Income Redistribution Through Social Security: The Timing Matters

Social Security is the largest income redistribution program in the United States. Being primarily a retirement pension system, the redistribution has a particular timing. Taxes are collected through a regressive formula while workers are young and the benefits are paid through a progressive benefit formula when workers are retired. In this paper I investigate the welfare implication of the timing of this redistribution. I use a life cycle overlapping generations model in which individuals are heterogenous in their labor productivity as well as their mortality. Motivated by empirical facts I assume more productive individuals have lower mortality. I calibrate the model to match U.S. aggregate data and current Social Security benefit formula and taxes. I show that a redistribution system that has all the features of current Social Security in the U.S. (that is the same tax function and same bend points on benefit formula) but starts paying benefit at age 26 can increase the steady state - ex ante - welfare of all individuals by 5%. Every productivity type will benefit from this system. In particular for least productive individuals the welfare increases by as much as 15%. Under the new system size of the program (total taxes that it takes in and benefits that it pays) is unchanged and there is small effect on capital-output ratio, efficiency wages and rental rate. Therefore, almost all the welfare gains can be attributed to the timing.