Age-dependent risk aversion: Re-evaluating fiscal policy impacts of population aging

Phitawat Poonpolkul

The Journal of the Economics of Ageing, 2023, vol. 26, issue C

Abstract: The existing literature on fiscal unsustainability in the United States often evaluates three alternative policies: increasing the payroll tax rate, reducing pension benefits, and extending the retirement age. Studies suggest that reducing the replacement rate and increasing the retirement age provide higher welfare for future generations. However, these studies often assume constant risk aversion (CRA), which contradicts the empirical evidence that suggests risk aversion tends to increase with age. To provide a more comprehensive understanding of risk aversion, life-cycle behavior, and welfare under uncertainties, this study integrates age-dependent increasing risk aversion (IRA) into an overlapping generations model with risk-sensitive preferences. The quantitative analysis shows that individuals who exhibit IRA tend to adjust hours worked to reduce income risk and accumulate more precautionary savings to ensure future consumption. However, reducing uncertainty consumes resources that could otherwise have been used to increase overall consumption and leisure. Individuals who expect to become more risk averse in old age may prefer an increase in the payroll tax rate over the other two options, as the latter would result in relatively higher uncertainty.

Keywords: Overlapping generations model; Fiscal sustainability; Demographic changes; Increasing risk aversion (search for similar items in EconPapers)
JEL-codes: D15 D81 E62 J11 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:joecag:v:26:y:2023:i:c:s2212828x23000348

DOI: 10.1016/j.jeoa.2023.100474

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