Chapter

The Transition to Investment-Based Social Security When Portfolio Returns and Capital Profitability Are Uncertain

Martin Feldstein, Elena Ranguelova and Andrew Samwick

in Risk Aspects of Investment-Based Social Security Reform

Published by University of Chicago Press

Published in print December 2000 | ISBN: 9780226092553
Published online February 2013 | e-ISBN: 9780226092560 | DOI: http://dx.doi.org/10.7208/chicago/9780226092560.003.0003
The Transition to Investment-Based Social Security When Portfolio Returns and Capital Profitability Are Uncertain

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This chapter explores the transition from a pay-as-you-go system of social security pensions to an investment-based system in an economy in which portfolio returns and capital profitability are both uncertain. It analyzes the effects of investment risk on a proposal for prefunding social security put forward in earlier work by Martin Feldstein and Andrew Samwick. Feldstein and Samwick examine the effect of adding modest contributions to personal retirement accounts (PRAs) — initially set at 3 percent of earnings. Over a seventy-five-year transition period, as PRA savings accumulate, payroll taxes could decline to zero, and the PRA contribution rate could rise slightly to a steady-state 4.25 percent level. The chapter also assumes that the PRA portfolio is invested 60 percent in equities and 40 percent in corporate bonds, and suggests that investment risk in this portfolio can be handled by a combination of a higher PRA contribution rate, to shift the distribution of retirement benefits upward, and a government guarantee that total benefits under the new system will be at least as large as those under the current system.

Keywords: pay-as-you-go system; social security; pensions; portfolio returns; capital profitability; investment risk; prefunding; personal retirement accounts; payroll taxes; corporate bonds

Chapter.  23114 words. 

Subjects: Economic Systems

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