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(Note: I strongly recommend supplementing this lecture by reading essays I have written on these topics. The essays are more complete than this lecture. The essays are linked later on in the lecture.)
(An essay on this topic is, What's Wrong with Social Security?)
Review: an annuity calculation determines how much you can spend each year if you are going to live n years and have $X. Say, 10 years and $300,000
an insured annuity--pays the same amount regardless of n
Alternative: pay out a lump sum when you retire
Need insurance against living too long
People "under-annuitize" in the private market
Perhaps people are wise
(See the essay Fighting Murphy, reprinted in Learning Economics as chapter 47, "A Social Security Primer.")
Ratio of workers to retirees falling
Tax Effects (Prescott on market time vs. non-market time)
(See this essay on Prescott)
(In addition to chapter 47, see Privatization: The Ultimate "Lockbox" for Social Security)
If stocks earn 7 percent...
Y = GDP, E = earnings on all stocks, P = price of stocks (value of stock market)
P/Y = (P/E)(E/Y)
The P/E in recent years has been around 25
E/Y is around 0.10
If Y grows by 2 percent per year for 50 years, how can P grow by 7 percent for 50 years? It would mean that P/Y would be ten times higher than today.
If P/E stays constant, then in 50 years E/Y will be more than 1.0--more than all of GDP will go to corporate profits!?!
If E/Y stays at 0.10, then P/E will have to be 250. Drives future expected returns on stocks close to 0.
Conclusion: P/Y unlikely to rise tremendously, so stock market will not bail out social security
Will Privatization Cause a Funding Gap?
If Social Security were a pension, could be privatized at the stroke of a pen
Less tax revenue from current workers to pay for current retirees
Government has to borrow more
However, future government liabilities reduced
Economic effect should be zero
What will privatization do?
Keep Congress from disconnecting benefits, taxes
Give people more incentive to earn, save more
See also Saving Freedom.
Adjust retirement age for longevity
Index to prices, not wages
Need more saving