Social Security reform in the presence of informality

As populations age, countries across the globe are dealing with issue of how to fund retirement consumption for their workers. The design Social Security programs is more difficult when country also exhibits an informal economy where workers avoid taxation government and not entitled its benefits. In this paper, I study example Chile–a that transitioned from a pay-as-you-go system private, individual accounts in 1981 significant sector–in order quantify transitional welfare impact privatization have option evade public through informality. construct OLG model which allows households split working time between taxed formal sector, untaxed home production. find large long-run gains roughly 10 15 percent low high-productivity workers, respectively. However, these come at expense losses two groups: low-productivity who retired reform within 5 years reform. presence informality leads conflicting mechanisms: (1) elasticity channel decreases reform: including as imperfectly substitutable formality utility labor supply renders payroll tax less distortionary, (2) market wage increases causes growth can receive without facing distortions any remaining sector. Quantitative results indicate stronger case Chile, inclusion privatizing Security.