Designing an Optimal Public Pension System

1 We would like to express our sincere gratitude for the invaluable advice received from Professor Takashi Kamihigashi (Kobe University) as well as Senior Economist Ryo Ishida (Policy Research Institute, Ministry of Finance) during the writing of the first draft of this paper. 2 This paper uses a two-period overlapping generations model in order to provide a theoretical design for an optimal public pension system based on a partial equilibrium analysis. Household preferences only depend on two periods consumption and leisure and is homogeneous of degree m with respect to consumption in the working and retired periods. We present characteristic features of an optimal public pension system in this paper. First, differences in the population growth rate do not affect the relative level of the optimal net lifetime burden rate of each generation. Second, if 0m or 1m, the optimal public pension system can be expressed explicitly. Third, the difference between the market time-preference rate and social time-preference rate provides a crucial insight into the optimal burden rate of each generation.