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Health risk and the welfare effects of Social Security
Published online by Cambridge University Press: 04 October 2022
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.
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- © The Author(s), 2022. Published by Cambridge University Press
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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