Changing Progressivity as a Means of Risk Protection in Investment-Based Social Security

47 Pages Posted: 27 Jun 2007 Last revised: 8 Sep 2010

See all articles by Andrew A. Samwick

Andrew A. Samwick

Dartmouth College - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: April 2007

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.

Suggested Citation

Samwick, Andrew A., Changing Progressivity as a Means of Risk Protection in Investment-Based Social Security (April 2007). NBER Working Paper No. w13059, Available at SSRN: https://ssrn.com/abstract=986909

Andrew A. Samwick (Contact Author)

Dartmouth College - Department of Economics ( email )

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