Temptation and social security in a dynastic framework European Economic Review (published online 8 Aug 2012) We investigate welfare and aggregate implications of a pay-as-you-go (PAYG) social security system in a dynastic framework in which individuals h

We investigate welfare and aggregate implications of a pay-as-you-go (PAYG) social security system in a dynastic framework in which individuals have self-control problems. The presence of self-control problems induces individuals to save less because of their urge for temptation towards current consumption. Individuals ’ efforts to balance between the short-term urge for temptation and the long-term commitment for consumption smoothing result in self-control costs. In this environment PAYG social security works as a self-control cost reducing device. In contrast, the presence of altruism induces individuals to save more. This in turn mitigates the adverse affects of self-control problems and PAYG social security on savings but magnifies the self-control costs. We find that in our environment the adverse welfare effects of a PAYG system are further mitigated relative to the environments that incorporate altruism and self control issues separately. Interestingly, the welfare effects vary significantly across different types of households. Richer households demand more PAYG social security as they face larger self-control costs