Abstract
This paper introduces an overlapping-generations model with earnings heterogeneity and borrowing constraints. The labour income tax and the allocation of tax revenue between social security and forward intergenerational public goods are determined in a bidimensional majoritarian voting game played by successive generations. The political equilibrium is characterized by an ends-against-the-middle equilibrium where low-income and high-income individuals form a coalition in favour of a lower tax rate and less social security while middle-income individuals favour a higher tax rate and greater social security. Government spending then shifts from social security to public goods provision if higher wage inequality is associated with a borrowing constraint and a high elasticity of marginal utility of youth consumption.
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The authors would like to thank Professor Kazuo Ogawa, the Editor of this journal and three anonymous referees for their valuable comments and suggestions. Financial support of the Nomura Foundation is gratefully acknowledged.
