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The Economics of Social Security Reform

  • Peter Diamond

Economic analysis centers on three questions whether to have a mixed defined contribution (DC)/defined benefit (DB) plan and how to invest the funding. The paper compares a DB funded plan with a funded DC plan without any individual choice. The paper then considers individu choice about benefits, with particular attention to widows. Portfolio choice is considered for a central fund and in individual accounts, particularly the costs of implementation, as are the implications of greater funding. The implications for the labor market are examined. The major economic issues are not controversial. More funding involves higher taxes (or lower benefits) in the near-term in order to have lower taxes (or higher benefits) in the long run. More funding can reduce the frequency of needed adjustments to Social Security and can increase national savings. These economic effects are similar with or without individual accounts, although the politics will differ. The financial advantage of a diversified portfolio applies to a central fund, whether for a DC or a DB. Indeed, a DB that adjusts well handles risk better than a DC. Economically, the case for diversification is clear, but political questions arise about investing well and avoiding improper interference in corporate governance. Individual accounts respond to political concerns and allow diversity in individual portfolios but add to administrative costs and raise questions about the quality of individual investment decisions. They also raise the political question of maintaining redistribution. It is unclear whether individual accounts would make the labor market more or less efficient. My bottom line is that a well-run DB system is economically more efficient than a mixed DC/DB system. The real issue then becomes how well the US government could run either system.

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File URL: http://www.nber.org/papers/w6719.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6719.

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Date of creation: Sep 1998
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Publication status: published as Arnold, R. D., M. J. Graetz and A. H. Munnell (eds.) Framing the Social Security Debate: Values, Politics, and Economics, National Academy of Social Insurance. Brookings Institution Press, 1998.
Handle: RePEc:nbr:nberwo:6719
Note: PE AG
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  1. John Geanakoplos & Olivia S. Mitchell & Stephen P. Zeldes, 1998. "Social Security Money's Worth," Center for Financial Institutions Working Papers 98-27, Wharton School Center for Financial Institutions, University of Pennsylvania.
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  14. Blake, David, 2003. "Pension Schemes and Pension Funds in the United Kingdom," OUP Catalogue, Oxford University Press, edition 2, number 9780199243532, March.
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  17. Martin Feldstein & Andrew Samwick, 1997. "The Economics of Prefunding Social Security and Medicare Benefits," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 115-164 National Bureau of Economic Research, Inc.
  18. Olivia S. Mitchell, 1998. "Social security reform in Latin America," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 15-18.
  19. Feldstein, Martin & Samwick, Andrew A., 1992. "Social Security Rules and Marginal Tax Rates," National Tax Journal, National Tax Association, vol. 45(1), pages 1-22, March.
  20. Bohn, Henning, 1998. "Risk Sharing in a Stochastic Overlapping Generations Economy," University of California at Santa Barbara, Economics Working Paper Series qt9r2809f0, Department of Economics, UC Santa Barbara.
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