NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

On Financing Retirement with an Aging Population

Ellen R. McGrattan, Edward C. Prescott

NBER Working Paper No. 18760
Issued in February 2013
NBER Program(s):   EFG   PE

A problem facing the United States is financing retirement consumption as its population ages. Proposals for switching to a saving-for-retirement system that do not rely on high payroll taxes have been challenged on the grounds that welfare for some cohorts will fall. We show how to devise a transition path from the current U.S. system to a saving-for-retirement system that increases the welfare of all current and future cohorts, with estimates of future gains that are twice as large as those found with typically used macroeconomic models. The gains are large because there is more productive capital than commonly assumed. Furthermore, the gains are amplified if we lower capital taxes in addition to payroll taxes because the value of business equity increases relative to the capital stock. Our quantitative results depend importantly on accounting for differences between actual government tax revenues and what revenues would be if all income were taxed at the income-weighted average marginal tax rates used in our analysis.

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An online appendix is available for this publication.

This paper was revised on November 1, 2013

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w18760

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