Working Paper: NBER ID: w7016
Authors: Martin Feldstein; Elena Ranguelova; Andrew Samwick
Abstract: In this paper we study the transition from a pay-as-you-go system of Social Security pensions to an investment-based system in an economy in which portfolio returns and capital profitability are both uncertain. The paper extends earlier studies by Feldstein and Samwick that modeled the transition process in a nonstochastic environment and by Feldstein and Ranguelova that examined the implication of portfolio risk after the transition to an investment-based system has been completed. We analyze transitions to a mixed system that maintains the current 12.4 percent pay-as-you-go tax rate as well as to a system that is completely investment-based. We model intergenerational guarantees and assess the risk of such guarantees to taxpayers. We find that transitions to either a completely investment-based system or a mixed system that maintains current law benefits can be done with little additional saving in the early years (a maximum of three percent) and substantially lower combinations of taxes and saving deposits in the later years. The extra risk to retirees and/or taxpayers is relatively small, making the investment-based plans preferable to a pure pay-as-you-go system for reasonable degrees of risk aversion.
Keywords: Social Security; Investment-based system; Portfolio returns; Capital profitability; Stochastic simulations
JEL Codes: H55; J26
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government intervention (O25) | Moderate retiree risk mitigation (G52) |
| Transition to a mixed system (one-third investment-based and two-thirds PAYGO) (H55) | Risk levels between pure investment-based and mixed systems (G11) |
| Contributions to PRAs of less than one-third of the projected PAYGO tax rate (H55) | Annuity payments that exceed future social security pensions (H55) |
| PRA saving rates (G51) | Distribution of annuity benefits relative to benchmark benefits (H55) |