Social security with differential mortality

Abstract

This paper examines the welfare angle of Pay As You Go (PAYG) type social security under differential mortality among different income groups. Empirical evidence suggests that agents who have low income tend to start working earlier and have shorter longevity than those with middle or high income. Since a PAYG social security program collects payroll taxes whenever agents are working, and it pays retirement benefits as long as retirees are alive, each individual’s well being depends on how longthey contribute to and receive payments from this program as well as how much. Implications of the low income groups’ shorter longevity are examined both analytically and quantitatively. In the analytical part, in a simple two period partial equilibrium model, we observe that a social security program can have regressive outcome even though the benefits of the program are designed to be progressive. We also derive the conditions under which this can happen. Afterwards, we create a large scale quantitative OLG model calibrated to the US economy to compare aggregate and welfare implications of the US type PAYG, a non progressive PAYG, and a means tested pension program. Our results clearly indicate that incorporating differential mortality into the model changes the welfare implications of social security programs.