Two computations to fund social security

He Huang, Selahattin Imrohoroǧlu, Thomas J. Sargent

    Research output: Contribution to journalArticlepeer-review


    We use a general equilibrium model to study the impact of fully funding social security on the distribution of consumption across cohorts and over time. In an initial stationary equilibrium with an unfunded social security system, the capital/output ratio, debt/output ratio, and rate of return to capital are 3.2, 0.6, and 6.8%, respectively. In our first experiment, we suddenly terminate social security payments but compensate entitled generations by a massive one-time increase in government debt. Eventually, the aggregate physical capital stock rises by 40%, the return on capital falls to 4.4%, and the labor income tax rate falls from 33.9 to 14%. We estimate the size of the entitlement debt to be 2.7 times real GDP, which is paid off by levying a 38% labor income tax rate during the first 40 years of the transition. In our second experiment, we leave social security benefits untouched but force the government temporarily to increase the tax on labor income so as gradually to accumulate private physical capital, from the proceeds of which it eventually finances social security payments. This particular government-run funding scheme delivers larger efficiency gains (in both the exogenous and endogenous price cases) than privatization, an outcome stemming from the scheme's public provision of insurance both against life-span risk and labor income volatility.

    Original languageEnglish (US)
    Pages (from-to)7-44
    Number of pages38
    JournalMacroeconomic Dynamics
    Issue number1
    StatePublished - 1997


    • Fiscal Policy
    • General Equilibrium
    • Overlapping Generations
    • Social Security Funding

    ASJC Scopus subject areas

    • Economics and Econometrics


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