Date of Award

12-2012

Degree Type

Report

Degree Name

Master of Science (MS)

Department

Economics and Finance

First Advisor

T. Scott Findley

Abstract

Social security in the United States will encounter financial strains due to an aging population. The decreasing worker to retiree ratio will reduce retirement benefits relative to today’s benefits so long as the tax rate and eligibility age are not altered. Policy makers assume that they should make policies to maintain the current benefit levels.

In contrast to this assumption, this paper does not presume that policy makers should preserve current benefits. An analysis of the required tax rate to maintain lifetime utility across the current and future demographic regimes is undertaken rather than just a calculation of the tax rate needed to maintain present benefits. A comparison of life-cycle consumption models across the present and future demographic regimes shows that the tax rate should actually decrease 2-6 percentage points in order to equate lifetime utility. This result is opposite of the prescribed tax increase to maintain retirement benefits. This finding holds with varying assumptions of intertemporal decision making including exponential discounting (as in standard life-cycle models), hyperbolic discounting, and short planning horizons.

This counter-intuitive result is driven by the inability of a social security program (with a below market internal rate of return) to improve welfare for the models mentioned above under the present demographic regime. The future demographic regime only reduces the internal rate of return and thus makes the program less advantageous. Therefore, in order to maintain utility across regimes, the pension program must be reduced.

Comments

This work made publicly available electronically on December 19, 2012.

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