The risk-sharing implications of alternative social security arrangements

Abstract

An important aspect of the current U.S. social security system is the tradeoff between the risk-sharing it provides and the distortions it imparts on private decisions. We focus on this tradeoff as it applies to labor market risk and capital accumulation. Specifically, we compare the current U.S. system to a particular proposal put forth in 1996 by the federal Advisory Council on Social Security (1996). We also examine the merits of abolishing social security altogether. We find that, absent general equilibrium effects, the risk-sharing benefits of the current system outweigh the distortions associated with either the alternative or a system of privately administered pensions. Once we incorporate equilibrium effects, however, the interaction between the social security system, private-savings decisions, and the means with which the government finances its nonpension expenditures results in a significant welfare benefit being associated with either reform or abolition. These welfare gains arise in spite of the fact that we explicitly incorporate the ‘social security debt’: the social cost of meeting the obligations associated with the current system.