# Social Security, Part 2

(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.)

### Why is Social Security an Annuity?

(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

### Why Worry about Social Security?

(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)

### Privatization--what it would and would not do

(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