Important Social Insurance Programs

• Social Security

• Unemployment insurance

• Disability Insurance

• Workers Compensation

• Medicare

Distributional Issues

• Actuarially fair return

• Intergenerational redistribution

– Total benefits = Nb * B

– Total taxes = t * Nw * w

– If total benefits = total taxes:Nb * B = t * Nw * w orB = t * (Nw/Nb) * w

Social Security Wealth for

Representative Individuals

Single Male

-1000

-800

-600

-400

-200

0

200

400

Year Cohort Turns 65

Low

Average

High

Max

Single Female

-1000

-800

-600

-400

-200

0

200

400

Year Cohort Turns 65

Low

Average

High

Max

One-earner Couple

-1000

-800

-600

-400

-200

0

200

400

Year Cohort Turns 65

Tho

usan

ds o

f 200

6 D

olla

rs

Low

Average

High

Max

Two-earner Couple

-800

-600

-400

-200

0

200

400

Year Cohort Turns 65

Tho

usan

ds o

f 200

6 D

olla

rs

Low

Average

High

Max

Other Distributional Issues

• Redistribution within a generation– Differences by earnings– Differences by lifespan– Differences by living arrangements– Differences by number of earners in the family

• Normative evaluation

The Social Security Trust Fund

• Social Security and National Saving

• Budget Treatment of Social Security– Off budget– Unified budget

Worker RetireeTrust Fund

Social Security and Savings Behavior

• Life-cycle theory of savings

• Wealth Substitution Effect

• Retirement Effect

• Bequest Effect

Empirical Evidence

• Martin Feldstein’s work– CONS = f(DI, W, SSW, X)

– MPCssw = .028

– 60% reduction in personal saving

• Others• Rosen: Social security has had a negative effect

on saving, but magnitude of effect is unclear

Effects on Retirement and Labor Supply

• 1930 LFPR 65+ was 54%• 2001 LFPR 65+ was 18%• Effect of Social Security

– Income Effect – SS raises retirement income– Substitution Effect – SS reduces the cost of retiring– Earnings test

• Impact on Younger Workers?

Distribution of Wealth

• Bequeathable v Annuitized Wealth

• Effect of Social Security on Bequeathable Wealth

• Effect on Wealth Mobility

Budget Constraint for Present and Future Consumption

Present consumption (c0)

Fut

ure

cons

umpt

ion

(c1)

N

M

I0

I1

D

I0 - S

I1 + (1+r) S

S

(1+r)S

I1 - (1+r) BF

B

(1+r)B

At endowment point consumer neither saves nor borrows

Utility-maximizing Choice of Present and Future Consumption

Present consumption (c0)

Fut

ure

cons

umpt

ion

(c1)

N

M

I0

I1

E1c1*

A

c0*

Saving

Crowding out of private saving due to Social Security

Present consumption (c0)

Fut

ure

cons

umpt

ion

(c1)

N

M

I0

I1

E1c1*

A

c0*

R

T

I0T

(1+r)T

Saving after Social Security

Other ways Social Security Affects Saving

• Retirement effect

• Bequest effect

• Empirical evidence

Empirical Evidence: Does Social Security Reduce Saving?

• Time-series evidence– Martin Feldstein (1974, 1996) v Leimer and

Lesnoy (1982)

• Cross-section evidence

• Evidence from other countries– Attanasio and Brugiavini (2003) and Italy

Retirement Decisions

• Social security wealth and the retirement decision

• Empirical evidence– Diamond and Gruber [199]– Gruber and Wise [2004]

Long-Term Stresses on Social Security

Projected revenues and projected costs of Social Security as share of Gross Domestic Product

Source: Social Security Trustees [2006]

Maintain the Current System

• Raise the payroll tax

• Raise the Maximum Taxable Earnings Level

• Raise the Retirement Age

• Reducing the Cost-of-Living Adjustment

• Change the Benefit Formula

• Comparing the Options

Privatize the System

• Personal Accounts• Pros and cons of personal accounts

– Effect on Solvency– Effect on Saving

• Carve-out accounts• Add-on accounts

– Risk– Administration– Distribution

Understanding the economics of insurance markets

• Why individuals value insurance

• Why insurance markets may fail– Adverse selection– Moral hazard

• What tradeoffs in designing social insurance

Expected Utility Model

• EU = (1-p) U(C0) + pU(C1)–Where

• p stands for the probability of an adverse event

• C0 and C1 stand for consumption in the good and bad states of the world

Expected Utility Example: Insurance

• Individual with $20,000 annual income

• 4% probability of an accident costing $20K

• State 1: no accident $20,000 income

• State 2: accident $0 income

• a. what is expected income?

• b. What is actuarially fair premium?

Adverse Selection Problem• Insurance market fails because of adverse

selection:– Individuals know more about their risks than

insurance company– Only those with high chance of adverse outcome, or if

premium is a fair deal, buy insurance– Adverse selection causes insurance companies to

lose money

• Example (HIV,

Insurance and Moral Hazard

• Moral hazard

• Deductible

• Co-payment

• Co-insurance

Moral Hazard

Medical services per year

Pric

e pe

r un

it

Dm

Sm

M1M00

P0

.2P0

a b

h

deadweight loss

Flat-of-the-curve medicine

Co-Pay and Insurance

• D for annual doctor visits:

• D = 4.22- .0444 Pd

• How many visits at $50 per visit

• With insurance and 10% copay,– How many visits– What is welfare loss

Health Care Expenditures and Health Outcomes

Additional Considerations

• The Elasticity of Demand for Medical Services

• Does Moral Hazard Justify Government Intervention?– Third Party Payment

Other Market Failures in the Health Care Market

• Information Problems

• Externalities

Do We Want Efficient Provision of Health Care?

• Paternalism

• The Problem of the Uninsured– Who are the uninsured?– Does health insurance improve health

High Health Care CostsFigure 9.5: Expenditures on health care as share of Gross Domestic Product, selected countries

(1960-2004)

0

2

4

6

8

10

12

14

16

1960 1970 1980 1990 2000 2004

Year

Hea

lth E

xpen

ditu

res

as P

erce

ntag

e of

GD

P

Australia Canada France Germany Japan United Kingdom United States

Causes of Health Care Cost Inflation

• The Graying of America

• Income Growth

• Improvements in Quality

• Commodity Egalitarianism