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Health risk and the welfare effects of Social Security

Published online by Cambridge University Press:  04 October 2022

Shantanu Bagchi  and
Juergen Jung
Shantanu Bagchi*
Affiliation:
Department of Economics, Towson University, Towson, MD, USA
Juergen Jung
Affiliation:
Department of Economics, Towson University, Towson, MD, USA
*
*Corresponding author. Email: sbagchi@towson.edu
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Abstract

We quantify the importance of idiosyncratic health risk in a calibrated general equilibrium model of Social Security. We construct an overlapping generations model with rational-expectations households, idiosyncratic labor income and health risk, profit-maximizing firms, incomplete insurance markets, and a government that provides pensions and health insurance. We calibrate this model to the US economy and perform two computational experiments: $\left (i\right)$ cutting Social Security’s payroll tax, and $\left (ii\right)$ modifying Social Security’s benefit-earnings rule. Our findings suggest that health risk amplifies the welfare implications of both experiments: downsizing Social Security always leads to higher overall welfare, but the welfare gain is larger when we account for health risk, and increasing the progressivity of Social Security’s benefit-earnings rule has a larger positive effect on welfare in the presence of health risk. We also find that allowing households additional tools to self-insure against health risk weakens the precautionary motive, so our experiments have similar welfare implications both with and without health risk.

Keywords

Health riskSocial Securitybenefit-earnings ruleconsumption smoothinggeneral equilibriumE62E21H31H55I14
Type
Articles
Information
Macroeconomic Dynamics , Volume 27 , Issue 7 , October 2023 , pp. 1767 - 1806
Copyright
© The Author(s), 2022. Published by Cambridge University Press

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Footnotes

†

We thank Matt Chambers, Svetlana Pashchenko, Ponpoje Porapakkarm, Kai Zhao, participants of the CBE D&R Conference at Towson University in 2019, participants of the Midwest Macro Meetings 2019, and participants of the IIPF Annual Congress 2019.

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