Population aging, social security and fiscal limits

We use an overlapping generations (OLG) life-cycle model with distortionary taxation on labor and capital to derive a threshold dependency ratio, i.e. a point in the cross-section distribution of the population beyond which tax revenues can no longer sustain the planned level of transfers to retirees. We quantify the level of the threshold; the distance of the economy from the threshold; and the probability of reaching the threshold at some point in the future. The model is calibrated on the United States and fourteen European countries which have dependency ratios among the highest in the world. We examine the effects on the threshold and welfare of a number of policies often advocated to improve the sustainability of pension systems. New tax data on dynamic Laffer effects are provided.