Nonseparable Preferences and Optimal Social Security Systems
40 Pages Posted: 10 Sep 2007 Last revised: 7 Jul 2010
Date Written: September 2007
In this paper, we consider economies in which agents are privately informed about their skills, which are evolving stochastically over time. We require agents' preferences to be weakly separable between the lifetime paths of consumption and labor. However, we allow for intertemporal nonseparabilities in preferences like habit formation. We show that such nonseparabilities imply that optimal asset income taxes are necessarily retrospective in nature. We show that under weak conditions, it is possible to implement a socially optimal allocation using a social security system in which taxes on wealth are linear, and taxes/transfers are history-dependent only at retirement. The average asset income tax in this system is zero.
Suggested Citation: Suggested Citation