How should we Reform Social Security?

 This question matters to every single one of us. As workers, we all pay into the Social Security system, and we all anticipate receiving benefits when we are retired. The current discussion will determine both the level of taxes we pay now and the benefits we will receive in the future. The average person could be forgiven for thinking that the debate over Social Security is complicated, arcane, and impossible to understand without an immense amount of study. In fact, the basics of the system are quite straightforward, and the most important elements of the discussion can be understood using very little economics. In this chapter, we demystify the arguments about Social Security. This will make it easier for you to understand why you pay Social Security contributions, what you can expect to get in the future, and whether the politicians and talking heads are making any sense when they discuss various reforms. Road Map At the heart of the economic analysis of Social Security is a very straightforward idea: “forced saving.” Individuals are required to give up some of their income now—income that they could, if desired, have used for current consumption—and, in return, they are promised income in the future. Understanding Social Security from the individual perspective means understanding the impact of this forced saving on individual choices. Meanwhile, we also need to understand how Social Security looks from a government perspective. Social Security contributions are a source of government revenue, and Social Security payments are an example of a government transfer. These revenues and payments enter into the government’s budget constraint. From the perspective of an individual, there is a disconnect in time between taxes and payments. Individuals pay taxes during their working years and receive transfers during their retirement years. But from the perspective of the government, taxes and payments take place at the same time. In any given year there are some individuals who are working and paying taxes, and the money they pay into the system is paid right back out to others who are in retirement. To address questions about reforming the Social Security program, we therefore need to understand (1) the structure of the program and (2) how it interacts with individual choices about consumption and saving. We study how individuals respond to Social Security by using a model of consumption and saving that applies over an individual’s lifetime. Once we understand how individuals make these choices, we ask how Social Security affects their decisions. Then we think about how the government fits into the picture. We study these flows into and from the Social Security program using the government budget constraint, to link changes in the program with changes in taxes. [2] In the end, we are able to see how individuals’ consumption and saving decisions are influenced by their beliefs about government behavior.