Social security, dynamic efficiency and self-control problems

We develop an OLG model with uncertainty on labor income and death age to study the welfare implications of unfunded Social Security programs in an economy where agents are affected by temptation à la Gul and Pesendorfer (2001, Econometrica 69, 1403). Tempted agents give additional value to the pre-commitment mechanism implicit in Social Security. Simulation studies calibrated on the US economy show that, in contrast to previous findings, Social Security may improve welfare even when it reduces aggregate consumption in a dynamically efficient economy. A reasonably small degree of temptation is enough to obtain this result. Our simulations, nevertheless, suggest that a payroll tax of 10 percent is possibly too large.