The Economic Effects of Social Security: Towards a Reconciliation of Theory and Measurement

In this paper we argue that actuarial valuation of Social Security benefit streams is theoretically inconsistent with the assumption of pure life cycle motives. Instead, we show that the simple discounted value of future benefits (ignoring the possibility of death) is often a good approximation to the relevant concept of value. This observation motivates a re-examination of existing empirical evidence concerning the economic effects of Social Security. We focus our attention on studies of distributional equity and personal saving behavior. In both cases we argue that the use of simple, rather than actuarial, discounting of survival-contingent income streams produces results that differ dramatically from previous findings. Specifically, estimates based on actuarial valuation may overstate the importance of redistribution between and within generations, and may understate the depressive effect of Social Security on personal wealth accumulation by a factor of three or more.