Retirement and Social Security: A Political Economy Perspective

Countries with higher implicit taxes on continued work are associated with lower labor force participation rates of the elderly. This paper constructs a politicoeconomic model that accounts for this feature based on multiple, self-fulfilling expectations of agents. In this model, agents are identical at birth and can become skilled (or remain unskilled) through educational investment. When agents hold expectations of higher future taxation (i.e., higher social security benefits), it provides a disincentive to engage in educational investment, thereby resulting in an unskilled majority. In turn, this unskilled majority supports higher taxation, which induces the retirement of the elderly and thus results in a lower labor force participation rate. The opposite applies when agents have expectations of lower taxes in their old age.