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The US Social Security program was created in part as an explicit response to the Great Depression. We evaluate the performance of Social Security as a protective safety net against a rare episode of sudden and significant loss of private wealth such as the Great Depression. We construct a model in which a rare event causes a shock to wealth at an unknown time. How well does Social Security function as a safety net against such risk? The answer depends critically on whether households optimize in the face of this risk. If the household has full information on the distribution of rare event risk and solves a dynamic stochastic problem to hedge this risk, then Social Security is unnecessary along this dimension. Alternatively, if the household does not account for rare event risk in its financial planning, then Social Security can provide very large welfare gains as a safety net. [ABSTRACT FROM AUTHOR]

How well does social security jointly insure lifetime earnings risk and longevity risk? We show that the answer to this fundamental question depends critically on the nature of economic mobility across generations. To show this result, we compare two economies. In our first economy, inheritances are uncorrelated with wage earnings, implying that an individual's earnings are unrelated to the wages and asset holdings of their predecessors. In our second economy, there is no such economic mobility; instead, low-wage earners are stuck receiving small inheritances from their low-wage ancestral line, while high-wage earners enjoy large inheritances from their high-wage ancestral line. We make these comparisons in a variety of settings including both fixed and endogenous factor prices. Social security causes large welfare losses in the first economy but can generate large welfare gains in the second economy. Given the apparent limits to economic mobility in the USA, the welfare gains from collective risk sharing through social security are potentially large. [ABSTRACT FROM AUTHOR]

With looming fiscal pressure from an aging population, policy makers must grapple with the question of how to restore solvency to the Social Security budget. At this crossroads, it seems wise to evaluate the effectiveness of the program in making people better off. Specifically, we survey four decades of economic theory to examine Social Security as a potential solution to underutilized, missing, or incomplete markets. We synthesize and highlight the ways in which the program improves wellbeing through mandatory saving and collective risk‐sharing, as well as the ways in which behavioral responses of individuals may unwind or even over‐turn the welfare gains of the program. [ABSTRACT FROM AUTHOR]

This paper quantifies the welfare gains from Social Security when individuals face uninsurable longevity risk. While past researchers have studied this basic question, we do so from a unique perspective. In contrast to traditional macroeconomic models that abstract from specific linkages between parents and children, in our model, children are born to specific parents whose longevity is uncertain. And because parental asset holdings evolve over the life of the parent, children face uninsurable bequest income risk in addition to their own longevity risk. We find that Social Security improves ex ante expected utility by 3.4% of lifetime consumption (for the second generation). Because our baseline analysis assumes full information and optimal hedging of longevity risk, we treat these welfare gains as a conservative estimate, and we show that the gains are significantly larger when individuals fail to hedge their longevity risk. [ABSTRACT FROM AUTHOR]

To help manage longevity risk, Social Security pays three types of benefits to retirees: retirement benefits as a life annuity, spousal benefits until the death of the primary earner, and survivor benefits after the death of primary earner. How effective is Social Security at insuring couples against the joint longevity risks that they face? We take a public finance approach to this important question by comparing a Laissez Faire economy to a variety of different public insurance structures including the First Best, the Second Best, and US Social Security. We find that the welfare gains to couples from participating in the US Social Security system are large, and the survivor benefit feature is the key to this result while the spousal benefit provides very little efficiency gains. In fact, the optimal mixture of spousal and survivor benefits (i.e., the Second Best) improves ex ante efficiency by providing a larger payment to widows and a smaller spousal benefit than the current US system. We obtain these results using a theoretical model of couples who have full information about gender‐specific longevity risks and solve a dynamic stochastic (regime‐switching) problem to optimally hedge these risks. [ABSTRACT FROM AUTHOR]

Growth in overall life expectancy is straining the Social Security budget, and the gap in life expectancy between the rich and poor is widening. Motivated by these facts, this paper does four things. First, we develop a simple way to summarize the degree of progressivity in a Social Security system. Second, we show that growth in the life expectancy gap over the last few decades unwinds three‐quarters of the progressivity of the Social Security system. Third, we develop simple reforms to Social Security that maintain the progressivity of the system and restore fiscal solvency. Fourth, we estimate the welfare effects of these potential reforms. [ABSTRACT FROM AUTHOR]

To maintain long-run solvency in light of changing demographics, the US Social Security system needs to be reformed. We present three reform options that protect the retirement benefits of the economically vulnerable while also balancing the Social Security budget. We refer to these three options as Rawlsian reforms because, with each reform option, the Social Security benefits of those at the low end of the income distribution are left intact. Two of our reforms break the link between the benefit cap and the tax cap by lowering the benefit cap. We explore the effect of each reform on ex-ante expected utility, the distribution of private savings, and the distribution of lifetime income in a life-cycle model. [ABSTRACT FROM AUTHOR]

A potential role of social security is to protect individuals who have accumulated little or no assets for retirement. Yet, this type of social safety net could reduce human capital formation by making the life-cycle financial rewards from education less attractive. For example, social security tax rates are correlated negatively with tertiary educational attainment across OECD countries. We construct a continuous-time overlapping-generations model with endogenous school duration that can account for this correlation, and we use the model to compute the social security tax rate that maximizes steady-state social welfare in general equilibrium. Social security in the model provides protection for retirees who arrive at retirement with no assets, and it can also redistribute wealth toward those with low earnings, but the program distorts the level of human and physical capital accumulation. In the presence of these characteristics, the social security tax rate that maximizes steady-state welfare is approximately 10%, which is about half of the average rate of 21% across the OECD. This result is robust to whether the social security program is redistributive or earnings based. [ABSTRACT FROM AUTHOR]

Typical neoclassical life-cycle models predict that Social Security has a large and negative effect on private savings. We review this theoretical literature by constructing a model where individuals face uninsurable longevity risk and differ by wage earnings, while Social Security provides benefits as a life annuity with higher replacement rates for the poor. We use the model to generate numerical examples that confirm the standard result. Using several benefit and tax changes from the 1970s and 1980s as natural experiments, we investigate the empirical relationship between Social Security and private savings and find little evidence to support the predictions from the theoretical model. We explore possible reasons for the lack of strong empirical findings. [ABSTRACT FROM AUTHOR]

Edward C. Prescott has argued that mandatory saving is socially desirable because it solves the problem of people intentionally free riding and becoming a welfare burden. Inspired by Prescott's argument, we develop a model in which rational individuals choose between saving and free riding. We find that free riding is a robust outcome for a significant share of the population and that everyone, including the free riders, benefits from the elimination of free riding through mandatory saving. Our results strengthen Prescott's position that free riding is a serious problem and that mandatory saving is socially desirable. [ABSTRACT FROM AUTHOR]

The Save More Tomorrow™ (or SMarT) plan has proven effective in raising employee saving rates and appears to be popular among participants and the media. An important question has remained on the minds of economists despite this success: just how close does the prescriptive SMarT plan come to approximating the normative life-cycle/permanent-income consumption rule? That is, does it pay (in a lifetime utility sense) to participate in a SMarT plan? We attempt to provide some rigorous answers to this question by employing a quantitative- theoretic model to perform dynamic welfare analysis, and our results tend to support the SMarT plan as a decent first approximation to the life-cycle/permanent-income rule. We also consider the problem of an altruistic employer seeking to maximize the lifetime utility of employees by appropriately choosing the default SMarT parameters in the face of employee heterogeneity in saving rates and uncertainty about whether they will actually stick with the plan. The employer's problem is augmented to include employee heterogeneity concerning risk taking, and we also consider the possibility that SMarT saving may be met with increased borrowing. [ABSTRACT FROM AUTHOR]

We study the optimal provision of social security in a dynamically efficient economy using a continuous-time overlapping-generations model in which consumers have short planning horizons. The short-horizon mechanism leads to dynamic optimization that is time-inconsistent over the life cycle. Our calibrated general-equilibrium results are generally supportive of social security for a wide array of social welfare functions. Thus, the basic life-cycle model can be augmented with only this slight twist in order to rationalize a social security program with the current U.S. tax rate. [ABSTRACT FROM AUTHOR]

We study the optimal size of a pay-as-you-go social security program for an economy composed of both permanent-income and hand-to-mouth consumers. While previous work on this topic is framed within a two-period partial equilibrium setup, we study this issue in a life-cycle general equilibrium model. Because this type of welfare analysis depends critically on unobservable preference parameters, we methodically consider all parameterizations of the unobservables that are both feasible and reasonable-all parameterizations that can mimic key features of macro data (feasible) while still being consistent with micro evidence and convention (reasonable). The baseline model predicts that the optimal tax rate is between 6 percent and 15 percent of wage income. [ABSTRACT FROM AUTHOR]

Unfunded public pension systems are primarily justified on grounds that many individuals lack sufficient capacity to appropriately save for retirement. We begin with a review of the known principle that a standard life-cycle/permanent-income consumer who discounts the future at an exponential rate can benefit from an unfunded public pension system only if the internal rate of return exceeds the private rate of return. However, a pay-as-you-go program with a below market internal rate can in fact improve lifetime utility if the consumer misestimates social security benefits, uses a hyperbolic discount function rather than the exponential function, uses a short planning horizon, behaves impulsively, or if a fraction of the population do no saving at all. A literature has consequently arisen to study how severe these behavioral defects need to be in order to justify a pay-as-you-go program. We survey this literature, and we conclude that the results are highly mixed as to whether an unfunded public pension that earns a below-market internal rate of return can be justified on grounds of shortsightedness in model economies. The challenge for this literature is that the conclusions crucially depend on the particular values of the preference parameters that are used in the simulation experiments, and these preference parameters are not observable, nor is there much consensus concerning the values that should be used in simulations. In fact, even when the analysis is confined to a small and reasonable space of the unobservable preference parameters, it is possible to reach nearly any policy conclusion. We offer some guidance for future work in this area. [ABSTRACT FROM AUTHOR]