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Political Risk Versus Market Risk in Social Security

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  • John B. Shoven
  • Sita N. Slavov

Abstract

Pay-as-you-go Social Security is typically characterized as a universal defined benefit pension program. Implicit in this characterization is a sense that the participant%u2019s investment in future benefits is somehow guaranteed, or safe from risk. This study develops the concept of %u201Cpolitical risk%u201D as the possibility that some future legislature will be forced to change the tax and benefit provisions of pay-as-you-go social security programs, when there are changes in the demographic and macroeconomic variables that support it. Thus there is a %u201Cpolitical risk%u201D to participants that might be compared to the %u201Cmarket risk%u201D in a personal accounts retirement scheme. In this paper, we carry out a detailed quantitative analysis of political risk in the U.S. Social Security system, as well as an overview of policy reforms in several European countries that demonstrate political risk more broadly across social security systems. For the U.S., we compute the internal rates of return (IRRs) from Social Security for various age groups and income levels, using the existing law in effect each year since 1939. We find considerable variation in IRRs through time for any birth cohort. Participants experienced significant declines in IRRs as a result of adjustments made to restore the system%u2019s solvency in 1983 and 1994. If the system were brought into actuarial balance in 2005, younger cohorts would experience another significant decline in their lifetime IRR. Our review of other countries demonstrates political risk in other social security systems as well. Law changes necessitated by actuarial imbalances pass demographic risk on to participants. The debate over personal accounts, therefore, is not one of %u201Csafe%u201D versus %u201Crisky%u201D benefits, but one of portfolio choice.

Suggested Citation

  • John B. Shoven & Sita N. Slavov, 2006. "Political Risk Versus Market Risk in Social Security," NBER Working Papers 12135, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:12135 Note: AG PE POL
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    References listed on IDEAS

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    1. John McHale, 2001. "The Risk of Social Security Benefit-Rule Changes: Some International Evidence," NBER Chapters,in: Risk Aspects of Investment-Based Social Security Reform, pages 247-290 National Bureau of Economic Research, Inc.
    2. Feldstein, Martin & Liebman, Jeffrey B., 2002. "Social security," Handbook of Public Economics,in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 32, pages 2245-2324 Elsevier.
    3. Peter Diamond, 2004. "Social Security," American Economic Review, American Economic Association, vol. 94(1), pages 1-24, March.
    4. Sita Nataraj & John B. Shoven, 2003. "Comparing the Risks of Social Security with and without Individual Accounts," American Economic Review, American Economic Association, vol. 93(2), pages 348-353, May.
    5. Daniele Franco, 2002. "Italy: A Never-Ending Pension Reform," NBER Chapters,in: Social Security Pension Reform in Europe, pages 211-262 National Bureau of Economic Research, Inc.
    6. Harris, Amy Rehder & Meyerson, Noah & Smith, Joel, 2001. "Social Insecurity? The Effects of Equity Investments on Social Security Finances," National Tax Journal, National Tax Association, vol. 54(n. 3), pages 645-68, September.
    7. Harris, Amy Rehder & Meyerson, Noah & Smith, Joel, 2001. "Social Insecurity? The Effects of Equity Investments on Social Security Finances," National Tax Journal, National Tax Association, vol. 54(3), pages 645-668, September.
    8. Didier Blanchet & Florence Legros, 2002. "France: The Difficult Path to Consensual Reforms," NBER Chapters,in: Social Security Pension Reform in Europe, pages 109-136 National Bureau of Economic Research, Inc.
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    Citations

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    Cited by:

    1. Francisco J. Gomes & Laurence J. Kotlikoff & Luis M. Viceira, 2012. "The Excess Burden of Government Indecision," NBER Chapters,in: Tax Policy and the Economy, Volume 26, pages 125-163 National Bureau of Economic Research, Inc.
    2. Brown, Jeffrey R. & Ivković, Zoran & Weisbenner, Scott, 2015. "Empirical determinants of intertemporal choice," Journal of Financial Economics, Elsevier, vol. 116(3), pages 473-486.
    3. Sita Slavov & Devon Gorry & Aspen Gorry & Frank N. Caliendo, 2017. "Social Security and Saving: An Update," NBER Working Papers 23506, National Bureau of Economic Research, Inc.
    4. Timothy Smeeding & Eva Sierminska & Andrea Brandolini, 2006. "Cross National Comparison of Income and Wealth Status in Retirement: First Results from the Luxembourg Wealth Study (LWS)," LWS Working papers 2, LIS Cross-National Data Center in Luxembourg.
    5. Libor Dusek, 2007. "Political Risk of Social Security: The Case of the Indexation of Benefits in the Czech Republic," CERGE-EI Working Papers wp318, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    6. Bossi, Luca, 2008. "Intergenerational risk shifting through social security and bailout politics," Journal of Economic Dynamics and Control, Elsevier, vol. 32(7), pages 2240-2268, July.
    7. Luciano Fanti, 2012. "PAYG pensions and fertility drop: some (pleasant) arithmetic," Discussion Papers 2012/147, Dipartimento di Economia e Management (DEM), University of Pisa, Pisa, Italy.
    8. Juraj Kopecsni & Libor Dusek, "undated". "Political Risk of Social Security: Evidence from Reforms in Hungary and the Czech Republic," EcoMod2007 23900044, EcoMod.
    9. Andrew Coleman, 2014. "To Save or Save Not: Intergenerational Neutrality and the Expansion of New Zealand Superannuation," Treasury Working Paper Series 14/02, New Zealand Treasury.
    10. Brown, Jeffrey R. & Weisbenner, Scott J., 2014. "Why do individuals choose defined contribution plans? Evidence from participants in a large public plan," Journal of Public Economics, Elsevier, pages 35-46.
    11. Alexandra Rudolph, 2016. "Pension programs around the world: Determinants of social pension," Courant Research Centre: Poverty, Equity and Growth - Discussion Papers 212, Courant Research Centre PEG.
    12. Erzo F.P. Luttmer & Andrew A. Samwick, 2015. "The Welfare Cost of Perceived Policy Uncertainty: Evidence from Social Security," NBER Working Papers 21818, National Bureau of Economic Research, Inc.

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