Markovian Social Security in Unequal Societies

40 Pages Posted: 24 Mar 2009  

Kaiji Chen

Emory University - Department of Economics; Federal Reserve Bank of Atlanta

Zheng Michael Song

Fudan University - School of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: March 24, 2009

Abstract

In this paper, we develop a dynamic politico-economic theory of social security to address two questions. First, how is social security sustained? Second, how does inequality affect the size of social security, and can the theoretical predictions be consistent with the observed puzzling relationships between inequality and the size of social security? As a stark framework, our model economy features the absence of altruism, commitment, reputation mechanism and electoral uncertainty. We characterize analytically a Markov perfect equilibrium and find that the joint between Markovian tax policy and tax distortion on private investment shapes an intertemporal policy rule linking taxes positively over time. The positive intertemporal tax linkage, by allowing current taxpayers to influence their own future social security benefit, provides the political support for social security. Moreover, we find that a larger wage inequality weakens the intertemporal tax linkage and, thus, reduces inter-generational redistributive benefit. This may lead to a smaller size of social security. Our theoretical predictions are in line with both time-series and cross-country correlations between inequality and social security.

Keywords: Intertemporal Tax Linkage, Markov Perfect Equilibrium, Political Economy, Redistribution, Social Security, Wage Inequality

JEL Classification: E60, H55, P16

Suggested Citation

Chen, Kaiji and Song, Zheng Michael, Markovian Social Security in Unequal Societies (March 24, 2009). Available at SSRN: https://ssrn.com/abstract=1367476 or http://dx.doi.org/10.2139/ssrn.1367476

Kaiji Chen

Emory University - Department of Economics ( email )

1602 Fishburne Drive
Atlanta, GA 30322
United States

HOME PAGE: http://https://sites.google.com/site/chenkaiji/research

Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

Zheng Song (Contact Author)

Fudan University - School of Economics ( email )

600 GuoQuan Road
Shanghai, 200433
China

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