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The Economics of Prefunding Social Security and Medicare Benefits

  • Martin Feldstein
  • Andrew Samwick

This paper presents a detailed analysis of the economics of prefunding benefits for the aged, focusing on Social Security but indicating some of the analogous magnitudes for prefunding Medicare Benefits. We use detailed Census and Social Security information to model the transition to a fully funded system based on mandatory contributions to individual accounts. The funded system we examine would permanently maintain the level of benefits now specified in current law and would require no new government borrowing (other than eventually selling the bonds in the Social Security trust fund). During the transition, the combined rate of payroll tax and mandatory saving rises at first by 2 percentage points (to a total of 14.4 percent) and then declines so that in less than 20 years it is less than the current 12.4 percent payroll tax. We estimate the impact of such prefunding on the growth of the capital stock and the level of national income and show that the combination of higher pretax wages and lower payroll taxes could raise wages net of income and payroll taxes by more than 35 % in the long run. We also discuss distributional issues and the way that the poor can be at least as well off as under Social Security. A stochastic simulation shows that a small increase in the mandatory saving rate would reduce the risk of receiving less than the scheduled level to less than one percent. Separate calculations are presented of the value of the 'forward-looking recognition bonds' and 'backward-looking recognition bonds' which the government might issue if it decides not to pay future social security benefits explicitly.

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File URL: http://www.nber.org/papers/w6055.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6055.

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Date of creation: Jun 1997
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Publication status: published as Bernanke, B. and J. Rotemberg (eds.) NBER Macroeconomics Annual 1997. Cambridge: MIT Press, 1997.
Handle: RePEc:nbr:nberwo:6055
Note: AG EFG HC PE
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  1. N. Gregory Mankiw, 1986. "The Equity Premium and the Concentration of Aggregate Shocks," NBER Working Papers 1788, National Bureau of Economic Research, Inc.
  2. S. Rao Aiyagari, 1994. "Optimal capital income taxation with incomplete markets, borrowing constraints, and constant discounting," Working Papers 508, Federal Reserve Bank of Minneapolis.
  3. Feldstein, Martin, 1996. "The Missing Piece in Policy Analysis: Social Security Reform," American Economic Review, American Economic Association, vol. 86(2), pages 1-14, May.
  4. Kessler, Denis & Wolff, Edward N, 1991. "A Comparative Analysis of Household Wealth Patterns in France and the United States," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 37(3), pages 249-66, September.
  5. Martin Feldstein, 1995. "Tax Avoidance and the Deadweight Loss of the Income Tax," NBER Working Papers 5055, National Bureau of Economic Research, Inc.
  6. Manuelli, Rodolfo, 1990. "Existence and optimality of currency equilibrium in stochastic overlapping generations models: The pure endowment case," Journal of Economic Theory, Elsevier, vol. 51(2), pages 268-294, August.
  7. 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, vol. 66, pages 467.
  8. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
  9. Thomas F. Cooley & Jorge Soares, 1999. "A Positive Theory of Social Security Based on Reputation," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 135-160, February.
  10. Bernheim, B Douglas, 1989. "Intergenerational Altruism, Dynastic Equilibria and Social Welfare," Review of Economic Studies, Wiley Blackwell, vol. 56(1), pages 119-28, January.
  11. Michael J. Boskin & Laurence J. Kotlikoff & Douglas J. Puffert & John B. Shoven, 1986. "Social Security: A Financial Appraisal Across and Within Generations," NBER Working Papers 1891, National Bureau of Economic Research, Inc.
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