Retirement Financing : An Optimal Reform Approach

We study Pareto optimal policy reforms aimed at overhauling retirement financing asan integral part of the tax and transfer system. Our framework for policy analysis is aheterogeneous-agent overlapping-generations model that performs well in matching the aggregateand distributional features of the U.S. economy. We present a test of Pareto optimalitythat identifies the main source of inefficiency in the status quo policies. Our test suggests thatlack of asset subsidies late in life is the main source of inefficiency when annuity markets areincomplete. We solve for Pareto optimal policy reforms and show that progressive asset subsidiesprovide a powerful tool for Pareto optimal reforms. On the other hand, earnings taxreforms do not always yield efficiency gains. We implement our Pareto optimal policy reformin an economy that features demographic change. The reform reduces the present discountedvalue of net resources consumed by each generation by about 7 to 11 percent in the steadystate. These gains amount to a one-time lump-sum transfer to the initial generation equal to10.5 percent of GDP