Optimal Intergenerational Transfers: Public Education and Pensions

Abstract

In presence of imperfections in education loan market, the standard policy response of intervening solely on education front, funded through taxes and transfers, necessarily hurts the initial working population. The literature suggests compensating them via payas-you-go pensions as a possible solution. But for various reasons sustainability of PAYG pensions is under serious doubt. We carry out the optimal policy exercise of a utilitarian government in a dynamically efficient economy with pension and education support obeying the Pareto criterion. We find that expansion of one instrument along with the other emerges as the optimal response, however, once the complete market level of education is achieved, the optimal policy suggests phasing pensions out. Eventually, government leads the economy to an equilibrium with zero pension and the Golden Rule level of education. This is achieved by exploiting only market opportunities without relying on other factors including human capital externalities, general equilibrium effects or sociopolitical factors.

Time Inconsistency and Endogenous Borrowing Constraints

“…Given the young are natural borrowers and the middle-aged, savers, it is conceivable a policy that taxes the latter and transfers to the former (and the old) could help curb the overborrowing of the middle-aged and prevent underconsumption by the old. Such a policy would be consistent with the thinking in Boldrin and Montes (2005), Bishnu (2013), Wang (2014) and Bishnu et al (2020) where time consistent agents in an imperfect credit market world benefit from a joint institutional arrangement (connecting education expenses when young and pension payouts when old). Such an arrangement acts as a stand-in for the missing (education) loan market and can replicate the complete market allocations.…”

“…m + a y R) : These constitute natural limits on borrowing/saving arising purely from the model restriction that all debts be cleared by the time the three periods are up. 8 No lender restricts debt as long as these minimal natural limits are met. As such, one can think of this economy as representing the pre-CPFB scenario.…”

“…We next consider the naive agent's problem at middle age. She has carried youthful debt, a y R, pre-determined, into middle age, but her preference over middle and old age consumption is (2), no longer (1): she takes a y as given and maximizes (2) subject to (7) and (8). Then the middle-aged agent's actual optimal asset demand, a m (a y ; ), a function of youthful debt, a y , and degree of middle self's present bias, ; solves…”

Reference‐dependent preferences, time inconsistency, and pay‐as‐you‐go pensions

“…While these issues are of tremendous practical importance, we believe they are best left for future work. Some of these transition hurdles in different contexts are studied in Andersen and Bhattacharya (2017) and in the recent work by Bishnu et al (2020).…”

Pareto-improving transition to fully funded pensions under myopia

“…10 Viewed this way, Andersen and Bhattacharya (2017) argue that a PAYG pension scheme is to be viewed as the just compensation to the retired for prior financing of public education, and in the presence of an intergenerational education externality, "once it has served its purpose, it can be phased out and that too in a Pareto-improving manner." Bishnu et al (2020) take this line of thinking further and derive the optimal path for subsidies to education and public pensions, not just a Pareto-improving path.…”