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Health Risk and the Welfare Effects of Social Security


  • Shantanu Bagchi

    (Department of Economics, Towson University)

  • Juergen Jung

    (Department of Economics, Towson University)


We quantify the importance of idiosyncratic health risk in a calibrated general equilibrium model of Social Security. We construct an overlapping generations model with rational-expectations households facing labor income, mortality, and health risks, profit maximizing firms, incomplete insurance markets, and a government that provides pensions and health insurance. We calibrate this model to the U.S. economy and perform two sets of computational experiments: (i) cutting Social Security’s payroll tax, and (ii) modifying the progressivity of the Social Security benefit-earnings rule. We find that both experiments have a larger effect on overall welfare when health risk is present in the model, compared to when health risk is absent. This is because the presence of health risk increases the importance of short-term consumption smoothing—an important channel of self-insurance, and Social Security interferes with this channel. We also find that health risk is important in showing that less progressive pension systems disproportionately hurt the poor. Finally, we show that our welfare results are not sensitive to the degree of risk aversion used in our computations, or to the elasticity of households’ labor choice.

Suggested Citation

  • Shantanu Bagchi & Juergen Jung, 2020. "Health Risk and the Welfare Effects of Social Security," Working Papers 2020-02, Towson University, Department of Economics, revised Dec 2020.
  • Handle: RePEc:tow:wpaper:2020-02

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    File Function: First version, 2020
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    More about this item


    Health risk; Social Security; benefit-earnings rule; consumption smoothing; general equilibrium.;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • I14 - Health, Education, and Welfare - - Health - - - Health and Inequality

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