The Aging Population and the Size of the Welfare State

Data for the United States and countries in Western Europe indicate a negative correlation between the dependency ratio and labour tax rates and the generosity of social transfers, after controlling for other factors that influence the size of the welfare state. This is despite the increased political clout of the dependent population implied by the aging of the population. This Paper develops an overlapping generations model of intra-and inter-generational transfers (including old-age social security) and human capital formation which addresses this seeming puzzle. We show that with democratic voting, an increase in the dependency ratio can lead to lower taxes or less generous social transfers.