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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]

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]

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]

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]