Macro Shocks, Life Cycle Effects, and Fiscal Policy

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by Nathaniel E. Hipsman, Harvard University

Though many elderly Americans rely on Social Security for most of their income, the program cannot survive in its current state, as is often discussed, due to lower productivity and population growth in recent decades.  Toward the end of finding a replacement, I consider the larger problem of optimal taxation in an economy with overlapping generations, intra-cohort heterogeneity, and aggregate uncertainty.  This project considers such a problem in three separate contexts.  First, I solve the optimal affine taxation problem in a simple, complete markets model.  Second, I restrict asset markets to risk free government debt and risky capital, and forbid the government from taking positions in the risky market.  Finally, I consider a version of the model where taxation may be nonlinear, but it must meet political economy constraints which rule out policies that will be reformed at a later date.

Early results from the first of these problems suggest that optimal capital taxes are zero and optimal labor taxes respond only to population growth and expected future population growth, with higher population growth leading to lower tax rates.  However, these results will likely not hold in the more realistic second and third settings.

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