05 Dec 2014Working Paper Summaries

Seesaws and Social Security Benefits Indexing

by Matthew Weinzierl

The indexation of Social Security benefit payments has emerged in recent years as a flashpoint of debate in the United States. While the overall fiscal implications of benefits-indexing reform have been widely discussed, this paper's contribution is to explore both the positive and normative aspects of indexation's distributional consequences across the population of retirees. In particular, the author studies the direct effects that changes in benefits-indexing have on retirees who differ in two important ways: initial wealth at retirement and mortality rates after retirement. The author proposes a simple but flexible theoretical framework that converts benefits reform first into changes to retirees' consumption paths and then into a net effect on social welfare. He uses recently-produced data on the net worth, benefit levels, and mortality risks of Social Security beneficiaries by lifetime income decile to provide quantitative results. Finally, he introduces survey evidence on the priorities Americans have for Social Security, a first step in pinning down the normative implications of these effects of indexing reform. The results suggest that the value retirees place on protection against longevity risk is an important caveat to the widespread enthusiasm for a switch to a slower-growing price index such as the chained CPI-U. Key concepts include:

This paper outlines a flexible and relatively simple formal structure for modeling tradeoffs in the direct effects of benefits-indexing reform on a population of diverse retiree households.
A useful metaphor for thinking about the direct effects of indexation on a wide range of retirees is a playground seesaw, where two facts about retired households in the United States push down on opposite ends.
Variation across retiree households means that any given reform to benefits-indexing generates effects with exactly opposite welfare implications.
A large majority of retirees are likely to sit on the left end of the seesaw, that is, favor a steeper path of benefits that effectively annuitizes more of a given retiree's total wealth.

Author Abstract

The price indexation of Social Security benefit payments has emerged in recent years as a flashpoint of debate in the United States. I characterize the direct effects that changes in that price index would have on retirees who differ in their initial wealth at retirement and mortality rates after retirement. I propose a simple but flexible theoretical framework that converts benefits reform first into changes to retirees' consumption paths and then into a net effect on social welfare. I calibrate that framework using recently produced data on Social Security beneficiaries by lifetime income decile and both existing and new survey evidence on the normative priorities Americans have for Social Security. The results suggest that the value retirees place on protection against longevity risk is an important caveat to the widespread enthusiasm for a switch to a slower-growing price index such as the chained CPI-U.