Friday, April 22, 2016

More on the implications for Social Security policy of workforce heterogeneity

In a recent blog post, I mentioned that Anne Alstott's new book had got me thinking about how the Social Security system ought to make greater use than it currently does of information that it collects regarding people's career earnings.  Specifically, low-earners are more likely than high-earners to suffer a significant "ability drop" as they enter their sixties - strengthening the case for empowering the former, relative to the latter, to choose an affordable earlier retirement without penalty.  Also, when prospective retirees are choosing between early and late retirement options, with annual benefits being adjusted accordingly, the fact that low-earners generally have lower remaining life expectancies than high-earners, at any given age, means that their "neutrality points" with regard to this choice may systematically differ.

Neil Irwin, in his Upshot column in today's New York Times, makes another point that is related to this theme.  As recent research by Raj Chetty et al has shown, the fact that high-earners have longer life expectancies than low-earners means that the former may often get higher internal rates of return from the system than the latter, even though the benefits formula has a progressive declining-match-rate feature.

This suggests that, in principle, if an insurer in a robust private market was offering life annuities to people who were near retirement age, and if it had ready access to information about career earnings, it would have reason to use this information in setting the relationship between premiums and annual benefits.  Otherwise, it would face adverse selection (i.e., high-earners would be able to masquerade as having average, rather than above-average, life expectancies).

The more I think about it (although I am not currently planning to write about it - too much else on my plate), the more it seems like career earnings-based heterogeneity in the workforce is an interesting frontier to think about in Social Security design, and not just on the standard redistributive ground that lifetime income may be relevant to need.

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