Optimal fiscal policy in the design of social security reforms

The quantitative literature has documented that a privatization of the social security system generates large long-run welfare gains at the cost of welfare losses for transition generations. In this article, we maximize over the entire policy space, following the optimal fiscal policy approach. The resulting allocation, by construction, lies on the constrained Pareto frontier. We find that the optimal design of reforms exhibits sizeable welfare gains arising from a reduction in labor supply distortions. In contrast, the welfare gains coming from the reduction of savings distortions are relatively small. © 2008 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.