Intergenerational Tax-Transfer Policies, Growth, and the Distribution of Consumption

Neil Bruce and Stephen J Turnovsky ()

No UWEC-2008-13, Working Papers from University of Washington, Department of Economics

Abstract: In this paper we develop an overlapping-generations economy populated by mortal workers and retirees. Workers receive a stream of earnings from human capital, which consists of the stock of skills and knowledge that makes workers productive, and which grows by workers making investments in new human capital. Once acquired, human capital can be transferred to new workers entering the economy by means of an “education system”. Human capital is embodied in workers, so the economy loses human capital through mortality, and through a pre-mortality event described as “retirement”. The government undertakes two sorts of intergenerational transfers: i) a “younger-to-older” or “social security” transfer that insures workers against the pre-mortality loss of consumption by providing benefits to retirees, and ii) an “older-to-younger” or “education transfer” that provides “start-up” human capital to new workers entering the economy. The transfer programs are funded by taxes on earnings and consumption. With the simplifying assumptions of constant mortality and retirement hazard rates, the economy is aggregated and its growth rate derived. The growth rate is decreased by social security transfers if they are financed by taxes on the earnings, but education transfers can increase the growth rate regardless of how they are financed. The growth rate is higher if there is a greater share of consumption taxes in the tax mix, however the “optimal” tax mix is to finance social security transfers fully with consumption taxes and education transfers fully with earnings taxes. We also analyze earnings/consumption inequality in the economy, and show that the size distribution is a Pareto distribution. The impacts of the transfer programs on the mean and median values and the concentration index are derived.

Date: 2008-05

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