List of References
Diamond, Peter, 1998, “Economics of Social Security Reform – An Overview,” paper for NASI Conference, Framing the Social Security Debate: Values, Politics, and Economics.
Feldstein, Martin, 1996, “The Missing Piece in Policy Analysis: Social Security Reform,” American Economic Review, Vol. 86, No. 2, pp. 1–14.
Gruber, Jonathan, and David Wise, 1998, “Social Security Programs and Retirement Around the World,” National Bureau of Economic Research: Cambridge, Working Paper No. 6134.
James, Steven, 1997, “A Public versus a Private Canada Pension Plan: A Survey of the Economics,” Government of Canada, Department of Finance Working Paper.
Kotlikoff, Laurence, 1996, “Privatizing Social Security at Home and Abroad,” American Economic Review, Vol. 86, No. 2, pp. 368–372.
Mitchell, Olivia, and Stephen Zeldes, 1996, “Social Security Privatization: A Structure for Analysis,” American Economic Review, Vol. 86, No. 2, pp. 363–367.
Pencavel, John, 1987, “The Labor Supply of Men: A Survey,” Handbook of Labor Economics, edited by Orley Ashenfelter and Richard Layard, North Holland: Amsterdam, Vol 1, pp. 3–98.
Rust, John, 1997, “Discussion,” Social Security Reform: Links to Savings, Investment, and Growth, edited by S. Sass and R. Triest, Federal Reserve Bank of Boston, Conference Series No. 41, pp. 96–101.
Social Security Administration, “1998 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds,” April 28, 1998.
Valdivia, Victor, 1997, “The Insurance Role For Social Security; Theory and Lesson for Policy Reform,” IMF Working Paper 97/113.
Prepared by Vincent Hogan and Stephen Tokarick.
Feldstein (1996, p. 3) estimates that the real pretax rate of return on nonfinancial corporate capital averaged 9.3 percent over the period from 1960 to 1995, while the return on Social Security contributions averaged 2.6 percent over the same period. However, this calculation of the return on Social Security contributions is biased downward. Social Security has served a welfare function directed at reducing poverty among the elderly, as well as being a pension plan. If this welfare function had been handled separately from Social Security, the return on contributions would have been higher, but tax rates would have also been higher to fund the welfare aspects of the system.
See Feldstein (1996, p. 5). He also notes that the payroll tax increases the deadweight loss from the personal income tax by as much as 50 percent because it is imposed on top of federal and state income taxes.
Social Security provides insurance against the possibility that individuals will deplete their accumulated savings by living longer than anticipated. Valdivia (1997) finds that a government pension program can significantly raise welfare by providing insurance against this outcome.
To give an order of the magnitudes involved, Diamond (1995) estimates the size of the benefit cut needed to restore actuarial balance to the Social Security system as a function of when the cuts are enacted. He found that if benefits for those reaching age 62 in 2002 or later are cut, then a reduction in benefits of around 20 percent is needed. If the benefit reduction is postponed until 2012, then a reduction of about 26 percent would be required. If the benefit cut is delayed until 2022, it would rise to over 33 percent.
Under legislation enacted in 1983, the retirement age is scheduled to rise gradually in steps from its current level of 65 to 67.
Kotlikoff (1996) finds that a shift to a fully funded system can generate substantial increases in output, capital stock, and real wages. He estimates that the gains could be sufficient to finance a 4 percent increase in annual consumption. These simulations, however, are likely to overstate the beneficial effect of a shift to a funded system on savings since they do no reflect the potential substitution of mandatory savings through the Social Security system for other types of personal savings.
Establishing a fully funded system is expected to increase total savings by an amount roughly equal to the present value of one generation’s pensions. However, in transition, the system will incur a liability equal to the value of the transitional generation’s pensions. This liability will be of the same order of magnitude as the increase in savings, thus giving a net change in savings of approximately zero.
Kotlikoff (1996) also finds that the capital stock rises, despite the cost of transition, because individuals increase their total savings in response to the higher return which is assumed to be offered by a fully funded system. For such an increase in returns on retirement savings to occur, it has to be assumed that the shift to full funding will be accompanied by a change in the system from a defined benefit to a defined contribution pension plan and that the assets accumulated by the fully funded plan will be invested in private securities. Moreover, the interest elasticity of savings with respect to expected returns is a crucial parameter in these simulations. Kotlikoff (1996) appears to assume that the substitution effect from a higher returns on savings would outweigh the income effect, so the elasticity is significantly greater than zero. If a value closer to zero was assumed, then the switch to a funded system would generated less of an increase in private savings and would have a correspondingly smaller effect on capital formation and growth.
Under any of the various privatization schemes proposed, the government would remain involved in Social Security. Participation in the system would continue to be compulsory; its operation would be regulated; and the government would continue to provide minimum benefits in an effort to guard against poverty among the elderly.
Feldstein’s criticism could apply equally to a highly regulated system of privately managed accounts. For example, private fund managers could be obliged by law or regulation to invest a portion of their clients’ Social Security contributions in government bonds.
In other words, the government can diversify away some of the systematic market risk whereas the private market cannot, by definition. The Canadian Government recently promised to offset any gains or losses in the value of the pension fund due to unexpected market movements in precisely this manner. See Heller (1998) and James (1998) for a detailed discussion of these issues.
There is still some linkage, since under the current system pensions are determined by a formula which relates benefits to lifetime earnings.