Various tax policy alternatives to delay retirement: some computations and implications

Demographic challenges have been threatening the fiscal sustainability of pension systems across most of the developed world. A popular policy response to pension financing difficulties is the encouragement (or enforcement) of later retirement, as well the legislation of higher payroll taxes over time. In this paper we analyze how various tax policy experiments, including changes in the Social Security payroll tax, affect people?s desire to leave the workforce and the state of the economy. For this purpose we build a general-equilibrium life-cycle model with rational and myopic consumers, facing a mortality risk. Agents leave accidental bequests and are heterogeneous in their age-dependent work productivity. We incorporate productive government expenditures, categorize people into the rich and poor, and endogenize people?s retirement decision. We find that although some reasonable fiscal reforms are unlikely to abruptly delay people?s planned retirement dates, there exists a number of alternative fiscal arrangements which are welfare and output enhancing, consumption-smoothing, and more or less distributionally neutral. This alone suggests that the welfare losses due to the pension crisis can potentially be counter-balanced by various fiscal reforms. Increasing the payroll tax is the most distortive among all the existing tax policy reforms. Increasing bequest and capital tax rates by reasonable magnitudes have the least impact on output, implying that the combination of higher capital and bequest taxes with a lower social security payroll tax can be used to generate extra revenues to cope with the pension crisis. The highest combined welfare gain, positive to all agents, can be achieved by increasing the consumption tax, but this tax also tends to encourage retirement.