A Matter of Trust: Understanding Worldwide Public Pension Conversions

52 Pages Posted: 10 Nov 2010

See all articles by Kent A. Smetters

Kent A. Smetters

University of Pennsylvania - Business & Public Policy Department; National Bureau of Economic Research (NBER)

Walter Theseira

Nanyang Technological University

Multiple version iconThere are 2 versions of this paper

Date Written: April 9, 2010

Abstract

Security markets between generations are naturally incomplete in a laissez-faire economy since risk sharing agreements cannot be made with the unborn. But suppose that generations could trade if, for example, a representative of the unborn negotiated on their behalf today. What would the trades look like? Can government fiscal policy be used to replicate these trades? Would completing this missing market be Pareto improving when the introduction of the new security changes the prices of existing assets? This paper characterizes analytically the hypothetical trades between generations and shows how the government can replicate these trades by taxing the realized equity premium on investments in a symmetric fashion. This tax is equivalent to the government providing a “collar-like” guarantee on personal investments. When technology shocks are mostly driven by changes in depreciation, a positive tax (a long collar) replicates the hypothetical trades; this tax is also Pareto improving under fairly general conditions. When technology shocks are mostly driven by changes in productivity, the choice between a positive and negative tax rate is unclear. However, with log utility, Cobb-Douglas production, and a depreciation rate less than 100 percent, a negative tax (short collar) is Pareto improving. Simulation analysis is used to consider more complicated cases, including when depreciation and productivity are both uncertain. Under the baseline calibration for the U.S., a positive tax (a long collar) on the equity premium is Pareto improving.

Keywords: Social Security, Trust, Pension, System, Countries, Workers, Private, Reform, Demographic, Model

Suggested Citation

Smetters, Kent and Theseira, Walter, A Matter of Trust: Understanding Worldwide Public Pension Conversions (April 9, 2010). Pension Research Council Working Paper No. 2010-04, Available at SSRN: https://ssrn.com/abstract=1706212 or http://dx.doi.org/10.2139/ssrn.1706212

Kent Smetters (Contact Author)

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Walter Theseira

Nanyang Technological University ( email )

HSS 04-53, 14 Nanyang Drive
Singapore, 639798
Singapore

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