AEA Session H5Social Security Reform THE WAGE GAP AND PUBLIC SUPPORT FOR SOCIAL SECURITY

Tax rates on labor income rose in most industrial countries in the the 1970s and 1980s, in large part to fund burgeoning social security systems. The growth of the welfare state coincided with increased returns to education, and thus broader wage differentials between workers with relatively high levels of skills or education and those without. This paper provides a theoretical framework which connects these phenomena. We show that the aging of the population and the return to education both affect the political-economy determination of tax rates and the generosity of transfers in a democratic framework. Using panel data on the United States and nine European countries, we provide supportive empirical evidence. 1 Analytical Framework The analytical framework is similar to that used in our previous work [Razin, Sadka, and Swagel (2001)]. Consider a standard overlapping-generations model in which each generation lives two periods: a working period and a retirement period. There are two types of workers: skilled workers provide one efficiency unit of labor per unit of labor time during their Þrst period of life, while unskilled workers provide only q < 1 efficiency units of labor per unit of labor time in thi