Lifetime Wealth Accumulation

Over his working life, Carlo builds up his stock of wealth, so he has $180,000 in his bank account when he retires. During retirement, he dissaves, exactly using up the $180,000 he accumulated while working. Social Security: The Government’s View Now let us shift perspective and examine the Social Security system from the perspective of the government. The original intention was that Social Security would be (approximately) pay-as-you-go. Under a strict pay-as-you-go system, the inflows to the government in the form of tax revenues are exactly balanced by outflows to retired people. In any given year, in other words, the government takes money from those that are working and transfers all that money—not a cent more, not a cent less—to those who are retired.

Under this system the government does not maintain any kind of “savings accounts” for individuals: it taxes you when you work and transfers the revenues to retirees at the same time. The government promises to make payments to you after you retire, with these payments being financed by those who will then be working. Let us pause for a moment here. We have to determine how to capture transfers across different generations in the economy in as simple a setup as possible. The easiest way to do this is to suppose that everyone in the economy is just like Carlo. That is, every working person in the economy earns $40,000 and pays $6,000 into the Social Security system. Every retired person receives a Social Security payment of $18,000 per year. Let us further suppose that there is the same number of people of every age in the economy. In each year the same number of people is born, and—like Carlo—they all live to exactly the age of 80. Like Carlo, everyone works for 45 years (from age 20 to 65) and is retired for 15 years (from age 65 to 80). If we wanted to calibrate this roughly to the US economy (that is, make the numbers in the example a bit more realistic), we might suppose that there are 4 million people born every year. Since everyone lives to the same age, this means that there are 4 million 20-year-olds, 4 million 21-year-olds, and so forth, up to 4 million 79-year-olds. (This implies a total population of 320 million, which is close to the size of the actual US population.) Having made these simplifications, it is a short step to realize that we might as well just suppose that there is only one person of each age. The basic structure of the economy will be the same, but the math will be much easier. (If you can prefer, though, you can multiply both sides of every equation that follows by 4 million.) Given this demography, what do the government finances look like? Every year, the government collects $6,000 each in Social Security revenues from 45 working people, so that the total revenues are given by the following equation: Social Security revenues = 45 × $6,000 = $270,000. Meanwhile, the government pays out $18,000 each year to 15 people: Social Security payments = 15 × $18,000 = $270,000. You can see that we have chosen the numbers for our example such that the Social Security system is in balance: revenues equal receipts. A system like this one would indeed be pay-as- you-go. The Effect of a Change in Social Security Benefits Now, what would happen in this example if the government decided it wanted to increase Social Security payments by $3,000 per year? The total increase in payments would equal $45,000 since all 15 retired individuals would receive the extra $3,000. If the government is required to keep the Social Security system in balance, then it would also be obliged to increase Social Security contributions by $1,000 per worker (since there are 45 workers). How would Carlo (and everybody else like him) feel about this change?