Consumption, Retirement, and Social Security: Evaluating the Efficiency of Reform with a Life-Cycle Model

Published: 2006


This paper analyzes the effect of a potential reform to the Social Security system on individuals’ retirement and consumption choices. We first estimate the coefficients for a life—cycle model. We assume intratemporally nonseparable preference orderings and endogenous retirement. Our framework allows the possibility of disability. The specification predicts a change in consumption at retirement; we use the empirical magnitude of the change, together with desired retirement age, to identify key parameters such as the curvature of the utility function. We then qualitatively and quantitatively study the possible long—run effect of a Social Security reform in which individuals no longer face the OASI payroll tax after some specified age, and their subsequent earnings have no bearing on their Social Security benefits. Simulations indicate that retirement ages would rise by as much as one year, equivalent variations could average $5000 (1984 dollars) per household or more, and reform could generate $2500 or more additional income tax revenue per household.

Key Findings

    • We analyze a simple reform aimed at alleviating the labor-supply distortions of the current Social Security program. After a long vesting period (e.g., 34 years of contributions) workers would no longer face the OASI payroll tax., potentially increasing wages by 10.6 percent.
    • Lost revenues to the system would be made up by a small increase in the payroll tax during the vesting period.
    • Under this scenario, retirement ages could rise by nearly a year on average and additional gains accruing to society from extra income taxes due to longer careers could average another $3000 per household.