September 28th, 2014
from the Minneapolis Fed
A problem that faces many countries including the United States is how to finance retirement consumption as the 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 would fall for some groups such as retirees or the working poor.
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 generations, with estimates of future gains close to 70 percent higher than those found in 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 income 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.