Aging, voters and lower income tax: A role for pension design

Abstract

This paper examines the political economy effect of population aging on income tax rates and the role of intragenerationally fair pensions. We explore both effects in an overlapping-generations small open economy where young voters benefit from tax-funded education spending according to individual ability and labor supply. Aging raises the effective pension contribution rate and lowers the ability of the median young voter who unambiguously prefers a lower income tax rate. Higher statutory contribution rates exacerbate the trend if the return to capital exceeds population growth. Lower preference for leisure attenuates the trend when intra-generational fairness links contributions and pensions to individual labor income. The overall effect of aging on domestic wealth per worker is ambiguous. Our findings identify why lower income tax rates are politically sustainable and how pension design may help meet the challenge of population aging