Temptation and Social Security in Dynastic Framework

We investigate the welfare implications of a pay as you go (PAYG) social security system in a dynastic framework in which agents have self-control problems. Unlike the previous studies, we incorporate altruism and temptation into our analysis. The presense of these two additional factors affects agents’ intertemporal decision problems in two opposite directions. That is, on the one hand agents want to save more because of their altruistic concerns, on the other hand, they want to save less because of their urge of temptation towards current consumption. Agents’ efforts to balance between the long-term commitment (consumption smoothing and altruism) and the short-term urge of temptation result in a self-control cost. In this environment, the existence of social security system provides not only consumption smoothing and risk-sharing mechanisms but also a channel that reduces the severity of temptation. We calibrate our model to the US data. Our quantitative results show that the presence of temptation and altruism mitigates the adverse welfare effects of a PAYG system. JEL Classification: E21, H55