Changing Progressivity as a Means of Risk Protection in Investment-Based Social Security / Andrew A. Samwick.

By:

Samwick, Andrew A

Contributor(s):

National Bureau of Economic Research

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w13059.Publication details: Cambridge, Mass. National Bureau of Economic Research 2007.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: This paper analyzes changes in the progressivity of the Social Security benefit formula as a means of lessening the risk inherent in investment-based Social Security reform. Focusing on a single cohort of workers, it simulates the distribution of benefits subject to both earnings and financial risks in a reformed system in which solvency has been restored and traditional benefits have been augmented by personal retirement accounts (PRAs). The simulations show that some investment in equities is desirable in all cases. However, switching from the current benefit formula to the maximally progressive formula -- a flat benefit independent of earnings -- improves the welfare of the the bottom 30 percent of the earnings distribution even if they reduce their PRA investments in equity to zero. An additional 30 percent of earners can lessen their equity investments without loss of welfare under the maximally progressive formula. Intermediate approaches in which traditional benefit replacement rates for lower earnings are reduced by less than those for higher earnings allow about half of the equity risk to be eliminated for the lowest earnings decile. Sensitivity tests show that these patterns are robust to different assumptions about risk aversion, the equity premium, and the size of the personal retirement accounts established by the reform.

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Previous	nber w13056 The Incentives to Start New Companies: Evidence from Venture Capital /	nber w13057 Trade, Knowledge, and the Industrial Revolution /	nber w13058 An Economic Analysis of Platform Sharing /	nber w13059 Changing Progressivity as a Means of Risk Protection in Investment-Based Social Security /	nber w1306 Monetarist Monetary Policy, Exchange Risk, and Exchange Rate Variability /	nber w13060 Identifying Technology Spillovers and Product Market Rivalry /	nber w13061 Why Do Private Acquirers Pay So Little Compared to Public Acquirers? /	Next

April 2007.

This paper analyzes changes in the progressivity of the Social Security benefit formula as a means of lessening the risk inherent in investment-based Social Security reform. Focusing on a single cohort of workers, it simulates the distribution of benefits subject to both earnings and financial risks in a reformed system in which solvency has been restored and traditional benefits have been augmented by personal retirement accounts (PRAs). The simulations show that some investment in equities is desirable in all cases. However, switching from the current benefit formula to the maximally progressive formula -- a flat benefit independent of earnings -- improves the welfare of the the bottom 30 percent of the earnings distribution even if they reduce their PRA investments in equity to zero. An additional 30 percent of earners can lessen their equity investments without loss of welfare under the maximally progressive formula. Intermediate approaches in which traditional benefit replacement rates for lower earnings are reduced by less than those for higher earnings allow about half of the equity risk to be eliminated for the lowest earnings decile. Sensitivity tests show that these patterns are robust to different assumptions about risk aversion, the equity premium, and the size of the personal retirement accounts established by the reform.