Distributive concerns when replacing a pay-as-you-go system with a fully funded system

Abstract

The author uses a simulation model to quantify the impact on income distribution of having a neutral social security program that is fully funded replace a progressive social security program that redistributes income toward the poor but is financed by a pay-as-you-go method. He finds that if the original pay-as-you-go system is large enough to yield an income replacement rate of at least 40 percent for the middle class and 200 percent for the poor, then the proposed change helps the poor in the long run, so long as public debt does not increase by more than 40 percent of GDP during the transition. Such a reform allows an increase in the capital stock per worker, so in the long run the poor benefit more through higher real wages than they lose because progressive redistribution has ended. In the short run, however, a compensatory program is needed because the poor lose their subsidy before receiving the long-term benefit. In most cases, the 40 percent of GDP available from the increase in public debt is enough to finance a transfer program that compensates the poor in the"short"run (the first 50 years). The author concludes that concern about the welfare of the poor is unwarranted, in both the short and long runs, if the compensatory program is implemented.Environmental Economics&Policies,Economic Theory&Research,Safety Nets and Transfers,Services&Transfers to Poor,Rural Poverty Reduction