Working Paper: NBER ID: w13059
Authors: Andrew A. Samwick
Abstract: This paper analyzes changes in the progressivity of the Social Security benefit formula as a means of lessening the risk inherent in investment-based Social Security reform. Focusing on a single cohort of workers, it simulates the distribution of benefits subject to both earnings and financial risks in a reformed system in which solvency has been restored and traditional benefits have been augmented by personal retirement accounts (PRAs). The simulations show that some investment in equities is desirable in all cases. However, switching from the current benefit formula to the maximally progressive formula -- a flat benefit independent of earnings -- improves the welfare of the the bottom 30 percent of the earnings distribution even if they reduce their PRA investments in equity to zero. An additional 30 percent of earners can lessen their equity investments without loss of welfare under the maximally progressive formula. Intermediate approaches in which traditional benefit replacement rates for lower earnings are reduced by less than those for higher earnings allow about half of the equity risk to be eliminated for the lowest earnings decile. Sensitivity tests show that these patterns are robust to different assumptions about risk aversion, the equity premium, and the size of the personal retirement accounts established by the reform.
Keywords: Social Security; Progressivity; Investment-Based Reform; Welfare; Risk Protection
JEL Codes: D31; H55; J26
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| changes in the progressivity of the social security benefit formula (H55) | financial risk faced by low-income beneficiaries (G52) |
| increasing progressivity (H29) | necessity for investment in equities (G12) |
| maximally progressive formula (C51) | welfare of the lowest 30% of earners (I30) |
| maximally progressive formula (C51) | ability to reduce equity investments without losing welfare (D69) |
| intermediate approaches (B52) | equity risk elimination for the lowest earnings decile (D63) |
| most progressive benefit (H55) | higher expected utility for low earners (D11) |