Social Security and Demographic Uncertainty: The Risk Sharing Properties of Alternative Policies

Henning Bohn

No 7030, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: As the U.S. population ages, the growing retiree-worker ratio increases the burden of public retirement systems. Is it efficient to maintain a defined benefit social security system? Should PAYGO benefits be reduced and private retirement savings be encouraged? The paper examines these questions in a neoclassical growth model with overlapping generations and demographic uncertainty. In case of shocks to the birth rate, I find that a defined-benefits social security system is more efficient ex-ante than a defined-contribution or privatized system. This is because small cohorts generally enjoy favorable wage and interest rate movements. They are in the labor force when the capital- labor ratio is high and they earn capital income when the capital-labor ratio is low. A defined benefit system helps to offset the effect of these factor price movements by imposing higher taxes on small cohorts. Neither defined-benefits nor its main alternative are fully efficient, however, because they all fail to adjust current retiree benefits in response to anticipated future demographic changes. In case of changes in life-expectancy, the efficient policy response depends on the predictability of deaths at the individual level and on the availability of annuities. Reduced benefits can be efficient if annuities markets are missing and the mortality change is such that accidental bequests decline, but not otherwise.

Date: 1999-03
Note: PE
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Published as "Will Social Security and Medicare Remain Viable as the U.S. Population is Aging?", Carnegie-Rochester Conference Series on Public Policy, Vol. 50, no. 1 (June 1999): 1-53.
Published as Social Security and Demographic Uncertainty: The Risk-Sharing Properties of Alternative Policies , Henning Bohn. in Risk Aspects of Investment-Based Social Security Reform , Campbell and Feldstein. 2001

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Chapter: Social Security and Demographic Uncertainty: The Risk-Sharing Properties of Alternative Policies (2001)
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