Myopia and Social Security Financing

Abstract

This article compares the welfare effects offinancing Social Security with consump- Abstract tion and payroll taxes in an economy in which a segment of the population is myopic. The article shows that so long as there are myopic agents who fail to allocate consumption according to the first-order optintality condinons, social welfare can be improved by a switch from the payroll tax to the consumption tax in financing Social Security. The gains from the tax substitution are larger the higher the rate of return on capital and, up to a point, the larger the myopic population. Furthermore, means testing is more likely to improve social welfare if moral hazard is less serious or if Social Security is financed by the consumption tax instead of the payroll tax.