A program of Personal Retirement Accounts (PRAs) funded by deposits equal to 2.3 percent of earnings (up to the Social Security maximum) would permit retirees to receive more income in retirement than with the current Social Security program while at the same time making it unnecessary to increase the 12.4 percent payroll tax in response to the aging of the population. The gross cost of these deposits, approximately 0.9 percent of GDP, could be financed for more than a decade out of the budget surpluses currently projected by the Congressional Budget Office. By the year 2030, the additional corporate tax revenue that results from the enlarged capital stock financed by PRA assets would be able to finance fully these personal tax credits. During the intervening years (about 2020 to 2030), a reduction of other government spending or an increase in taxes would be needed if budget deficits are to be avoided. If implemented, the PRA program would not only increase retirement income and stabilize the Social Security payroll tax, but would also substantially increase national saving and GDP. NOTE: This is a revised version of "Two Percent Personal Retirement Accounts: Their Potential Effects on Social Security Tax Rates and National Saving," by Martin Feldstein and Andrew Samwick, issued in April, 1998 as working paper 6540.

International economic crises will continue to occur in the future as they have for centuries past. The rapid spread of the 1997 crisis in Asia and of the 1982 crisis in Latin America showed how shifts in market perceptions can suddenly bring trouble to countries even when there has been no change in objective conditions. More recently, the sharp jump in emerging market interest rates after Russia's August 1998 default underlined the vulnerability of all emerging market economies to increases in investors' aversion to risk. Emerging market countries that want to avoid the devastating effects of such crises must protect themselves. They cannot depend on the International Monetary Fund or other international organizations nor expect that a new global financial architecture' will make the world economy less dangerous. Taking steps to protect themselves requires more than avoiding those bad policies that make a currency crisis inevitable. The process of contagion makes even the virtuous vulnerable to currency runs. Liquidity is the key to self-protection. A country that has substantial international liquidity -- large foreign exchange reserves and a ready source of foreign currency loans -- is less likely to be the object of a currency attack. Substantial liquidity also permits a country that is attacked from within or without to defend itself better and to make more orderly adjustments. The challenge is to find ways to increase liquidity at reasonable cost.

Increasing the rate of saving is an important priority for many emerging market countries. This paper focuses on Mexico and discusses a variety of policies through which the government of Mexico could stimulate a higher rate of saving. These ideas are building blocks rather than an overall plan. Some are mutually exclusive but most are options that could be combined to achieve a higher rate of saving. Although the emphasis is on policy options that can be helpful in raising saving, the paper also discusses proposals that would be likely to reduce the rate of saving. The primary focus of the paper is on tax reforms, but there is also a discussion of financial regulation, government debt management, and the new system of retirement saving accounts.

The Medicare program of health care for the aged now costs more than $5,000 per enrollee, a national cost of more than $200 billion a year. The official projections that these costs will rise rapidly from 2.5% of GDP now to 5.5% of GDP in 2030 and 7% of GDP in 2070 assume that structural changes in health care will prevent the even more rapid growth of spending that would occur if past trends continue. These GDP shares are equivalent to increasing the payroll tax rates that rise from 5% of total wages now to 14% of total wages by 2070. Alternatively, if the increased Medicare spending is financed by an across-the-board increase in income tax rates, all tax rates would rise by 46 percent (e.g., from 28% to 41%). If Medicare costs continue to be tax financed, the sharp increase in Medicare costs would cause a substantial increase in the deadweight loss of the tax system. Even with quite favorable assumptions, the increased deadweight loss is likely to be almost as large as the direct increase in the health care costs themselves. This paper analyzes an alternative life cycle approach to paying for the cost of health care of the aged: a system of investment-based individual Retiree Health Accounts (RHAs) to which the government deposits funds during individuals' working years. At retirement the individual could use the accumulated fund to purchase a fee-for-service plan like the current Medicare package, to pay for membership in an HMO, or to establish a medical savings account with a high deductible insurance policy. Using data from the Social Security administration, I estimate that annual RHA deposits equal to about 1.4% of total payroll would eventually be enough to pay for the full increase in the cost of Medicare, obviating a nine percentage point payroll tax increase.

China has legislated a mixed social security pension system with a defined benefit pay-as-you-go portion and an investment-based defined contribution portion. This paper analyses the economics of these two types of systems in the Chinese context and calculates the advantage to China of using an investment-based portion. Several options for reform of the recently legislated system are considered.

Going from low inflation to price stability involves a short term loss (associated with the" higher unemployment rate required to reduce the inflation) and results in a series of welfare gains" in all future years. The primary source of these gains is the reduction in the distortions that result" from the interaction of tax rules and inflation. The paper quantifies the gains associated with" reducing the distortion in favor of current consumption rather than future consumption and in" favor of the consumption of owner occupied housing. These tax effects are much larger than the" effect on the demand for money that is generally emphasized in studies of the distorting effect of" inflation. The seignorage gains are also small in comparison to other effects of the tax-inflation" interaction. The estimates imply that the annual value of the net benefits of going from two" percent inflation to price stability are about one percent of GDP. Discounting this growing" stream of benefits at a real discount rate of five percent implies a net present value of about more" than 30 percent of GDP. All estimates of the short-run cost of going from low inflation to price" stability are less than this.

The traditional method of analyzing the distorting effects of the income tax greatly underestimates its total deadweight loss as well as the incremental deadweight loss of an increase in income tax rates. Deadweight losses are substantially greater than these conventional estimates because the traditional framework ignores the effect of higher income tax rates on tax avoidance through changes in the form of compensation (e.g., employer paid health insurance) and through changes in the patterns of consumption (e.g., owner occupied housing). The deadweight loss due to the increased use of exclusions and deductions is easily calculated. Because the relative prices of leisure, excludable income, and deductible consumption are fixed, all of these can be treated as a single Hicksian composite good. The compensated change in taxable income induced by changes in tax rates therefore provides all of the information that is needed to evaluate the deadweight loss of the income tax. These estimates using TAXSIM calibrated to 1994 imply that the deadweight loss per dollar of revenue of using the income tax rather than a lump sum tax is more than twelve times as large as Harberger's classic estimate. A marginal increase in tax revenue achieved by a proportional rise in all personal income tax rates involves a deadweight loss of nearly two dollars per incremental dollar of revenue. Repealing the 1993 increase in tax rates for high income taxpayers would reduce the deadweight loss of the tax system by $24 billion while actually increasing tax revenue.

The first part of this paper argues that income inequality is not a problem in need of remedy. The common practice of interpreting a rise in the gini coefficient measure of inequality as a bad thing violates the Pareto principle and is equivalent to using a social welfare function that puts negative weight on increases in the income of high income individuals. The real distributional problem is not inequality but poverty. The paper considers three sources of poverty and asks what if anything might be done about each of them: unemployment; a low level of earning capacity; and individual choice.