Important Social Insurance Programs Social Security Unemployment insurance Disability Insurance Workers Compensation Medicare

Distributional Issues Actuarially fair return Intergenerational redistribution –Total benefits = N b * B –Total taxes = t * N w * w –If total benefits = total taxes: N b * B = t * N w * w or B = t * (N w /N b ) * w

Social Security Wealth for Representative Individuals Source: Updated tables, furnished by C. Eugene Steuerle and Adam Carasso, Source: Updated tables, furnished by C. Eugene Steuerle and Adam Carasso, See C. Eugene Stueuerle and Jon M. Bakija [1994] for original tables and methodology. See C. Eugene Stueuerle and Jon M. Bakija [1994] for original tables and methodology. All values expressed in 2006 dollars.All values expressed in 2006 dollars.

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 Retiree Trust 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) –MPC ssw =.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 (c 0 ) Future consumption (c 1 ) N M I0I0 I1I1 D I 0 - S I 1 + (1+r) S S (1+r)S I 1 - (1+r) B F B (1+r)B At endowment point consumer neither saves nor borrowsAt endowment point consumer neither saves nor borrows

Utility-maximizing Choice of Present and Future Consumption Present consumption (c 0 ) Future consumption (c 1 ) N M I0I0 I1I1 E1E1 c1*c1* A c0*c0* Saving

Crowding out of private saving due to Social Security Present consumption (c 0 ) Future consumption (c 1 ) N M I0I0 I1I1 E1E1 c1*c1* A c0*c0* R T I0TI0T (1+r)T Saving after Social SecuritySaving 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(C 0 ) + pU(C 1 ) –Where p stands for the probability of an adverse event C 0 and C 1 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 Price per unit DmDm SmSm M1M1 M0M0 0 P0P0.2P 0 a b h deadweight loss Flat-of-the-curve medicine

Co-Pay and Insurance D for annual doctor visits: D = 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 Costs

Causes of Health Care Cost Inflation The Graying of America Income Growth Improvements in Quality Commodity Egalitarianism