Pay-As-You-Go versus Advance-Funded Public Pension Systems under Imperfect Capital Markets

Abstract

In this article I asked whether pay-as-you-go pension plans for public sector workers give local governments an incentive to offer workers overly generous pension benefits and to substitute labor for other inputs in the production of local public goods. I show that the answer turns in part on whether capital market imperfections represent an effective constraint for consumers. If a community's public assets and liabilities are capitalized into property values and borrowing constraints are not binding, these incentives are not present. If borrowing constraints are effective, these incentives exist even if capitalization is working smoothly.