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Changing Progressivity as a Means of Risk Protection in Investment-Based Social Security

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  • Andrew A. Samwick

Abstract

This paper analyzes changes in the progressivity of the Social Security benefit formula as a means of lessening the risk inherent in investment-based Social Security reform. Focusing on a single cohort of workers, it simulates the distribution of benefits subject to both earnings and financial risks in a reformed system in which solvency has been restored and traditional benefits have been augmented by personal retirement accounts (PRAs). The simulations show that some investment in equities is desirable in all cases. However, switching from the current benefit formula to the maximally progressive formula -- a flat benefit independent of earnings -- improves the welfare of the the bottom 30 percent of the earnings distribution even if they reduce their PRA investments in equity to zero. An additional 30 percent of earners can lessen their equity investments without loss of welfare under the maximally progressive formula. Intermediate approaches in which traditional benefit replacement rates for lower earnings are reduced by less than those for higher earnings allow about half of the equity risk to be eliminated for the lowest earnings decile. Sensitivity tests show that these patterns are robust to different assumptions about risk aversion, the equity premium, and the size of the personal retirement accounts established by the reform.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13059.

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Date of creation: Apr 2007
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Publication status: published as Brown, Jeffrey R., Jeffrey Liebman, and David A. Wise (eds.) Social Security Policy in a Changing Environment. Chicago: University of Chicago Press, 2009.
Handle: RePEc:nbr:nberwo:13059

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  1. Poterba, James M. & Samwick, Andrew A., 2003. "Taxation and household portfolio composition: US evidence from the 1980s and 1990s," Journal of Public Economics, Elsevier, vol. 87(1), pages 5-38, January.
  2. Samwick, Andrew A., 1999. "Social Security Reform in the United States," National Tax Journal, National Tax Association, vol. 52(n. 4), pages 819-42, December.
  3. James M. Poterba & Joshua Rauh & Steven F. Venti & David A. Wise, 2009. "Lifecycle Asset Allocation Strategies and the Distribution of 401(k) Retirement Wealth," NBER Chapters, in: Developments in the Economics of Aging, pages 15-50 National Bureau of Economic Research, Inc.
  4. Martin Feldstein & Elena Ranguelova, 2000. "Accumulated Pension Collars: A Market Approach to Reducing the Risk of Investment-Based Social Security Reform," NBER Working Papers 7861, National Bureau of Economic Research, Inc.
  5. Martin Feldstein & Elena Ranguelova, 2001. "Individual Risk in an Investment-Based Social Security System," NBER Working Papers 8074, National Bureau of Economic Research, Inc.
  6. Brooks,Robin & Razin,Assaf (ed.), 2005. "Social Security Reform," Cambridge Books, Cambridge University Press, number 9780521844956, April.
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