Dropping Out of Social Security

54 Pages Posted: 17 Jan 2008

See all articles by Kent A. Smetters

Kent A. Smetters

University of Pennsylvania - Business & Public Policy Department; National Bureau of Economic Research (NBER)

Jan Walliser

affiliation not provided to SSRN

Date Written: January 1, 2002


The liability facing a pay-as-you-go social security system can be calculated in several ways. The exact liability measure chosen can significantly affect the conversion of a public pay-as-you-go system to a system based on individually funded accounts. Most conversions, including that which took place in Chile, as well as in many plans to convert the US system, assume the largest measure, known as the "shutdown liability." That measure pays many workers who have contributed to the public system more money than the public system is actually worth to them, thereby placing a larger burden on future generations. Other liability measures, though, are hard to implement due to an information asymmetry between the government and individuals about an individual's skill level. This paper demonstrates that a very simple reform plan - simply letting people drop out of social security - generates a truthful revelation equilibrium in which agents reveal private information about their skill level. The new assumed liability measure can be as little as half of the shutdown liability as the new measure more accurately assigns a liability for each individual based on their true value of remaining in social security. A smaller liability, therefore, is passed to future generations which also generates quicker transition paths. Moreover, interestingly, the drop out method also does a better job of protecting the welfare of the initial elderly when general revenue is used to pay for the transition. Simulation evidence is provided using a large-scale lifecycle simulation model that allows for heterogeneous skill levels. The evidence demonstrates the importance of the dropping out approach relative to the traditional conversion method that assumes the shutdown liability.

Suggested Citation

Smetters, Kent and Walliser, Jan, Dropping Out of Social Security (January 1, 2002). Michigan Retirement Research Center Research Paper No. WP 2002-022, Available at SSRN: https://ssrn.com/abstract=1084676 or http://dx.doi.org/10.2139/ssrn.1084676

Kent Smetters (Contact Author)

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jan Walliser

affiliation not provided to SSRN ( email )

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