We derive the optimal replacement ratio of the pay-as-you-go public pension system for the US economy in a life-cycle model that 1) replicates the empirical wage heterogeneity and 2) endogenizes the individual’s labor supply decision. The optimal net pension replacement ratio is found to be in the range of 0%–43% depending on demographic parameters and, in particular, the Frisch labor supply elasticity. Reducing the pensions from the present to the optimal pension policies implies considerable welfare gains amounting to approximately 0.1%–4.1% of total consumption. The welfare increase is particularly pronounced for the greyer US population that is projected for the time after the demographic transition.
Abel, A., N. Mankiw, L. Summers, and R. Zeckhauser. 1989. “Assessing Dynamic Efficiency: Theory and Evidence.” Review of Economic Studies 56: 1–20.
Aiyagari, R. S. 1994. “Uninsured Idiosyncratic Risk and Aggregate Saving.” Quarterly Journal of Economics 109: 659–684.
Altonij, J. G. 1986. “Intertemporal Substitution in Labor Supply: Evidence from Micro Data.” Journal of Political Economy 94: S176–S215.
Altonij, J. G., F. Hayashi, and L. Kotlikoff. 1997. “Parental Altruism and Intervivos Transfers: Theory and Evidence.” Journal of Political Economy 105: 1121–1166.
Bansal, R., and A. Yaron. 2004. “Risks for the Long Run: A Potential Resolution of Asset Prices Puzzles.” Journal of Finance 59 (4): 1481–1509.
Budría Rodriguez, S., J. Díaz-Giménez, V. Quadrini, and J.-V. Ríos-Rull. 2002. “Updated Facts on the U.S. Distributions of Earnings, Income, and Wealth.” Federal Reserve Bank of Minneapolis Quarterly Review 26: 2–35.
Caldara, D., J. Fernández-Villaverde, and J. F. Rubio-Ramiírez. 2012. “Computing DSGE Models with Recursive Preferences.” Review of Economic Dynamics 15: 188–206.
Caliendo, F. N., N. L. Guo, and R. Hosseini. 2014. “Social Security is NOT a Substitute for Annuity Markets.” Review of Economic Dynamics 17: 739–755.
Conesa, J. C., and D. Krueger. 1999. “Social Security Reform with Heterogeneous Agents.” Review of Economic Dynamics 2: 757–795.
De Nardi, M., S. Imrohoroğlu, and T. J. Sargent. 1999. “Projected US Demographics and Social Security.” Review of Economic Dynamics 2: 575–615.
De Nardi, M., and F. Yang. 2016. “Wealth Inequality, Family Background, and Estate Taxation.” Journal of Monetary Economics 77: 130–145.
Domeij, D., and M. Floden. 2006. “The Labor Supply Elasticity and Borrowing Constraints: Why Estimates are Biased.” Review of Economic Dynamics 9: 242–262.
Epstein, L. G., and S. E. Zin. 1989. “Substitution, Risk Aversion and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework.” Econometrica 57: 937–969.
Epstein, L. G., and S. E. Zin. 1991. “Substitution, Risk Aversion and the Intertemporal Behavior of Consumption and Asset Returns: An Empirical Analysis.” Journal of Political Economy 99 (2): 263–268.
Fehr, H., M. Kallweit, and F. Kindermann. 2013. “Should Pensions be Progressive?” European Economic Review 63: 94–116.
Fernández-Villaverde, J., and D. Krueger. 2007. “Consumption over the Life Cycle: Facts from Consumer Expenditure Survey Data.” Review of Economics and Statistics 89 (3): 552–565.
Fuster, L., A. İmrohoroğlu, and S. İmrohoroğlu. 2003. “A Welfare Analysis of Social Security in a Dynastic Framework.” International Economic Review 44: 1247–1274.
Grant, C., C. Koulovatianos, A. Michaelides, and M. Padula. 2006. “Evidence on the Insurance Effect of Redistributive Taxation.”.Working Paper.
Grant, C., C. Koulovatianos, A. Michaelides, and M. Padula. 2010. “Evidence on the Insurance Effect of Redistributive Taxation.” Review of Economics and Statistics 92 (4): 965–973.
Guvenen, F. 2009. “An Empirical Investigation of Labor Income Processes.” Review of Economic Dynamics 12: 58–79.
Guvenen, F., F. Karahan, S. Ozkan, and J. Sang. 2015. “What Do Data on Millions of U.S. Workers Reveal About Life-Cycle Earnings Risk?.”.NBER Working Paper Series (20913).
Hansen, G. 1993. “The Cyclical and Secular Behavior of the Labor Input: Comparing Efficiency Units and Hours Worked.” Journal of Applied Econometrics 8: 71–80.
Heathcote, J., F. Perri, and G. L. Violante. 2010. “Unequal We Stand: An Empirical Analysis of Economic Inequality in the United States, 1967–2006.” Review of Economic Dynamics 13: 15–51.
Heer, B. 2001. “Wealth Distribution and Optimal Inheritance Taxation in Life-Cycle Economies.” Scandinavian Journal of Economic 103: 445–465.
Heer, B., and A. Irmen. 2014. “Population, Pensions and Endogenous Economic Growth.” Journal of Economic Dynamics and Control 46: 50–72.
Heer, B., and A. Maußner. 2009. Dynamic General Equilibrium Modeling: Computational Methods and Applications., 2nd ed. Heidelberg: Springer.
Hubbard, R. G., and K. L. Judd. 1987. “Social Security and Individual Welfare: Precautionary Saving, Borrowing Constraints, and the Payroll Tax.” American Economic Review 77: 630–646.
Huggett, M. 1996. “Wealth Distribution in Life-Cycle Economies.” Journal of Monetary Economics 38: 373–396.
Huggett, M., and G. Ventura. 1999. “On the Distribution Effects of Social Security Reform.” Review of Economic Dynamics 2: 498–531.
Hurd, M. D. 1989. “Mortality Risk and Bequests.” Econometrica 57: 799–813.
İmrohoroğlu, A., S. İmrohoroğlu, and D. H. Joines. 1995. “A Life Cycle Analysis of Social Security.” Economic Theory 6: 83–114.
İmrohoroğlu, A., S. İmrohoroğlu, and D. H. Joines. 1999. “Social Security in an Overlapping Generations Economy with Land.” Review of Economic Dynamics 2: 638–665.
İmrohoroğlu, S., and S. Kitao. 2009. “Labor Supply Elasticity and Social Security Reform.” Journal of Public Economics 93: 867–878.
Kaplan, G. 2012. “Inequality and the Life Cycle.” Quantitative Economics 3: 471–525.
Killingsworth, M. R. 1983. Labor Supply. Cambridge, MA: Cambridge University Press.
Kitao, S. 2014. “Sustainable Social Security: Four Options.” Review of Economic Dynamics 17: 756–779.
Krueger, D., and A. Ludwig. 2007. “On the Consequences of Demographic Change for Rates of Returns to Capital, and the Distribution of Wealth and Welfare.” Journal of Monetary Economics 54: 49–87.
Krueger, D., and F. Perri. 2006. “Does Income Inequality Lead to Consumption Inequality? Evidence and Theory.” Review of Economic Studies 73: 163–193.
MaCurdy, T. E. 1981. “An Empirical Model of Labor Supply in a Life-Cycle Setting.” Journal of Political Economy 89: 1059–1085.
Mendoza, E. G., A. Razin, and L. L. Tesar. 1994. “Effective Tax Rates in Macroeconomics Cross Country Estimates of Tax Rates on Factor Incomes and Consumption.” Journal of Monetary Economics 34: 297–323.
Nishiyama, S., and K. Smetters. 2007. “Does Social Security Privitization Produce Efficiency Gains?” Quarterly Journal of Economics 122: 1677–1719.
Peracchi, F., and V. Perroti. 2010. “Subjective Survival Probabilities and Life Tables: Evidence from Europe.”.EIEF Working Papers Series, 1016.
Peterman, W. B., and K. Sommer. 2016. “How Well Did Social Security Mitigate the Effects of the Great Recession?.”.Working Paper.
Quadrini, V. 2000. “Entrepreneurship, Saving, and Social Mobility.” Review of Economic Dynamics 3: 1–40.
Storesletten, K., C. I. Telmer, and A. Yaron. 1999. “The Risk-Sharing Implications of Alternative Social Security Arrangements.” Carnegie-Rochester Series on Public Policy 50: 213–259.
Storesletten, K., C. I. Telmer, and A. Yaron. 2004. “Consumption and Risk Sharing over the Business Cycle.” Journal of Monetary Economics 51: 609–633.
Trabandt, M., and H. Uhlig. 2011. “The Laffer Curve Revisited.” Journal of Monetary Economics 58: 305–327.
UN. 2015. “World Population Prospects: The 2015 Revision, Methodology of the United Nations Population Estimates and Projections.”ESA/P/WP. 242.
The B.E. Journal of Macroeconomics publishes significant research and scholarship in theoretical and applied macroeconomics. The range of topics includes business cycle research, economic growth, and monetary economics, as well as topics drawn from the substantial areas of overlap between macroeconomics and international economics, labor economics, finance, development economics, political economy, public economics, econometric theory.