Is the Social Security Crisis Really as Bad as We Think?

Abstract

Because they ignore the household-level and macroeconomic adjustments associated with longevity improvements, the actuarial projections of the Social Security Administration overestimate the Social Security crisis. Using a general-equilibrium model with heterogeneous agents and incomplete markets, I show that accounting for these adjustments, a significantly smaller decline in benefits is needed to balance the Social Security budget. Households respond to the longevity improvements by delaying retirement and Social Security benefit collection, working more hours, and by also saving more. In general equilibrium, these effects lead to a natural expansion of Social Security's tax base and generate significant delayed retirement credits, which the actuarial estimates completely overlook.JEL Classifications: E21, H55, J22

Aging, Retirement, and Pay-as-You-Go Pensions

“…In conclusion, with respect to all this literature, we show that when retirement is fully endogenous the effects of an aging population may not be detrimental to the PAYG pension system because agents could adjust their old-age labour supply accordingly. Incidentally, a similar result, in a computable OLG model, has recently been shown by Bagchi (2016). As a policy conclusion, we claim that governments should not restrict the elderly labour supply by imposing upper limits to the retirement age.…”

Can removing the tax cap save Social Security?

“…Several studies contend that the SSA's actuarial projections overestimate the extent of the insolvency in Social Security, and also underestimate the tax increases that will be needed to balance Social Security's budget in the long run. Bagchi (2014) argues that because the SSA's projections do not account for how key household-level and macroeconomic variables will respond to the longevity improvements, the actuarial projections overestimate the Social Security crisis. Once these responses are accounted for, Bagchi (2014) shows that longevity improvements lead to a decline in Social Security benefits that is only two-thirds of the SSA's estimates.…”

“…Bagchi (2014) argues that because the SSA's projections do not account for how key household-level and macroeconomic variables will respond to the longevity improvements, the actuarial projections overestimate the Social Security crisis. Once these responses are accounted for, Bagchi (2014) shows that longevity improvements lead to a decline in Social Security benefits that is only two-thirds of the SSA's estimates. Similarly, De Nardi et al (1999) find that balancing Social Security's budget will require an additional 17.1 percentage points tax increase on the top of the SSA's actuarial projections, simply because the SSA's projections do not account for the negative impact that these higher taxes will have on the tax base.…”

“…The table shows that on the average, benefits decline by 14.6% from their baseline level, which is significantly smaller that the actuarial estimates of the SSA (23-25%). 9 This should not be surprising, as the current model accounts for all the household-level and macroeconomic adjustments to the longevity improvement: households respond by supplying more labor and also by saving more, which leads to a natural expansion in Social Security's tax base (Bagchi, 2014).…”

Social Security and Saving: An Update

“…For instance, Hosseini (2015) shows that the large welfare gains from mandatory annuitization are mostly washed out by the distortions that it causes to the equilibrium price of annuity contracts, as adverse selection causes high mortality individuals to exit the private annuity market. Second, the impact of changes in Social Security rules to maintain fiscal solvency in the face of a demographic shock depend on how individuals respond (Kitao 2014;Bagchi 2016). Finally, if Social Security causes large reductions in personal savings, then growth in the generosity of the Social Security system in recent decades may help to explain the precipitous decline in the aggregate personal saving rate in the U.S. from near 10% in the 1980s to close to zero in more recent years (Parker 1999;Gokhale, Kotlikoff, and Sabelhaus 1996).…”