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Abstract:
All observers agree that Social Security reform is needed restore the program's solvency. This paper examines the impact of alternative reforms on Social Security finances, on the wider U.S. economy, and on workers who contribute to and receive benefits from the program. In one reform we consider, Social Security benefits are eventually reduced about one-third so that benefits can be financed with the present 12.4 percent payroll tax rate. Workers are required to contribute an additional 2 percent of their wages to a new defined-contribution pension. We embed Social Security's finances in a neoclassical growth model and show how additions to Social Security and defined-contribution pension reserves, if they are saved, can increase the future growth of productivity and wages and reduce the rate of return on capital. These economy-wide impacts in turn affect the lifetime wages and pensions of workers born in successive generations. They have differing effects on workers depending on workers' relative earnings and the trend in their earnings over their careers. Our model includes a microsimulation component to measure these effects on individual workers.

Our findings suggest that scaling back traditional Social Security and replacing part or all of it with defined-contribution pensions can potentially increase national saving over a very lengthy horizon, thus lifting the domestic capital stock and wages. The potential benefits are larger for high-wage workers than for average- and low-wage workers. Because of the potential impact of this reform on the U.S. capital-labor ratio, real capital returns might be adversely affected by this reform, reducing the rate of return workers will obtain in their defined-contribution pension accounts. Our results also imply that generations which will retire before about 2035 would enjoy higher lifetime pensions and net incomes under a policy that maintains Social Security benefits with tax hikes. That is, generations that will retire over the next 30 or 40 years would be better off under a policy that preserves Social Security through tax hikes than under a policy that scales back benefits and partially replaces them with benefits from a new defined-contribution system.

Social Security, retirement

Abstract:
As their populations grow older, the industrial countries face steep increases in public pension costs. If countries change their pension systems in advance of sharply higher pension costs, it is possible to prepare for the added retirement costs by funding a portion of the future liabilities through increased saving. By boosting capital formation and economic growth, higher saving has the potential to increase the incomes - and the welfare - of future workers and retirees.

This paper considers investment accumulation and pension adequacy in light of financial market risk. We examine two alternative reforms of the U.S. pension system that are aimed at pre-funding part of future pension liabilities and increasing national saving. The first policy expands the role of advance funding in the existing Social Security system by moving toward a policy of tax increases that are large enough to maintain close actuarial balance over a 75-year horizon. Under the alternative policy, the traditional Social Security program adopts pay-as-you-go financing after 2033 and a new system of individual investment accounts is adopted to supplement (reduced) pensions under the traditional system. Advance funding takes place in the new individual investment account system.

The findings reported in this paper show the implications of investing part of the pension fund accumulation in assets which are subject to significant financial market risk. A major conclusion is that the magnitude of financial risk is empirically quite large. Surprisingly, some of the risks connected with advance funding can be even greater when assets are accumulated within the traditional Social Security program rather than individual investment accounts. Although advance funding in Social Security holds out the promise of raising national saving and future output even more than fund accumulation in individual accounts, the variability of returns on Trust Fund investments can have more far-reaching effects on the aggregate economy, through its potential impact on national savings, returns on capital, and the average wages. For example, a sequence of unexpectedly high investment returns on Trust Fund reserves might induce policymakers to reduce the Social Security contribution rate, lessening the flow of net savings from Trust Fund accumulation. The reduced rate of saving would in turn slow the growth of the capital stock, possibly increasing the real return on capital and reducing still further the required contribution rate for Social Security.

pension reform, financial market risk

Abstract:
This paper considers the arguments for fundamental pension reform in Germany and the United States. The two countries have recently made or are considering reforms that would reduce the generosity of the traditional, pay-as-you-go pension system. Some or all of the lost benefits would be replaced by pensions from newly created individual, defined-benefit, retirement accounts. The paper addresses three questions that are relevant for assessing fundamental reform: (1) Should the pension system move toward advance funding of future benefit obligations? (2) What financial assets should be accumulated to back future pension promises? (3) Should the existing system be reformed to include individual retirement accounts?

Abstract:
This paper describes an analysis of career earnings patterns developed for predicting the impact of Social Security reform. We produce estimates of age-earnings profiles of American men and women born between 1931 and 1960. The estimates are obtained using lifetime earnings records maintained by the Social Security Administration. We use a standard econometric approach to develop forecasts of future individual earnings, and we supplement these estimates by developing estimates of the shape and prevalence of nine stylized earnings patterns of U.S. workers. These two alternative approaches to estimating career earnings patterns have significant advantages over the traditional analytical approach of examining a small number of representative workers who are assumed to have steady earnings throughout their careers. Few workers have level career earnings, so the traditional approach to policy simulation represents a serious distortion of actual labor market experience. Moreover, differences in the pattern of career earnings can produce wide disparities in pension entitlements, even for workers with the same average earnings, under individual account and other retirement plans. Since defined-contribution pension plans are frequently proposed as a supplement or replacement for traditional Social Security, it is important that policy simulation be based on accurate representations of career earnings patterns.

Social Security, Retirement, pension

Abstract:
This paper examines the trend in career earnings profiles and lifetime earnings inequality using a new data set that links micro-census information from a Census Bureau survey (the Survey of Income and Program Participation, or SIPP) with the summary earnings records (SER) maintained by the Social Security Administration. It then considers the implications of these trends for the trend of Social Security replacement rates and future changes in the inequality of pension income. The data set covers men and women born in successive years between 1926 and 1965 using a combination of observed and predicted earnings.

Our analysis finds that aggregate male wage and employment patterns have remained much more stable than is the case for women. Although less educated men in recent birth cohorts have fared worse than men in earlier cohorts who had the same schooling, the increase in average educational attainment has largely offset the employment and relative wage losses suffered by less educated men. Among women, while female employment rates and average earnings remain lower than those of men of the same age, the male-female gap is now much smaller than it was in earlier cohorts. The age pattern of employment and earnings among women is growing more similar to the pattern observed among men.

Our tabulations of historical earnings and forecast of future earnings patterns suggest that that lifetime earnings inequality will increase significantly among men. Compared with men born between 1936-1940, we predict that men born in 1961-1965 will experience 12 percent greater inequality in career earnings. Even though women's inequality has increased if we measure inequality among full-time, year-round workers who are employed during a particular year, inequality has fallen sharply if we widen the sample to include all women who are potentially available to work. The rising employment rate of women has increased the percentage of working-age years that women spend in jobs. It has dramatically reduced the fraction of women who earn extremely low lifetime wages because they are employed in only a few years of their potential careers. The noticeable increase in lifetime earnings inequality among men has thus been offset, at least in part, by a sizable reduction in career earnings inequality among women.

Social Security, Retirement, Pension

Abstract:
The recent financial crisis and historical record suggest important lessons about the design of national pension systems. First, wide fluctuation in asset returns makes it hard for well-informed savers to select a saving rate or a sensible investment strategy for DC pensions. Workers who follow identical investment strategies but who retire a few years apart can receive DC pensions that are startlingly unequal. Second, it is hard for ordinary workers, as opposed to optimal planners, to make sensible choices about portfolio allocation. Their investment errors mean that actual returns fall short of the theoretical returns that could be earned by a well-informed, disciplined investor.

Abstract:
All major industrial countries will experience significant population aging over the next several decades. In both academic circles and the business press it is widely believed that population aging will have important effects on financial markets because of its expected impact on saving rates and the demand for investment funds. This paper reviews the literature on the macroeconomic and asset market effects of population aging, focusing on four related issues: (a) The impact of population age structure on aggregate household saving; (b) The effect of population aging on investment demand; (c) Evidence on the influence of population age structure on financial market asset prices and returns; and (d) Effects of globalization on our interpretation of the impact of demographic change.

Abstract:
In the half century after World War II labor force participation in the population past age 60 fell substantially in nearly all rich countries. Declining participation rates became a matter of major concern when it became clear that population growth rates were slowing and the average age of citizens in most rich countries was rising. A rapidly growing number of aged was living longer but spending a smaller number of years in the paid workforce. This paper examines recent trends in retirement behavior in 21 rich countries. It proposes three straightforward measures of labor force exit, and it estimates labor force exit rates using a variety of labor supply indicators, including the labor force participation rate, the employment rate, average work hours in the population, and average weekly earnings in the population. The results suggest that in recent years exit rates from paid work are declining among older citizens. This pattern is found both for men and women, and it is found in a large majority of countries in the analysis. In many countries labor force participation rates at older ages reached a low point in the 1990s, but since that time participation rates have increased. The rebound in male participation rates has been substantial in several countries. On average across the 21 countries, participation rates among 60-64 year-old men have rebounded over 9 percentage points since a low point in the participation rate was reached, usually in the 1990s. This rise in the participation rate of 60-64 year-old men has offset almost one-quarter of the decline in participation rates that occurred between 1960 and the low point of participation rates.

Abstract:
Most economists assume economic agents are well informed, far sighted, and rational. By “rational” they mean that agents use sound logic when deciding on a course of action. Rational agents combine all the information at their disposal, including knowledge of their own references and long-term interests, to make logical choices that maximize their well-being given the constraints facing them. This essay considers empirical evidence on whether this model explains saving for retirement or the timing of retirement. Many observers are skeptical that workers make retirement decisions in the far sighted and logical manner just described. Unlike other economic choices, which are repeated many times over the course of one's life, the decision of when to retire is made only once. Workers are not given the opportunity to improve on decision making through constant repetition. As an alternative to fully rational decision making, agents might imitate the behavior of others who are presumed to be better informed or to have superior skills in planning. Alternatively, workers may adopt and follow simple rules of thumb, which can produce decisions that depart significantly from a financially optimal choice.

The evidence on the financial soundness of workers' retirement choices is mixed. When polled about their preparations for retirement, large minorities of Americans acknowledge they have given no thought to the subject, have saved little or nothing in pension and other retirement accounts, and lack confidence they will be able to afford retirement. Many workers near retirement age are ignorant of the rules that will determine their pension benefits. Economists and financial planners report alarming evidence that middle-aged and older workers face large saving shortfalls compared with the nest eggs needed to retire at the typical retirement age. Extensive evidence shows that a substantial minority of workers experiences big drops in consumption after they retire, which appears to violate a basic implication of the life-cycle model.

On the other hand, recent analysis of the best survey evidence on workers' earnings, pension accumulations, Social Security entitlements, and non-pension saving reveals that very few workers have nest eggs that obviously and substantially fall short of what is “optimal” under some conceivably rational plan. Many workers who have little or no retirement saving can all back on Social Security or public assistance to support minimal onsumption in old age. The drop in consumption that occurs after retirement could be explained by declines in workers' consumption requirements after they leave work. Alternatively, it could be the unwelcome byproduct of a plant closing or the onset of serious disease, events that force workers to leave work early. Even if the possibility of a plant closing or poor health were fully anticipated in a far-sighted plan, the worker may have rationally intended to accept a big cut in
consumption if his or her career came to a premature end. This means we cannot rule out rational foresight when workers enter retirement with little savings or when they experience big drops in consumption over the course of their retirement. Bad outcomes may have been fully anticipated – and accepted – in a far-sighted and rational retirement plan.

Recent research findings on worker savings and retiree consumption do not prove that retirement and saving decisions are made in a fully rational and far-sighted way. The evidence only shows it is hard to rule out rationality and far-sightedness using available information on households' consumption and savings. What older workers actually tell us about their saving behavior, retirement plans, and knowledge of pension rules suggests that relatively few make big investments in learning or thinking about the financial trade-offs that are relevant to retirement. Many workers probably consider the payoffs from such investments to be uncertain and small. Compared with the happiness that retired workers could obtain if they followed a rational and far-sighted retirement plan, the loss in happiness they actually experience using a simpler decision-making rule may be minor.

Abstract:
Cash income offers an incomplete picture of the resources available to finance household consumption. Most American families are covered by an insurance plan that pays for some or all of the health care they consume. Only a comparatively small percentage of families pay for the full cost of this insurance out of their cash incomes. As health care has claimed a growing share of consumption, the percentage of care that is financed out of household incomes has declined. Because health care consumption is more important for some groups in the population than others, the growth in spending and changes in the payment system for medical care have reduced the value of standard income measures for assessing relative incomes across age groups and across the income distribution. More than a seventh of total personal consumption now consists of health care that is purchased with government insurance and employer contributions to employee health plans. In this paper we combine health care spending and insurance reimbursement data in the Medical Expenditure Panel Study with cash and noncash income data in the Current Population Survey to assess the impact of health insurance on the distribution of income and, in particular, on the age profile of income. Our estimates imply that gross money income and disposable cash and near-cash income significantly understate the resources available to finance household purchases. The estimates imply that a more complete measure of resources would show less inequality than the income measures that are currently used. The addition of estimates of the value of health insurance to countable incomes reduces measured inequality in the population and the income gap between young and old. Standard income measures imply that households with an aged household head have significantly lower average and median incomes than households with a head who is less than 55. In contrast, an income definition that includes the value of health insurance implies that aged households have higher incomes than households with a nonaged head.

Abstract:
An important decision facing retirement savers is how to allocate their savings across different assets. The decision includes the choice of how to divide investments between domestic and foreign holdings. This study uses return data for 1927-2005 to determine whether cross-border investing in the past would have been advantageous to retirement savers in eight large industrialized countries. By assumption investors can buy mutual fund shares in index funds for stocks and bonds in their home country and in any of seven foreign countries. The mutual funds' foreign holdings are not hedged to protect investors against currency fluctuations. The paper's goal is to determine whether workers in the eight countries would have obtained higher expected retirement incomes, with smaller risk of catastrophic investment shortfalls, if they invested part of their retirement savings in foreign stocks and bonds. Consistent with past theoretical and empirical findings, the results show that workers could have improved expected financial performance by investing in foreign as well as domestic equities. Remarkably, retirement savers in nearly all countries would have obtained higher average pensions with a 100% foreign allocation than with a 100% domestic allocation, even if they followed extremely native strategies in allocating equity investments across different foreign markets. For retirement savers in most countries, though not the United States, native overseas investment strategies would also have reduced the risk of catastrophically poor investment performance. In all countries, retirement savers who selected a global portfolio allocation along the efficient frontier could obtain better average pensions with lower risk of very small pensions than savers who restrict their investments to the domestic stock and bond funds.

Abstract:
No abstract available.

Abstract:
North America offers lessons about policies that help sustain low unemployment. This article examines the effects of supply-side policies, which boost the skills of the workforce and improve microeconomic incentives facing workers and employers. Two supply-side policies were expanded after the mid-1980s. First, the United States increased earnings supplements, payable to low-income workers, to encourage adults to find and keep jobs. Second, social assistance programs limited the duration of transfer payments and linked support benefits to workers participation in job search, occupational training, and community work experience programs. These measures increased job holding among economically disadvantaged adults. In the 1980s and 1990s the United States also maintained strong incentives for employers to create jobs for the hard-to-employ. Payroll tax and regulatory burdens on employers were kept low, and the modest legal minimum wage was allowed to fall in real terms. US experience suggests that selective supply-side policies can boost the employment rates of the hard-to-employ and help maintain a low rate of structural unemployment.

Abstract:
In December 2001 the President's Commission to Strengthen Social Security published a report describing plans to reform Social Security through the introduction of new, privately managed, defined-contribution pension accounts. The new accounts are to be financed by diverting a portion of payroll taxes that are now used to finance pensions under the existing defined-benefit public pension system. This paper evaluates the overall impact of the Commission's second plan on the distribution of retirement income and rates of return on pension contributions within and among future generations of married couples.

Abstract:
We consider the retirement behavior of civilian employees of the United States government. Unlike previous studies, this investigation is based upon a data set containing fairly complete and accurate information about the Social Security and employer-provided pensions for which employees are (or ultimately will be) eligible. These data permit us to specify the financial aspects of individual retirement decisions with a reasonable degree of precision. A large fraction of civil service pensioners is eligible to receive Social Security benefits because a part of their working careers was spent in Social-Security-covered employment. The prevalence of double pension coverage among government employees has raised serious equity questions about the treatment of civil servants by Social Security, and these questions have led to various suggestions for pension reform. Partly, the reform proposals have been put forward due to the perceived unfairness of "double dipping" which arises from the double pension coverage of government employees. Our analysis finds: (1) Both the amount of a Federal pension entitlement and the expected wait until the pension commences affect the timing of retirement from the Federal service. (2) The rate of anticipated wage growth significantly affects individual decisions to remain in Federal employment. (3) Workers who are eligible to ultimately receive Social Security in some cases show a different pattern of retirement than do workers not vested in Social Security. However, our analysis does not reveal any massive shift of Federal workers into Social-Security-covered employment in order to benefit from the "tilt" in the Social Security formula.

Abstract:
A crucial decision facing retirement savers is how to allocate their savings across broad investment classes, including the choice of how to divide investments between domestic and foreign holdings. This study investigates whether cross-border investing would have been advantageous to U.S. retirement savers in the past. The analysis is based on empirical evidence on asset returns in eight industrialized countries that have reliable historical time series data on stock and government bond returns. The goal is to determine whether U.S. workers would have obtained higher expected retirement incomes, with smaller risk of catastrophic investment shortfalls, if they invested part of their retirement savings in foreign stocks and bonds without hedging the currency risks of their overseas investments. The results show that workers could indeed have increased their expected pensions if they included unhedged foreign assets in their portfolio and if the portfolio were selected from one on the efficient frontier. Under many naive investing strategies, however, increasing workers' allocation to overseas assets will not reduce the risk of catastrophically poor investment performance. The tabulations show that the risk of obtaining a very low pension replacement rate actually increases if workers allocate a sizeable percentage of their savings to overseas investments.

Abstract:
This paper uses micro-census income data from the Luxembourg Income Study (LIS) to measure the current and future burden of financing public transfers, especially benefits supporting the aged and near-aged. The analysis distinguishes between income obtained from households' own saving and labor earnings, on the one hand, and the part financed with unfunded transfers, on the other. The burden of unfunded transfers is defined as the tax on factor income that is needed to pay for such transfers under a balanced budget rule. The paper develops a framework for estimating and forecasting this burden using micro-census reports on the current age distribution of factor incomes, the age distribution of transfer incomes, and U.S. Census Bureau projections of the future age structure of the population. Because survey data are inaccurate and incomplete, the micro-census income reports are adjusted to reflect under-reporting based on estimates of aggregate income from the national income and product accounts. Empirical estimates of current and future tax burdens are derived for four OECD countries. These show that the burden of German and U.S. transfers is unusually sensitive to the effects of an aging population. In contrast, the burden of public transfers in Finland and Britain is less sensitive to the effects of an older population because transfers in those countries are less heavily tilted toward aged beneficiaries. Factor incomes received by aged Americans are high by international standards, providing a partial offset to the sharp tilt of U.S. transfers in favor of the elderly. As the U.S. population grows older, factor incomes will decline more gradually than is the case in other rich countries, helping to maintain the size of its tax base.

Abstract:
One way to assess the effectiveness of a nation's pension system is to measure its success in bringing the incomes of the aged close to those enjoyed by the nonaged. The comparability of income estimates for the aged and nonaged depends, however, on the relative accuracy of the income reports for the two populations. Unfortunately, some income items that are particularly important to the elderly, including occupational pensions, income derived from financial assets, and returns on homeowners' net equity in their principal residence, are either unreported or significantly underreported in household surveys. In this paper we assess the effects of unmeasured and underreported income flows on the relative incomes of the aged and near-aged. We use survey data from the March Current Population Survey and the Survey of Consumer Finances. The latter survey contains information on wealth holdings as well as income. Using our broadest definition of income, which includes the return on net equity in an owner-occupied home and the predicted annuity flow from a household's financial assets, the incomes of aged households in the middle of the old-age income distribution appear to be similar to those of nonaged households in the middle of the nonaged income distribution. In the top and bottom one-quarter of the old-age income distribution, incomes under the broadest income definition are substantially higher than those of nonaged households in the equivalent position of the income distribution. This income pattern diverges sharply from the one that would be inferred under the Census Bureau's standard money income definition, which shows that aged households have noticeably lower incomes than the nonaged.

Abstract:
Pension reform can potentially increase saving and improve incentives for labor force participation later in life. We investigate whether these effects are likely to occur and the potential size of the effects on private and total saving and on employment past age 55. Our survey of existing evidence and new empirical analysis focus on three issues: The possible reduction in other government saving if more assets are accumulated in a public retirement program; the reduction in non-pension private saving if assets are accumulated in new private retirement accounts; and the increase in old-age labor supply that could occur if Social Security benefits are reduced.

We find mixed evidence that faster accumulation of assets in public or private retirement funds would produce higher public and private saving. Using the most optimistic estimates of the public saving response to faster accumulation in public retirement funds, we find advance funding will cause a big increase in aggregate saving and future national income. However, international evidence suggests governments are likely to offset a large percentage of public pension fund accumulation by reducing saving in other government accounts. The evidence on private saving suggests that savers tend to offset faster accumulation of assets in pension accounts with lower saving in non-pension accounts. Most empirical estimates of the labor supply response to Social Security reductions imply the response will be small. Even using unrealistically high estimates of responsiveness, we find that a one-third cut in benefits will add less than 3 percent to the future labor force.

Abstract:
This paper uses micro-census income data from the Luxembourg Income Study (LIS) and the Medical Expenditure Panel Survey (MEPS) in combination with previously published data on the age profile of public health spending to measure the current and future burden of financing public transfers, particularly benefits supporting the aged and near-aged. The burden of unfunded transfers is defined as the tax on factor income that is needed to finance paygo transfers under a balanced budget rule. I develop a framework for estimating and forecasting this burden using micro-census reports on the current age distribution of factor incomes, the age distribution of transfer incomes, and projections of the future age structure of the population. I adjust micro-census income reports to reflect under-reporting in household surveys. In an extension of previous research, I develop new estimates of public health benefits by age of recipient. Estimates of current and future tax burdens are derived for four OECD countries. These show that the burden of U.S. transfers is unusually sensitive to the effects of an aging population. In contrast, transfers in Finland and the United Kingdom are less heavily tilted toward aged beneficiaries. Factor incomes received by aged Americans are high by international standards, providing a partial offset to the sharp tilt of U.S. transfers in favor of the elderly. A major surprise is the relatively high disposable incomes of aged citizens in Germany and the U.S. When the full cost of public health benefits is added to other sources of cash and near cash income, the aged in those countries receive effective incomes that are approximately as high as adults who are near the peak of their working careers.