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The Missing Piece in Policy Analysis: Social Security Reform

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  • Martin Feldstein

Abstract

This lecture discusses the economic losses that result from an unfunded social security retirement system and the potential gain from shifting to a funded system. The social security payroll tax distorts labor supply and the form in which compensation is paid. Although each individual's benefits are linked to that individual's previous payroll tax payments, the low equilibrium rate of return inherent in an unfunded system implies a `net' payroll tax that causes distortions. The resulting deadweight loss is 1% of each year's GDP in perpetuity, an amount equal to 20% of payroll tax revenue and a 50% increase in deadweight loss of the personal income tax. Also, there is the loss of investment income resulting from forcing employees to accept the low implicit return of an unfunded program rather than the much higher return paid on private saving or in a funded social security program. The present value of the annual losses from using an unfunded system exceeds the benefit to those who received windfall transfers when the program began and when it expanded. Shifting to a funded program cannot reverse the crowding out of capital that has already occurred. Recognizing the existing unfunded obligation only makes that piece of the national debt explicit, but shifting to a funded program limits crowding out of capital formation to the amount that already occurred. Future increases in annual saving that result from economic growth are able to earn the higher rate of return on real capital. The present value of these gains is equivalent to a perpetuity of more than 2% of GDP a year. The combi- nation of improved labor market incentives and higher real return on saving has a net present value gain of more than $15 trillion, an amount equivalent to three percent of each future year's GDP forever.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5413.

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Date of creation: Jan 1996
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Publication status: published as The Richard T. Ely Lecture, in American Economic Review, 86, No.2, May 1996 , pp.1-14.
Handle: RePEc:nbr:nberwo:5413

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  1. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  2. Joseph G. Altonji & Fumio Hayashi & Laurence J. Kotlikoff, 1989. "Is the Extended Family Altruistically Linked? Direct Tests Using Micro Data," NBER Working Papers 3046, National Bureau of Economic Research, Inc.
  3. Feldstein, Martin & Dicks-Mireaux, Louis & Poterba, James, 1983. "The effective tax rate and the pretax rate of return," Journal of Public Economics, Elsevier, Elsevier, vol. 21(2), pages 129-158, July.
  4. Martin Feldstein, 1995. "Behavioral Responses to Tax Rates: Evidence from TRA86," NBER Working Papers 5000, National Bureau of Economic Research, Inc.
  5. Arrow, Kenneth J & Lind, Robert C, 1970. "Uncertainty and the Evaluation of Public Investment Decisions," American Economic Review, American Economic Association, American Economic Association, vol. 60(3), pages 364-78, June.
  6. Alan J. Auerbach & Jagadeesh Gokhale & Laurence J. Kotlikoff, 1991. "Generational Accounts - A Meaningful Alternative to Deficit Accounting," NBER Working Papers 3589, National Bureau of Economic Research, Inc.
  7. Laurence J. Kotlikoff, 1995. "Privatization of Social Security: How It Works and Why It Matters," NBER Working Papers 5330, National Bureau of Economic Research, Inc.
  8. Diamond, P. A., 1977. "A framework for social security analysis," Journal of Public Economics, Elsevier, Elsevier, vol. 8(3), pages 275-298, December.
  9. Martin Feldstein & Andrew Samwick, 1992. "Social Security Rules and Marginal Tax Rates," NBER Working Papers 3962, National Bureau of Economic Research, Inc.
  10. Arnold Harberger, 1964. "Taxation, Resource Allocation, and Welfare," NBER Chapters, in: The Role of Direct and Indirect Taxes in the Federal Reserve System, pages 25-80 National Bureau of Economic Research, Inc.
  11. Martin Feldstein, 1982. "The Optimal Level of Social Security Benefits," NBER Working Papers 0970, National Bureau of Economic Research, Inc.
  12. Martin Feldstein, 1999. "Tax Avoidance And The Deadweight Loss Of The Income Tax," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 674-680, November.
  13. Leimer, Dean R & Lesnoy, Selig D, 1982. "Social Security and Private Saving: New Time-Series Evidence," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(3), pages 606-29, June.
  14. Browning, Edgar K, 1987. "On the Marginal Welfare Cost of Taxation," American Economic Review, American Economic Association, American Economic Association, vol. 77(1), pages 11-23, March.
  15. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 66, pages 467.
  16. Martin Feldstein, 1994. "Tax policy and international capital flows," Review of World Economics (Weltwirtschaftliches Archiv), Springer, Springer, vol. 130(4), pages 675-697, December.
  17. Feldstein, Martin & Pellechio, Anthony, 1979. "Social Security and Household Wealth Accumulation: New Microeconometric Evidence," The Review of Economics and Statistics, MIT Press, vol. 61(3), pages 361-68, August.
  18. Martin Feldstein, 1995. "Social Security and Saving: New Time Series Evidence," NBER Working Papers 5054, National Bureau of Economic Research, Inc.
  19. Feldstein, Martin & Liebman, Jeffrey B., 2002. "Social security," Handbook of Public Economics, Elsevier, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 32, pages 2245-2324 Elsevier.
  20. Martin Feldstein, 1985. "Should Social Security Be Means Tested?," NBER Working Papers 1775, National Bureau of Economic Research, Inc.
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