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Dropping Out of Social Security

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Author Info

  • Kent Smetters

    (The Wharton School, University of Pennsylvania)

  • Jan Walliser

    (The International Monetary Fund)

Abstract

The liability facing a pay-as-you-go social security system can be calculated in several ways. The exact liability measure chosen can significantly affect the conversion of a public pay-as-you-go system to a system based on individually funded accounts. Most conversions, including that which took place in Chile, as well as in many plans to convert the US system, assume the largest measure, known as the “shutdown liability.” That measure pays many workers who have contributed to the public system more money than the public system is actually worth to them, thereby placing a larger burden on future generations. Other liability measures, though, are hard to implement due to an information asymmetry between the government and individuals about an individual’s skill level. This paper demonstrates that a very simple reform plan –– simply letting people drop out of social security –– generates a truthful revelation equilibrium in which agents reveal private information about their skill level. The new assumed liability measure can be as little as half of the shutdown liability as the new measure more accurately assigns a liability for each individual based on their true value of remaining in social security. A smaller liability, therefore, is passed to future generations which also generates quicker transition paths. Moreover, interestingly, the drop out method also does a better job of protecting the welfare of the initial elderly when general revenue is used to pay for the transition. Simulation evidence is provided using a large-scale lifecycle simulation model that allows for heterogeneous skill levels. The evidence demonstrates the importance of the dropping out approach relative to the traditional conversion method that assumes the shutdown liability.

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File URL: http://www.mrrc.isr.umich.edu/publications/Papers/pdf/wp022.pdf
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Bibliographic Info

Paper provided by University of Michigan, Michigan Retirement Research Center in its series Working Papers with number wp022.

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Length: 51 pages
Date of creation: Jan 2002
Date of revision:
Handle: RePEc:mrr:papers:wp022

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  1. Geanakoplos, J. & Mitchell, O.S. & Zeldes, S.P., 1998. "Social Security Money's Worth," Papers 98-05, Columbia - Graduate School of Business.
  2. Joel Slemrod & Jon Bakija, 2004. "Taxing Ourselves, 3rd Edition: A Citizen's Guide to the Debate over Taxes," MIT Press Books, The MIT Press, edition 3, volume 1, number 026269302x, December.
  3. Alan J. Auerbach & Laurence J. Kotlikoff & Robert P. Hagemann & Giuseppe Nicoletti, 1989. "The Economic Dynamics of an Ageing Population: The Case of Four OECD Countries," OECD Economics Department Working Papers 62, OECD Publishing.
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Cited by:
  1. Richard W. Evans & Laurence J. Kotlikoff & Kerk L. Phillips, 2012. "Game Over: Simulating Unsustainable Fiscal Policy," NBER Chapters, in: Fiscal Policy after the Financial Crisis, pages 177-202 National Bureau of Economic Research, Inc.

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