Kent Smetters

Consumption taxes and economic efficiency with idiosyncratic wage shocks

Fundamental tax reform is examined in an overlapping‐generations model in which heterogeneous agents face idiosyncratic wage shocks and longevity uncertainty. A progressive income tax is replaced with a flat consumption tax. If idiosyncratic wage shocks are insurable (i.e., no risk), this reform improves (interim) efficiency, a result consistent with the previous literature. But if, more realistically, wage shocks are uninsurable, this reform reduces efficiency, even though national wealth and output increase over the entire transition path. This efficiency loss, in large part, stems from reduced intragenerational risk sharing that was previously provided by the progressive tax system.

Fiscal and Generational Imbalances: New Budget Measures for New Budget Priorities

This paper describes the deficiencies of the measures used to calculate the federal budget, make revenue and spending projections, and assess the sustainability of current fiscal policies. The nature of the deficiencies hides the tremendous impact that Social Security and Medicare commitments will have on the budget in the future, given the way the programs are structured currently and the momentous demographic shift underway as the baby boom generation approaches retirement age. This paper proposes two new simple measures that will enable government officials and the public to calculate more accurately the costs of maintaining these programs into the relevant future. The measures provide a better understanding of the costs involved, when they will be incurred, and by whom. The measures also provide a way to meaningfully compare the various solutions that have been proposed for dealing with the impending fiscal crisis that will be caused by Social Security and Medicare. This article was also published as a monograph by the AEI Press, the publisher for the American Enterprise Institute.

Does the Open Economy Assumption Really Mean That Labor Bears the Burden of a Capital Income Tax

Abstract The conventional view holds that domestic labor, not domestic capital, bears most of the long-run burden of a corporate income tax in an open economy due to the ability of capital to move across borders. This result assumes that domestic and foreign products (as well as investments) are perfect substitutes. This paper includes imperfect product substitution within a multi-sector open-economy model, and shows that much of the burden may fall on capital. To be sure, if savings falls sufficiently, much of the burden shifts to labor, but this fact also holds in a closed economy. Hence, the debate about tax incidence must focus more on the savings response and less on whether an economy is open or closed.

Guaranteeing Defined Contribution Pensions: The Option to Buy Back a Defined Benefit Promise

After a long commitment to defined benefit (DB) pension plans for U.S. public sector employees, many state legislatures have introduced defined contribution (DC) plans for their public employees. In this process, investment risk that was previously borne by state DB plans has now devolved to employees covered by the new DC plans. In light of this trend, some states have introduced a guarantee mechanism to help protect DC plan participants. One such guarantee takes the form of an option permitting DC plan participants to buy back their DB benefit for a price. This article develops a theoretical framework to analyze the option design and illustrate how employee characteristics influence the options cost. We illustrate the potential impact of a buy-back option in a pension reform enacted recently by the State of Florida for its public employees. If employees were to exercise the buy-back option optimally, the market value of this option could represent up to 100 percent of the DC contributions over their work life.

Measuring Social Security's Financial Problems

The U.S. Social Security system has helped keep many retirees out of poverty. However, according to the Social Security and Medicare Trustees, Social Security faces a future financial shortfall of

Fiscal and Generational Imbalances: An Update

10.4 trillion in present value. This enormous imbalance has received little attention in public debates about Social Security. Instead, the media and policymakers continue to focus on the programs trust fund and several other ad-hoc measures that create a misleading impression of the size of Social Securitys financial problem. Although the Social Security Trust Fund is not projected to be exhausted until 2042, Social Securitys

Do the Markets Care about the

10.4 trillion present value imbalance is accruing interest and will grow by

2.4 Trillion U.S. Deficit?

600 billion during 2004 alone. The current cash-flow federal budget, however, is biased against reforms that would improve Social Securitys finances. As shown herein, a new federal accounting system would remove this bias.

Analyzing Fiscal Policies in a Heterogeneous-Agent Overlapping-Generations Economy

This paper provides an update of the U.S. fiscal and generational imbalances that we originally calculated in Gokhale and Smetters (2003) and presents the calculations in several alternative ways. We find that a lot has changed in just a few years. In particular, the nations fiscal imbalance has grown from around

Optimal Portfolio Choice Over the Life Cycle with Social Security

44 trillion as of fiscal year-end 2002 to about