We model pay-as-you-go social security systems as the outcome of majority voting within a overlapping generations model with production. When voting, individuals make two choices, pay the elderly their pensions or default, which amount to promise themselves next period. Under general circumstances, there exist equilibria where pensions are voted into existence and maintained. Our analysis uncovers two reasons for this. The traditional one relies on intergenerational trade and occurs at inefficient equilibria. A second reason relies on the monopoly power of the median voter. It occurs when a reduction in current saving induces a large enough increase in future return on capital to compensate for the negative effect of the tax. We characterize the steady state and dynamic properties of these equilibria and study their welfare properties. Journal of Economic Literature Classification Numbers: C72, C78,
Bibliographical noteFunding Information:
Financial support from the Fundaci6n Marc Rich, CICYT (SEC96-0738). and the Funda-ci6n BBV is acknowledged. We are grateful to an anonymous referee of this review for valuable criticisms and suggestions. Seminar participants at the American Economic Association 1995 meetings, Bilbao, Cambridge (UK), C.E.M.F.I. (Marid), Chicago, C.O.R.E. (Louvain-la-Neuve), L.S.E., N.B.E.R. 1995 Summer Institute, Northwestern, Pompeu Fabra, and UCLA, contributed important comments.
- Overlapping generations; political economy; social security systems; taxation