Differential mortality and the progressivity of social security

Abstract

I examine if the positive correlation between wealth and survivorship has any implications for the progressivity of Social Security's current benefit-earnings rule. Using a general-equilibrium macroeconomic model calibrated to the U.S. economy, I show that the optimal benefit-earnings link for Social Security is largely insensitive to wealth-dependent mortality risk. This is because while a more progressive benefit-earnings rule provides increased insurance for households with relatively unfavorable earnings histories, and therefore lower savings and survivorship, their relatively high mortality risk heavily discounts the utility from old-age consumption. I find that these two effects roughly offset each other, yielding nearly identical optimal benefit-earnings rules both with and without differential mortality. JEL Classification Codes: E21, E62, H55

The rising longevity gap by lifetime earnings – Distributional implications for the pension system

“…1 Further, several studies theoretically analyze the optimal design of the pension system when life expectancy is heterogeneous (for an overview see Pestieau and Ponthiere (2016)) or use structural models to quantify the distributional and welfare implications of pension reforms, e.g. Fehr et al (2013), Bagchi (2016), and Sanchez-Romero and Fürnkranz-Prskawetz (2017). For example Sanchez-Romero and Fürnkranz-Prskawetz (2017) develop an overlapping generations model with heterogeneous life expectancy, calibrated to the US economy.…”

Health Risk and the Welfare Effects of Social Security

“…As a result, a proportional benefit-earnings formula maximizes welfare because it imposes smaller distortions on saving and labor supply. More recently, Bagchi (2019) examines how the positive correlation between income and life expectancy interacts with the welfare implications of Social Security's benefit-earnings formula, and arrives at a similar conclusion: the optimal PIA formula is slightly less concave in the presence of differential mortality, because the poor heavily discount the utility from old-age consumption. In our baseline model, health risk affects labor income, medical expenditures, and also mortality risk, so in effect we capture the same mechanisms.…”

“…While we do not focus on overall income tax progressivity, our experiments with the Social Security's benefit-earnings rule are essentially examining the implications of modifying the degree of redistribution implicit in Social Security. Two papers that specifically look at the implications of modifying Social Security's progressivity are Nishiyama and Smetters (2008) and Bagchi (2019). Nishiyama and Smetters (2008) show that the relatively long averaging period in Social Security's benefit-earnings rule already provides substantial insurance against early life income uncertainty affecting retirement consumption, so the welfare gains from increased progressivity do not outweigh its distortions on labor supply and saving.…”

“…Nishiyama and Smetters (2008) show that the relatively long averaging period in Social Security's benefit-earnings rule already provides substantial insurance against early life income uncertainty affecting retirement consumption, so the welfare gains from increased progressivity do not outweigh its distortions on labor supply and saving. On the other hand, Bagchi (2019) examines how the correlation between earnings and mortality risk interacts with the welfare effects of Social Security's benefit-earnings rule, and finds that due to their lower expected utility from old-age consumption, poorer households with lower probability of survival do not necessarily benefit from increased progressivity. We extend this literature by examining the progressivity of Social Security's benefit-earnings formula in a framework with health-dependent income, health expenditures, as well as health dependent mortality risk.…”

The Rising Longevity Gap by Lifetime Earnings: Distributional Implications for the Pension System

“…1 Further, several studies theoretically analyze the optimal design of the pension system when life expectancy is heterogeneous (for an overview see Pestieau and Ponthiere (2016)) or use structural models to quantify the distributional and welfare implications of pension reforms, e.g. Fehr et al (2013), Bagchi (2016), andSanchez-Romero andFürnkranz-Prskawetz (2017). For example Sanchez-Romero and Fürnkranz-Prskawetz (2017) develop an overlapping generations model with heterogeneous life expectancy, calibrated to the US economy.…”