Retirement Effects of Proposals by the President's Commission to Strengthen Social Security
Posted: 19 Apr 2005
The President's Commission to Strengthen Social Security has proposed a number of changes in Social Security, each of them introducing personal accounts funded from a portion of payroll tax receipts, and in one case, out of additional contributions. These changes are presented in the form of three separate models. In addition to establishing personal accounts, provisions of these proposals would reduce the rate of growth in benefits, increase actuarial adjustments in benefits, increase benefits for low wage workers and survivors, and reduce the maximum benefit payable to those with highest covered earnings.
This paper simulates the retirement effects of the various elements of the proposals made by the President's Commission. Simulations are based on a structural dynamic model of retirement and saving, estimated with data from the first five waves of the Health and Retirement Study. The model posits that lifetime expected utility is constrained by an asset accumulation equation and an uncertain lifetime. Retirement preferences and time preferences are both allowed to be heterogeneous among workers, allowing the model to capture the peaks in retirement at both ages 62 and 65.
Simulating over the next 75 years, the model suggests that, holding other market adjustments constant, growth in real wages paid over the lifetime would cause the fraction of individuals working full time at age 62 to decline by 8.7 percentage points, or almost fifteen percent. The effect of the Commission's proposals is to provide individuals with incentives to delay their retirement substantially. Altogether, models 2 and 3 of the Commission's proposals would reduce retirements from full-time work by about 5 and 3 percentage points respectively, almost halving the increase in retirements due to higher real wages.
The largest effects on retirement from the Commission's proposals come from a provision in their model 2 that would keep benefits roughly constant in real terms. Compared to current law, which allows benefits to grow with wages, in 2075 this provision would increase the fraction of those 62 years old at full-time work by about 7 percentage points. Indexing benefits to life expectancy, as in Model 3, would lower the effect to 4 percentage points, about the same effect as allowing the system to continue, and after the trust fund is exhausted, paying benefits proportional to revenue. By 2075 a proposal in the Commission's model 3 to reduce benefits of early retirees, but raise the actuarial adjustment for those who postpone retirement past the normal retirement age, would create a 3.4 percentage point increase in full-time work for those 65 years old, increasing the number of 65 year olds working full-time by fifteen percent. Personal accounts would, by themselves, reduce full time work by 1.5 to 2.5 percentage points. Other elements of the proposals, including increasing benefits for low wage workers and reducing benefits for high wage workers, would produce only very modest changes in retirement behavior, even within affected groups.
Keywords: Personal accounts, social security, retirement
JEL Classification: H55, J26, J14, J32, E21, D31, D91, I3
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