The Optimal Design of Social Security Benefits

21 Pages Posted: 6 Feb 2009

See all articles by Shinichi Nishiyama

Shinichi Nishiyama

Congressional Budget Office

Kent A. Smetters

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

Date Written: September 1, 2008


The United States Social Security system is fairly unique in that it explicitly allows for a progressive formulation of retirement benefits by assigning a larger replacement rate to workers with small preretirement wages. In contrast, the public pension systems in other countries often replace a constant fraction of preretirement wages, although the length of the "averaging period" is typically shorter relative to the U.S. This paper examines the ex-ante optimal U.S. Social Security benefit structure using the model developed in Nishiyama and Smetters (2007). On one hand, progressivity in the benefit structure provides risk sharing against shocks that are difficult to insure privately. On the other hand, progressivity introduces various marginal tax rates that distort labor supply. Rather surprisingly, we find that the ex-ante best U.S. Social Security replacement rate structure is fairly "flat." Intuitively, the relatively long averaging period used in the U.S. system formulation already provides some insurance against negative idiosyncratic shocks, but in a manner that is more efficient than explicit redistribution.

Suggested Citation

Nishiyama, Shinichi and Smetters, Kent, The Optimal Design of Social Security Benefits (September 1, 2008). Michigan Retirement Research Center Research Paper No. 2008-197, Available at SSRN: or

Shinichi Nishiyama (Contact Author)

Congressional Budget Office ( email )

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2nd & D Streets, SW
Washington, DC 20515-6925
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Kent Smetters

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

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