Use the social security model developed in this chapter to answer this question. Suppose that a government

pay-as-you-go social security (pay-as-you-go social security: A social security system in which benefits to the old are financed by taxes on the working population) system has been in place for a long time, providing a social security payment to each old person of b units of consumption. Now, in period T suppose that the government notices that r>n, and decides to eliminate this system. During period T, the government reduces the tax of each young person to zero but still pays a social security benefit of b to each old person alive in period T. The government issues enough one-period government bonds, DT, to finance the social security payments in period T. Then, in period T+1, to pay off the principal and interest on the bonds issued in period T, the government taxes the old currently alive, and issues new one-period bonds DT+1. The taxes on the old in period T+1 are just large enough that the quantity of debt per old person stays constant, that is, DT+1=(1+n)DT. Then, the same thing is done in periods T+2, T+3, . . . , so that the government debt per old person stays constant forever.

a. Are the consumers born in periods T, T+1, T+2, . . . better or worse off than they would have been if the pay-as-you-go social security program had stayed in place? Consumers born in periods T, T+1, T+2, . . .

(CHOOSE BETWEEN A, B, C, D)

A. are not made any better or any worse off by the removal of the social security program and implementation of recurring government debt. The lifetime wealth of any consumer born in periods T+1 and on is identical to the lifetime wealth these consumers would have experienced if the pay-as-you-go social security system remained in place.

B. are made better off by the removal of the social security program and implementation of recurring government debt. Because r>n,

the consumers born in periods T, T+1, T+2, . . . will be made better off only needing to pay taxes when they are older.

C. are made worse off by the removal of the social security program and implementation of recurring government debt. The taxes imposed on consumers to finance debts will decrease their lifetime wealth because the consumers have limited access to savings in the current period which will earn them a better return given that r>n.

D. are made worse off by the removal of the social security program and implementation of recurring government debt. The consumers born in periods T, T+1, T+2, . . . are now burdened with a debt that earns them no benefit in the future period in the form of social security.