Transfer:
Higher DR lowers transfers
Higher unemployment lowers transfer
but reverse causality!!! need to use
instrument variables
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