Economics of Social Security

Estimated Retirement Benefits in the Social Security Statement

Chile's Next Generation Pension Reform

Since its inception in 1981, Chile's system of mandatory individual retirement accounts has become a model for pension reformers around the world. A March 2008 comprehensive pension reform law made major changes that address some key policy challenges including worker coverage, gender equity, pension adequacy, and administrative fees. The cornerstone of the new law sets up a basic universal pension as a supplement to the individual accounts system.

Alternate Measures of Replacement Rates for Social Security Benefits and Retirement Income

Replacement rates are common and useful tools used by individuals and policy analysts to plan for retirement and assess the sufficiency of Social Security benefits and overall retirement income. Because the calculation and meaning of replacement rates differs depending on the definition of preretirement earnings, this article examines four alternative measures: final preretirement earnings, constant income payable from the present value of lifetime earnings (PV payment), wage-indexed average of lifetime earnings, and inflation-adjusted average of lifetime earnings (CPI average). The article also calculates replacement rates for Social Security beneficiaries aged 64–66 in 2005.

Estimating the First Instance of Substantive-Covered Earnings in the Labor Market

Disability Benefit Coverage and Program Interactions in the Working-Age Population

It is widely known that about three-fourths of the working-age population is insured for Disability Insurance (DI), but the substantial role played by the Supplemental Security Income (SSI) program in providing disability benefit coverage is not well understood. Using data from the 1996 panel of the Survey of Income and Program Participation (SIPP) we find that over one-third (36 percent) of the working-age population is covered by SSI in the event of a severe disability. Three important implications follow: (1) SSI increases the overall coverage of the working-age population; (2) SSI enhances the bundle of cash benefits available to disabled individuals; and (3) interactions with other public programs—most notably the SSI path to Medicaid coverage—also enhance the safety net. Ignoring these implications could lead to inaccurate inferences in analytic studies.

The Reservation Wages of Social Security Disability Insurance Beneficiaries

Using the New Beneficiary Data System, this article examines the reservation wages of a sample of Social Security Disability Insurance (DI) beneficiaries with work capabilities. It analyzes the magnitude of the reservation wages of DI beneficiaries compared to the last wage earned and to benefit amounts. In addition, the article discusses the determinants of reservation wages for DI beneficiaries.

Disabled Workers and the Indexing of Social Security Benefits

This article presents the distributional effects of changing the Social Security indexing scheme, with an emphasis on the effects upon disabled-worker beneficiaries. Although a class of reform proposals that would slow the rate of growth of initial benefit levels over time—including price indexing and longevity indexing—initially appear to affect all beneficiaries proportionally, there can be different impacts on different groups of beneficiaries. The impacts between and within groups are mitigated by (1) the offsetting effect of changes in Supplemental Security Income benefits at the lower tail of the income distribution, and (2) the dampening effect of other family income at the upper tail of the income distribution. The authors present estimates of the size of these effects.

Social Security Cost-of-Living Adjustments and the Consumer Price Index

Old-Age, Survivors, and Disability Insurance (OASDI, Social Security) benefits are indexed for inflation to protect beneficiaries from the loss of purchasing power implied by inflation. In the absence of such indexing, the purchasing power of Social Security benefits would be eroded as rising prices raised the cost of living. Recently, the Consumer Price Index used to calculate the Cost-of-Living-Adjustment (COLA) for OASDI benefits has come under increased scrutiny. Some argue that the current index does not accurately reflect the inflation experienced by seniors and that COLAs should be larger. Others argue that the measure of inflation underlying the COLA has technical limitations that cause it to overestimate changes in the cost of living and that COLAs should be smaller. This article discusses some of the issues involved with indexing Social Security benefits for inflation and examines the ramifications of potential changes to COLA calculations.

Benefit Adequacy Among Elderly Social Security Retired-Worker Beneficiaries and the SSI Federal Benefit Rate

The federal benefit rate (FBR) of the Supplemental Security Income program provides an inflation-indexed income guarantee for aged and disabled people with low assets. Some consider the FBR as an attractive measure of Social Security benefit adequacy. Others propose the FBR as an administratively simple, well-targeted minimum Social Security benefit. However, these claims have not been empirically tested. Using microdata from the Survey of Income and Program Participation, this article finds that the FBR is an imprecise measure of benefit adequacy; it incorrectly identifies as economically vulnerable many who are not poor, and disregards some who are poor. The reason for this is that the FBR-level benefit threshold of adequacy considers the Social Security benefit in isolation and ignores the family consumption unit. The FBR would provide an administratively simple but poorly targeted foundation for a minimum Social Security benefit. The empirical estimates quantify the substantial tradeoffs between administrative simplicity and target effectiveness.

New Evidence on Earnings and Benefit Claims Following Changes in the Retirement Earnings Test in 2000

In April 2000, Congress enacted the Senior Citizens Freedom to Work Act of 2000, which removed the retirement earnings test for individuals at the full retirement age and older. This paper examines the labor force activity of workers aged 65–69 relative to older and younger workers in response to the removal of the earnings test. We use the 1 percent sample of Social Security administrative data that covers the period from 4 years before to 4 years following the removal of the test. Quantile regression methods allow us to identify the earnings levels of workers who change their work effort.

Poverty-level Annuitization Requirements in Social Security Proposals Incorporating Personal Retirement Accounts

In the current discussions of Social Security reform, voluntary personal retirement accounts have been proposed. Recent research and debate have focused on several aspects of these accounts, including how such accounts would affect aggregate saving, system finances, and benefit levels. Little attention, however, has been paid to policies that would govern the distribution of account balances. This analysis considers such policies with respect to the annuitization of account balances at retirement using the Social Security Administration's Modeling Income in the New Term (MINT) model and a modified version of a recent legislative proposal to evaluate the effects of partial annuitization requirements.

Social Security: A Financial Appraisal for the Median Voter

Calculations of the median voter's return from "investing" in Social Security suggest that for a majority of voters the U.S. Social Security system provides higher ex-post, or actual, returns than alternative assets.

Lifetime Redistribution Under the Social Security Program: A Literature Synopsis

This paper provides a brief overview of the more important studies of lifetime redistribution under the Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI) programs. Studies are categorized into two types: those that focus on redistribution across successive cohorts of workers or typical members of those cohorts, and those that focus on the distribution of results across characteristics of interest within particular cohorts of workers. A list of related studies is provided at the end for those interested in additional reading.

Historical Redistribution Under the Social Security Disability Insurance Program

This study uses Social Security administrative data on historical taxes and benefits by year, age, gender, and race for an ex post analysis of redistribution under the Disability Insurance program. The relationship between the taxes paid and benefits received to date under the program is described for successive cohorts as a whole and for specific race and gender groups both within cohorts and across time.

A Guide to Social Security Money's Worth Issues

This paper discusses some of the major issues associated with the question of whether workers receive their money's worth from the Social Security program. An effort is made to keep the discussion as nontechnical as possible, with explanations provided for many of the technical terms and concepts found in the money's worth literature. Major assumptions, key analytical methods, and money's worth measures used in the literature are also discussed. Finally, the key findings of money's worth studies are summarized, with some cautions concerning the limitations and appropriate usage of money's worth analyses.

Cohort-Specific Measures of Lifetime Net Social Security Transfers

This paper develops estimates of lifetime net transfers across cohorts under the Social Security Old-Age and Survivors Insurance (OASI) program. Estimates are developed both from the perspective of individual cohorts, indicating the extent to which each cohort has received or can expect to receive its money's worth from the program, and from the perspective of the OASI program, indicating the extent of redistribution across cohorts. This paper also contrasts intercohort redistribution under the present OASI program with the redistribution that would have occurred under two counterfactual pay-as-you-go programs that incorporate different implicit standards of fairness. The data sources and techniques employed in this analysis provide a more accurate and extensive description of the treatment of different cohorts under the OASI program than has been available to date. Estimates based on past or projected data are presented for all cohorts participating in the OASI program since its inception through the cohort born in 2050.

Simulating the Long-Run Aggregate Economic and Intergenerational Redistributive Effects of Social Security Policy ^*

This paper reports on the status of a long-run simulation model of the U.S. economy and its relationships with the Social Security program that was designed with these considerations in mind. The model was developed specifically to analyze the potential equity and efficiency effects of alternative Social Security policies in a long-run context.

A Mathematical Demonstration of the Pareto Optimality of Pay-As-You-Go Social Security Programs in a Closed Economy

A 1989 article by Breyer concludes that it is impossible to compensate pensioners in the transition from a pay-as-you-go public pension system to a privatized or funded system without making at least one later generation worse off; Breyer reaches this conclusion in the context of a simple overlapping generations model of a closed economy under the assumption that the transition results in increased saving by workers. Although this conclusion is correct under the increased saving assumption in the relevant domain of the production function, the proof that Breyer provides is not sufficient to establish that fact. This note extends Breyer's analysis to provide a sufficient proof.

Would Monetary Policy Be Effective if the OASDI Trust Funds Held Most Treasury Debt?

As a result of the buildup of the Old Age, Survivors, and Disability Insurance (OASDI) trust funds, the supply of U.S. securities to the public by the second and third decades of the next century might become extremely limited. While this increase in Federal savings would lower real interest rates and stimulate investment, the buildup would create a difficulty: it would force Federal Reserve open market operations to be conducted in assets other than Treasury securities. It is important to know whether monetary policy would continue to be effective under this new modus operandi. To answer this question it is necessary to have evidence concerning the transmission mechanism through which monetary policy affects the economy. Obtaining such evidence is especially important now since many economists argue that monetary policy works through a black box which we do not understand. Evidence demonstrating one channel though which monetary policy works is presented here. It is demonstrated that news of increases (decreases) in the Federal Reserve's target for the federal funds rate during the 1974–1979 period lowered (raised) stock prices. This period was unique because the Federal Reserve controlled its operating instrument, the federal funds rate, so closely that market participants were able to discern a change in the target on the day the target changed. This evidence supports the arguments of Tobin and Brunner and Meltzer that the stock market is an important link in the monetary transmission mechanism. The results indicate that if the OASDI trust funds purchased most or all Treasury securities, open market operations conducted using other assets would still be efficacious through this channel. By affecting bank reserves and thus the federal funds rate, these operations would influence stock prices and economic activity.

On the Existence of Pareto-Superior Reversals of Dynamically Inefficient Social Security Programs

Some proponents of the privatization of the Social Security program in the United States have suggested that, because privately available rates of return exceed the internal rate of return implicit in that program, it may be possible to find Pareto-superior privatization schemes. In a similar vein, Townley (1981) argues that, so long as the government can incur debt, a Pareto-superior scheme can always be found to convert a dynamically inefficient pay-as-you-go Social Security program to a fully funded basis. This note uses Townley's own model to demonstrate analytically that Pareto-superior schemes to reverse a dynamically inefficient pay-as-you-go social security program do not exist, either through privatization or through conversion of the program to a fully funded basis.

The Pareto Optimality of Existing Pay-as-You-Go Social Security Programs

In recent years, a number of proposals have been advanced for privatizing all or part of the Social Security program in the United States. These proposals range from the immediate abolition to the gradual phasing-out of Social Security taxes and benefits. This paper evaluates several premises that often underlie privatization proposals—that rates of return in the private sector exceed those implicit in the Social Security program, that privatization would lead to an increase in national saving, and that privatization could somehow improve the lifetime welfare of all affected generations. The paper first considers whether rates of return in the private sector actually exceed those implicit in the Social Secuirty program and discuss the conditions required for privatization to lead to an increase in national saving. The paper then demonstrates theoretically that an existing, well-managed, pay-as-you-go social security program is Pareto optimal in an economy with exogenous factor prices, regardless of the extent to which privately available rates of return exceed those implicit in the pay-as-you-go program; i.e., no privatization scheme can be found that benefits at least one present or future generation without harming at least one other generation, and no scheme can be found that allows the winners from privatization to compensate the losers and still come out ahead. The analysis is extended to incorporate the assumption of endogenous factor prices and the possibility that pay-as-you-go social security programs reduce private saving. The theoretical conclusions are illustrated by using a long-run economic projection model to simulate the aggregate economic and intergenerational redistributive effects of two stylized privatization schemes.

Social Security, Uncertainty Adjustments, and the Consumption Decision

This paper reports on an analysis of the consumption decisions of individuals. A consumption function is developed that can be viewed as an extension of the traditional life cycle-permanent income specification, with consumption determined as an age-specific proportion of current and prospective wealth. Special attention is focused on the degree of substitutability between current and prospective wealth and on the differential effects of the various types of prospective income flows on the consumption decision.

Social Security and Private Saving: An Examination of Feldstein's New Evidence

In a recent article in the Journal of Political Economy (Leimer and Lesnoy 1982), we presented new time series evidence that cast considerable doubt on earlier evidence presented by Martin Feldstein (1974) which implied that social security had a large and statistically significant negative effect on personal saving in the United States. Our results may be summarized as follows: First, the social security wealth variable used by Feldstein was seriously flawed as a result of a computer-programming error. Simply correcting this error substantially changes the estimated effect of social security on saving. Second, the statistical evidence depends upon assumptions which are embedded in the construction of the social security wealth variable. These assumptions relate, first, to how individuals form their expectations about the social security benefits they expect to receive and the social secrurity taxes they expect to pay and, second, to estimates of the number of workers, dependent wives, and surviving widows who will receive benefits. Adopting reasonable assumptions that differ from those used by Feldstein leads to generally weaker estimates of the relationship between social security and saving. Finally, the estimated relationship between social security and saving is acutely sensitive to the period of estimation examined. We concluded that the time series evidence simply does not support the hypothesis that social security has substantially reduced personal saving in the United States.

Social Security and Private Saving: New Time Series Evidence with Alternative Specifications

The purpose of this paper is to consider several alternative specifications of the consumer expenditure function.

Social Security and the Labor Supply of Aged Men: Evidence From the U.S. Time Series

The purpose of this paper is to investigate the effect of the social security system on the labor supply of aged men using U.S. time series data for the period 1947 to 1975. The specific phenomena to be explained is the dramatic decrease in the labor supply of aged men during this period. Between 1947 and 1975, the annual labor force participation rate of men 65 and over decreased from 47.8 percent to 21.7 percent—a decrease of 55 percent. In terms of annual hours worked per capita for men 65 and over, there was a decrease from about 880 hours to 312 hours during this period—a decrease of 65 percent. The specific focus of the analysis will be on the relative importance of social security in explaining this decrease in labor supply.

Cohort-Specific Effects of Social Security Policy

Social Security has sizable obligations to workers who contributed and made savings decisions in the anticipation of future benefits, and the assessment of future options must explicitly account for impacts on these as well as future participants. To this end, our paper develops cohort-specific, general-equilibrium comparisons of concrete policy alternatives.

Social Security and Private Saving: A Reexamination of the Time Series Evidence Using Alternative Social Security Wealth Variables

In an important article in the Journal of Political Economy [1974], Martin Feldstein estimated that the introduction of the social security system had reduced personal saving by 50 percent, with serious consequences for capital formation and output. His conclusion was based on a consumer expenditure function estimated with U.S. time series data and incorporating a social security wealth variable of his construction.

The original intent of this paper was to examine the sensitivity of Feldstein's conclusions to certain assumptions underlying his construction of the social security variable. In particular, we wanted to examine the implication of his assumptions concerning how individuals perceive future benefits and taxes.

Social Security and Retirement

Empirical evidence suggests that Social Security causes many individuals to retire earlier than otherwise. An important policy question is whether the program should be designed to lessen or eliminate this induced retirement effect. This paper proposes a framework for analyzing the socially desirable relationship between Social Security and retirement. Two common rationales for the program, forced saving and retirement insurance, are examined. If importance is attached to either of these rationales, then it is shown that retirement neutrality should probably not be a feature of Social Security.

Optimal and Majority-Voting Equilibrium Levels of Social Security

In the recent economic literature on social security, much attention has been focused on its welfare implications (e.g., Samuelson [1975]), and its impacts on individual retirement decisions (e.g., Boskin [1977]), Sheshinski [1978], Diamond and Mirrlees [1978]) and capital accumulation (e.g., Feldstein [1974], Munnell [1974], and Kotlikoff [1979]). In all these works, the level of social security is assumed to be exogenous alghough it is often determined in the real world by the desire of the majority of voters and thus is an endogenous variable of the economic system. While Browning [1975] and Hu [1978] did consider the determination of social security by a majority-voting process, they used the partial-equilibrium approaches in the sense that wages and the interest rate were assumed exogenous and independent of social security. The present paper constructs a simple three-period life-cycle model in which social security is determined by the majority-voting process, and the rate of interest by the demand for and supply of capital. In this framework, the tax rate voted by each person depends on the market rate of interest, which in turn is affected by the prevailing tax rate. It is assumed that social security is financed by a pay-as-you-go plan.

Life-Cycle Welfare Costs of Social Security

One-period models predict that a substantial welfare gain would result from removing the Social Security earnings test. In this paper we show that such models overestimate the size of potential gains.

If one uses instead a two-period model, which captures intertemporal effects, the net result of removing the earnings test is ambiguous. In the presence of a personal income tax, workers who reduce their labor supply in the first period create a welfare loss that must also be considered. We use a present-value model to estimate the change in lifetime welfare. We find that the net potential gain from removing the earnings test is probably small, especially when compared with the alternative of an increased personal income tax.

The Macroeconomic Effects of a Payroll Tax Rollback

In late 1977, the U.S. Congress passed Social Security legislation that included a series of increases in the payroll tax. These increases, which began in 1979 and carry on into the 1980s, substantially raise the projected levels of the Social Security trust funds. Since the amendments were passed, there has been some discussion and several proposals to roll back part of the tax. It is highly likely that additional rollback proposals will be made in the near future. The purpose of this paper is to shed some light on some of the macroeconomic effects of a payroll tax rollback.

Labor Supply, the Payroll Tax, and Internal Rates of Return to Social Security

There is empirical evidence that in the recent past the Old-Age Insurance portion of the Social Security program has acted as a net wage subsidy. In addition, the program had significant intragenerational redistributive effects. Our purpose is to demonstrate how these findings alter conventional views of the labor supply effects of Social Security. Our method is the analysis of a labor supply model that is extended to include empirically significant operational components of the program. We show that the analyses of others are special cases of our more general approach.

A Re-examination of the Link Between Social Security and Saving

This paper attempts to make two contributions to this research. The first one is expositional. A simple overlapping generation's model is developed and used to reinvestigate the wealth and endowment redistribution effects from the introduction of pay-as-you-go social security. Our second contribution is substantive and extends the analysis of the endowment redistribution effect. Finally, perspective is offered on the relationship between pay-as-you-go social security and private saving.