Pension and Social Security Systems

As people age, they eventually reach a state where they cannot produce as much as they consume.  Many poor societies used to encourage the elderly to commit suicide at that point, but modern societies are wealthy enough to afford to support vast numbers of elderly in their dotage.  This means that working-age people must somehow transfer resources to the elderly.  There are several mechanisms for accomplishing this:
1. Private savings.  Working-age people consume less than they earn and accumulate claims on future goods and services that they can consume in their dotage.
2. Government transfer programs.  The government requires that working age people consume less than they earn so that the elderly can have more. These come in two forms:
a) Individual forced savings accounts.
b) Pay-as-you-go transfers like Social Security (which is partly savings too).
3. Traditional social norms.  Usually descendents are expected to consume less than they earn during their working age so that they can transfer resources to their elderly parents or relatives. 

In every case, if each system achieves the same level of retirement in a year, then working-age people must transfer the same amount of real resources to retired people during that particular year.  The effect on real resources is exactly the same.  However, some systems create a higher stock of savings than others.  Imagine societies that live on wheat alone.  A system that required each individual to save for his own retirement would have vast storehouses of wheat whereas a system that used a pay-as-you go system might have zero storage.  Assuming zero spoilage in storage, the total amount of wheat produced every year would be exactly the same over an infinite horizon.  If there is spoilage, then the system with savings would actually need to produce more wheat than the pay-as-you-go system.   To avoid the expense of storage (and spoilage), the savings system could create paper commodity money which is worth a certain amount of grain.  Then people could produce extra wheat and trade it to their elders for paper money and store paper money rather than grain.  Money turns the savings system into something akin to the pay-as-you-go system.  

What system works best?
1. People do not save enough for the future because we are myopic.
2a. This is like #1, except that people are forced to save more than they otherwise would do.  One problem is that it can be politically manipulated by the finance industry to yield them extra profits.  Another problem is that some people cannot manage where to keep their savings and if people put their savings into risky investments, they may not have anything left at retirement.
2b. This is essentially an income tax and transfer program and has the same effect as an income tax except that it also reduces the incentive to save.
3. This can encourage people to have too many kids which can reduce per-capita income.  Also, children are even less reliable than financial markets. It is unfair due to random chances leading to wide differences in outcomes that are difficult to insure against.  An only child whose parents both get Alzheimer's disease must transfer a lot more resources than a family of six children whose parents remain healthy and productive their entire lives.   A parent of six children would get a much better retirement than a parent whose children all died in a tragic bus accident.

This issue was raised by Samuelson's "An exact consumption-loan model of interest with or without the social contrivance of money" JPE 1958 and critiqued by Lerner (1959) on the left and Meckling (1960) on the right.  They are all bothered that perfect competition does not accomplish the optimal result and give varying alternatives.  Also see: Feldstein, Martin S. “Induced Retirement and Aggregate Capital Accumulation.” JPE, 1974, 82(5).

Mortgage Interest Deduction

Leonhardt at NYT:

The mortgage interest deduction, for example, saves more than $5,000 a year for the typical household in the top 1 percent of earners. Most middle-income households don’t benefit from the deduction at all, because they instead claim the standard income tax deduction. And the mortgage deduction is the second-largest tax break for individuals, costing about $80 billion a year, more than the budgets for the Education Department and Justice Department combined. ...

The truth is, closing loopholes has much stronger support among economists and columnists than it does among voters. Only 23 percent of Americans benefit from the mortgage deduction, but 93 percent support it. ...
So what kind of tax increases do Americans support? The old-fashioned kind. Seventy-two percent support raising taxes on income above $250,000, according to a recent New York Times/CBS poll, and a large majority likewise favor raising Social Security taxes on the affluent.
In the end, the most likely tax increase may be the one that’s already on the books. On Jan. 1, 2013, all the Bush tax cuts — on the affluent and nonaffluent alike — are set to expire, which would solve roughly one-quarter of our long-term deficit problem. If Republicans have their way, all the tax cuts will be extended. If the Democrats have their way, most of them will be.