Modeling the Dynamic Macroeconomic Consequences of Social Security Reform

Published: 2001
Project ID: UM01-05


Over time, the Social Security program has evolved as a pay-as-you-go, or an unfunded system. With the well-known problems plaguing the current system, some have argued for a changeover to a funded system. Funding the system might help participants understand the relation between their taxes and benefits, and it might facilitate further reform that expands the latitude for individual choice. In this paper I describe a procedure in which the U.S. Social Security system could be transformed into a funded system virtually instantaneously through the use of government debt. Surprisingly enough, such a reform would have almost no direct economic consequences. It might, nonetheless, be significant: it might change society’s psychology when coping with future demographic trends, it might clarify for voters the full extent of the economy’s indebtedness, and it might facilitate additional reforms. While proposed reforms usually include provisions for new tax revenues, I suggest splitting the task into two parts: funding the system through national debt, and then paying down the national debt. Regardless of the theoretical framework used for understanding these changes, paying down the debt reduces the tax burden on future generations. In some cases, it leads as well to a substantial long-run increase in the economy’s stock of physical capital and, hence, potential output. Other models predict more modest changes, perhaps with reductions in the inequality of private wealth holdings.



John Laitner