Fiscal Effects of Social Security Reform in the United States

Abstract

Social Security is the largest social insurance program in the U.S., and has been shown to be a major determinant of the labor supply decisions of older workers. As such, reforming the Social Security system can have two fiscal impacts: a “mechanical” effect through changing the rules on benefits entitlements or taxation, and a “behavioral” effect through individual responses to these changes in benefits or taxes. We build a simulation model that computes these effects for major reforms to the system, building on estimated retirement responses to changing net Social Security entitlements. We then estimate the fiscal impact of reform for the 1931-1941 cohort of workers represented by the Health and Retirement Survey. We find that raising the early and normal retirement age by three years would reduce net costs for this cohort by roughly 30%, and that moving to a much higher benefit level would raise net costs by roughly 55%. Importantly, we find that in both cases the behavioral impacts on net costs are relatively small, at most one-third, and generally less than one-fifth of the total. The reason for these small effects is that the U.S. Social Security system is roughly actuarially fair, so that delaying or inducing retirement has relatively little impact on system balances; most of the effects that do arise are due to changes in general income and consumption taxes.