Social Security and National Saving

8/19/2019 Social Security and National Saving

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Alvaro Tejada

December 13, 2013

Social Security Reform and National Saving

The Social Security Act of 13! "a# one of the landmar$ legi#lation# in American

hi#tory% Since it# e#tabli#hment, the Social Security #y#tem ha# faced "ith challenge#

relating to not only &ublic "elfare but al#o it# economic im&act on the 'nited State#%

Today, Social Security i# one of the many challenge# facing current and future

generation#% (t i# clear that the #y#tem i# an integral &art of #ociety but it al#o &re#ent#

many economic &roblem# that can be deva#tating% ( #ee$ to analy)e the im&act the current

Social Security #y#tem ha# on national #aving, &er#onal #aving &lu# &ublic #aving, and it#

economic im&lication#% (n it# ince&tion, the #y#tem "a# on a &ay*a#*you*go ba#i# funded

by &ayroll ta+e# thi# #y#tem ha# undergone many change#, &articularly the 1-3 reform

"hich tran#formed the #y#tem into a &artially funded &en#ion #y#tem% (t i# im&ortant to

analy)e ho" Social Security affect# #aving, and conver#ely con#um&tion, becau#e

through thi# analy#i# it can bee #een ho" &re#ent and future generation# "ill be affected

by the #y#tem, by "hich "e can under#tand ho" to reform the #y#tem or &erha leave it

a# it i#%

Social Security &rovide# &en#ion# and in#urance for old age and #urvivor#, for the

di#abled and for ho#&ital e+&en#e# through .edicare% The &rimary #ource of income for

Social Security &en#ion# i# the &ayroll ta+, "hich i# at /%2 of a "or$er# "age &lu#

/%2 on the em&loyer, 2% for .edicare em&loyee# and em&loyer# each &aying

1%!4 1% 5rom it# ince&tion Social Security ha# been a &ay*a# you*go #y#tem in "hich

1 'nited State# of America% The 'nited State# Social Security Admini#tration% Status ofthe Social Security and Medicare Programs% Social Security 6oard of Tru#tee#, 2013%7eb%

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&ayroll ta+e# collected from current "or$er# are immediately given to current retiree#% (n

1-3, Social Security "a# reformed to ma$e it into a &artially funded #y#tem, in "hich

current &ayroll ta+e# "ould go into a Tru#t 5und, "hich "ill be u#ed to &ay retiree#% The

Tru#t 5und ha# been o&erating under a #ur&lu# #ince 1-3, but an increa#e in retirement

"ill cau#e the a##et# in the Tru#t 5und to be de&leted by the decade of 200, according to

current foreca#t# by the Tru#tee#% The 'nited State# government ha# al#o been o&erating

under a budget deficit for the &a#t decade and ha# u#ed the Tru#t 5und to finance

e+&enditure#% Thi# #y#tem of Social Security &lace# added burden on the 'nited State#

government, a# it ha# to com&ly "ith the obligation# to &ay current and future retiree#%

The o&&o#ite of a &ay*a#*you*go #y#tem i# a fully funded #y#tem% ( #hall analy)e the

difference# in the#e #y#tem# and ho" they affect national #aving%

The &ay*a#*you*go #y#tem "a# introduced "ith the &a##age of the Social Security

Act of 13!% (n order to a##ure that current retiree# "ere com&en#ated, the &ayroll ta+

"a# ado&ted% Thu#, the retiree# of the 10# had an advantage over younger "or$er# a#

they never had to &ay ta+e# into the #y#tem yet are full beneficiarie# of the #y#tem

any"ay% After the introduction of a &ay*a#*you*go #y#tem, the initial generation# of

beneficiarie# rai#e their current con#um&tion by more than other generation# reduce their

current con#um&tion the elderly have higher &ro&en#itie# to con#ume than "or$er# and

the "ealth tran#fer i# &aid for not ju#t by current young "or$er# "ith lo"er &ro&en#itie#

to con#ume4 but al#o by future generation#, "ho cannot reduce their con#um&tion at the

time the &rogram i# introduced becau#e they are not yet alive% Thu#, &rivate #aving fall#,

no &ublic #aving occur# in a &ay*a#*you*go #y#tem becau#e none of the ta+e# are #aved,

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therefore there i# no e8ual &ublic #aving to off#et the fall in &rivate #aving, therefore

national #aving fall#%

.artin 5eld#tein 194 lead the "ay in the theory that Social Security in it# not

fully funded #y#tem4 ha# a negative effect on #ocial #ecurity% '#ing calculation# from

191, he found that #ocial #ecurity ta+e# reduced di#&o#able income by :!1 billion in

191 &rice# corre#&onding to a reduction of &er#onal #aving# of :1- billion dollar#% ;e

further #tate# that the net #ocial #ecurity "ealth for 191 "a# :1,1/2 billion, "hich

im&lied a reduction in annual #aving of :3 billion dollar# Net Social Security 7ealth i#

e8ual to the &re#ent value of benefit# minu# the &re#ent value of contribution#%

2

Since the

net #ocial #ecurity "ealth i# &o#itive in 5eld#tein# analy#i#, according to increa#e in con#um&tion becau#e of the "ealth effect%3

Another di#advantage to &ay*a#*you*go i# the lo"er rate of return "or$er# receive "hen

they retire a# o&&o#ed to the mar$et rate of return they could receive had they been

allo"ed to #ave inve#t4 their money el#e"here% According to a 1- #tudy by Timothy

?ogley, a mature &ay*a#*you*go #y#tem "ould &ay a real return e8ual to the gro"th rate

of the ta+ ba#e, "hich in the long run i# e8ual to the rate at "hich the "or$ force gro"#

&lu# the rate of &roductivity gro"th thi# rate i# about 2%! in the 'nited State#, on

2 5eld#tein, .artin Journal of Political Economy , @ol% -2, No% ! Se&% * ct%, 194, &%

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average% The mar$et rate of return "hich ha# averaged -%! return over the la#t 0

year#4 e+ceed# thi#, therefore "or$er# e+&erience a #ub#titution effect due to forced

#aving and change in relative &rice# rate of return4 a# #tated &reviou#ly, the #ub#titution

effect create# a lo## in &rivate #aving# "hich "ould have other "i#e been inve#ted4 e8ual

to the &ayroll ta+ &aid by "or$er#%

(f Social Security affect# #aving negatively, thi# can cau#e a decrea#e in

inve#tment that decrea#e# ca&ital and concurrently lo"er "age# out&ut decrea#e# over

time, creating a le## &roductive economy, a &henomenon referred to a# Ccro"ding out%

Thi# can be noted above, in "hich a lac$ of #aving "ould reduce inve#tment in the

mar$et a# "or$er# are forced to inve#t in the Social Security #y#tem4 .artin 5eld#tein#

analy#i# of #aving ta$e# into account the life*cycle hy&othe#i#, in "hich "or$er# con#ume

at a young age, #ave for retirement, and then con#ume "hen they are retired% Thi#

analy#i# of #aving can only hold true if thi# hy&othe#i# hold# true too many variable#

e+i#t that can change a &er#on# behavior therefore they have to remain con#tant% The

Auerbach and Eotli$off model by Alan Auerbach and Fa"rence Eotli$off4 utili)e# F=,

meaning an overla&&ing generation# model to further &rovided evidence for .artin

5eld#tein# analy#i#% An F= model a##ume# the life*cycle hy&othe#i# and eliminate#

variable# #uch a# &lanned giving "hen com&aring t"o different generation# of &eo&le

retired and young "or$er#4% (n their 1-9 "or$ Dynamic Fiscal Policy, they te#ted an

F= model utili)ing Social Security and found that the addition of #ocial #ecurity created

4 ?ogley, Timothy% Gn the Tran#ition to a 5ully 5unded Social Security Sy#tem%G Fetter%13 .ar% 1-% Federal Reserve an! of San Francisco% N%&%, n%d% 7eb% ! Dec% 2013

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a decrea#e in ca&ital and "age#%! The#e finding# #hare correlation "ith the a##umed

con#e8uence# of a decrea#e in #aving# that are #tated above%

The alternative to a &ay*a#*you*go #y#tem i# a fully funded #y#tem of Social

Security% A fully funded #y#tem i# the method utili)ed by &rivate retirement account#

01$4, in "hich an em&loyee &ay# into an account, "ith no ta+ liabilitie#, and receive#

the money &aid into the account after retirement, "hen it i# ta+able% 'nder thi# method, a

"or$er# &rivate #aving goe# do"n but &ublic #aving goe# u& by the amount "hich the

"or$er# &rivate #aving decrea#ed, therefore national #aving remain# unchanged% The

government a##ume# no ri#$ under thi# method it i# u& to the "or$er to &ay into the

retirement account% (f Social Security had been initially #et u& a# fully funded #y#tem, the

initial generation "ould not have received the tran#fer# they received under the &ay*a#*

you*go method, thi# i# becau#e they "ould have not contributed to the #y#tem% The

retiree# of that time &eriod "ould not have received any retirement benefit#, the fir#t

generation to receive benefit# "ould have been the young "or$er# during that &eriod "ho

contributed to the #y#tem and "ould receive benefit# u&on retirement% The reduction in

#aving cau#ed by the "ealth tran#fer# in &ay*a#*you*go4 to the initial generation "ould

not be &re#ent% Therefore #aving "ould not have been affected had the #y#tem been fully

funded from it# ince&tion% ne &roblem "ith thi# "a# the &olitical re&ercu##ion of not

hel&ing the retiree# at the end of the =reat De&re##ion% Thi# forced the hand of the

government and they had no choice but to revert to a &ayroll ta+ and &ay*a#*you*go

funded #y#tem to eliminate &olitical re&ercu##ion#%

5 Auerbach, Alan B%, and Faurence B% Eotli$off% Dynamic Fiscal Policy% ?ambridgeH?ambridge#hireI ?ambridge 'J, 1-9 &% 1!*1/1% 7eb%

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The fully funded #y#tem ha# been u#ed a# a model for Social Security Reform and

it# &rivati)ation% .artin 5eld#tein 1/4 &ro&o#e# that a &rivati)ed fully funded #y#tem

"ould re8uire that em&loyee# or em&loyer# contribute to a retirement account% 'nli$e the

&ay*a#*you*go #y#tem, "hich ha# a fi+ed rate of &ayment, in thi# #y#tem em&loyee# and

em&loyer# can choo#e the amount they #ee$ to inve#t% The#e fund# are then inve#ted in

#toc$# and bond#%/ The #ub#titution effect e+&erienced in the unfunded #y#tem doe# not

e+i#t &rivate #aving i# not affected becau#e the amount contributed to the &lan i# an

amount that a "or$er "ould have other"i#e #aved and it i# at a higher rate than the

unfunded #ocial #ecurity #y#tem% ne major &roblem "ith a tran#ition form the current

#y#tem to a &rivati)ed #y#tem i# the effect on the tran#itional generation% 5eld#tein

&ro&o#e# that the government #hould borro" fund# to cover the benefit e+&en#e# for that

generation at thi# time, #aving remain# #tatic and the ca&ital #toc$ doe# not gro"% ;e

further #tate# that a# the #y#tem &rogre##e#, #aving "ill increa#e and the ca&ital #toc$ "ill

increa#e% The economic# behind thi# &ro&o#al ma$e #en#e, but under the current fi#cal

environment, it i# difficult to convince the &ublic that the 'nited State# government

#hould borro" more money% The government i# already in #tate in "hich it u#e# money

form the current Social Security tru#t fund to fund other government e+&en#e#%

Jeter Diamond, an economi#t from the .a##achu#ett# (n#titute of Technology,

o&&o#e# 5eld#tein on the &rivati)ation of the Social Security Sy#tem% Diamond 200!4

#tate# that after the a##et# in the Tru#t 5und are de&leted, reform #hould not be focu#ed on

overhauling the #y#tem, but rather to ma$e #olvent9% ;e &ro&o#e# that an increa#e in

6 5eld#tein, .artin% 1/% CThe .i##ing Jiece in Jolicy Analy#i#I Social Security

Reform% "merican Economic Revie# -/, &&% 1*1%7 Diamond, Jeter A%, Social Security, the =overnment 6udget and National Saving#.arch 19, 200!4% .(T De&artment of


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&ayroll ta+e# and a decrea#e in benefit# can allo" the Tru#t 5und to accumulate a##et# and

become #olvent% verall, Diamond claim# that national #aving "ill not be affected%

During the initial ta+ increa#e#, con#um&tion fall# and #aving ri#e#% After the return on

the increa#e of tru#t fund# i# received, con#um&tion ri#e#% The ri#e in con#um&tion

matche# the increa#e in national income from the original &eriod, therefore leaving

national #aving unaffected% Diamond believe#, li$e many &ro&onent# of $ee&ing Social

Security, that &eo&le# deci#ion# regarding retirement, e#&ecially the &oor "ho have a

higher marginal &ro&en#ity to con#ume, #hould be made by the government% 7herea#

#u&&orter# of &rivati)ation, li$e .artin 5eld#tein, believe &eo&le #hould be able to ma$e

their o"n choice# regarding retirement and the amount they #ee$ to #ave% The one caveat

for 5eld#tein #y#tem of &rivati)ation i# that a government mandate #till e+i#t# regarding

contribution# to retirement account#% 5eld#tein "ould al#o argue that the current #y#tem

doe# not hel& the &oor due to the &ayroll ta+e# &ayroll ta+e# are regre##ive, in that they

&ro&ortionally affect the &oor more than they &ro&ortionally affect the rich% Therefore,

according to 5eld#tein, the government i# not loo$ing out for the intere#t# of the &oor by

im&o#ing a regre##ive #y#tem of ta+ation to fund Social Security%

Jro&onent# of the &ay*a#*you*go #y#tem claim that the effect of Social Security on

national #aving i# over#tated% ne #uch argument can be rooted in the Ricardian


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&rivate #aving% ;e further #tate# that any increa#e in ta+e# by the government "ould be

off#et by be8ue#t# from one generation to the ne+t% 6arro doe# not ta$e into account the

&oor for e+am&le, "ho have high marginal &ro&en#ity to con#ume from the time they

"or$ and during their retirement% They #ave very little of their income% The idea of

be8ue#t# can only be attributed to tho#e "ho are mo#t "ell off in the &o&ulation% .artin

5eld#tein 19/4 argued that 6arro ignore# economic and &o&ulation gro"th in hi# model,

and that in a gro"ing economy &ublic debt negatively effect# #aving%

Although argument# to the contrary e+i#t, it can been #een that Social Security#

effect on #aving can have dra#tic effect# on the long run economic future of the 'nited

State#% ( believe the government #hould tran#ition into a &rivati)ed #y#tem or at lea#t

&artially &rivati)ed during the &eriod that the tru#t fund i# beginning to be de&leted% (n a

&artially &rivati)ed #y#tem, the government inve#t# the fund# contributed by em&loyee#

and em&loyer# into #toc$# and bond#, unli$e a fully &rivati)ed #y#tem in "hich firm#

handle the inve#tment#% ne i##ue "ith a &artially &rivati)ed #y#tem i# the fear that

government may ta$e an o"ner#hi& &o#ition in &rivate com&anie#% The government may

have it# fla"#, but ( believe &eo&le have more tru#t in the government u#ing their money

rather than &rivate firm#, judging by the mi#ta$e# made during the financial cri#i#% A fully

funded #y#tem "ould have &o#itive effect# on #aving% (f #aving "ere increa#ed, then

&eo&le and firm# "ould have more fund# to inve#t in ca&ital% ?a&ital gro"th lead# to

"age gro"th and an overall more &roductive economy% A# &reviou#ly #tated, the &roblem

"ith &rivati)ing the #y#tem i# the uncertainty of &roviding the tran#itional generation "ith

benefit#% ( agree "ith 5eld#tein in that the government #hould borro" money to &rovide

benefit# for that generation% ;e #tate# that thi# &ublic deficit "ould de&lete #aving

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initially and affect ca&ital gro"th, but "hen the #y#tem $ic$# into gear it #hould increa#e

#aving from the re8uired contribution# under the ne" &rivati)ed &lan%

Since it# ince&tion, the Social Security #y#tem ha# #erved a# a &artial #olution to

the &roblem# &o#ed by #ocial "elfare by &roviding in#urance during retirement, but it ha#

created economic 8ue#tion# and challenge# that have to be dealt "ith by current and

future generation#% .y analy#i# ha# #ho"n that the current Social Security #y#tem,

&artially funded, ha# had a negative im&act on national #aving in the 'nited State#% 6y

changing the #y#tem to a fully funded &lan, ( believe the government can become more

financially #olvent and create economic gro"th through an increa#e in #aving#% 7or$er

"ould be allo"ed to ma$e their o"n deci#ion# regarding their retirement &lan#, but

incentive# "ould be in &lace to encourage them to #ave for retirement &articularly higher

intere#t rate# and a re8uirement to contribute to a &rivate retirement account4% Social

Security i# one of the many challenge# facing our generation ( believe change# have to

be e8uitable and efficient% Although #ome "ould not agree that #ocial #ecurity ha# any

effect on #aving, it i# evident that change# have to be made, "hether dra#tic or minor, to

the #y#tem in order for the American economy to remain #table%

References

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Auerbach, Alan J., and Laurence J. Kotlikoff. Dynamic Fiscal Policy. Cambridge

[Cambridgeshire: Cambridge UP, !"# $. %&'(. )eb.

Cogle*, +imoth*. -n the +ransition to a ull* unded /ocial /ecurit* /*stem.

Letter. 0 1ar. !!". Federal Reserve Bank of San Francisco. 2.$., n.d. )eb.

& 3ec. 450.

3iamond, Peter A., Social Security, the Government Budget and National Savings

61arch #, 455&7. 18+ 3e$artment of 9conomics )orking Pa$er 2o. 5&'5!.

)eb.

9ngen, 9ric 1. and ale, )illiam ., 6!!#7, Effects of Social Security reform on

private and national saving , onference Series! "Proceedings# , issue Jun, $.

50'%4. )eb.

eldstein, 1artin $ournal of Political Economy, ;ol. "4, 2o. & 6/e$. ' -ct., !#%7, $.

!5&'!4(. )eb.

eldstein, 1artin. !!(.


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Social Security and National Saving

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