Social Security reform and intertemporal smoothing

This paper examines the welfare and distributional impact of switching from a defined benefit pension system like Social Security to a defined contribution system of personal retirement accounts (PRAs). While such a switch would do away with the transfers that low-wage workers receive through Social Security, it would have the benefit of reducing labor supply distortions. Moreover, a particular kind of PRA suggested in this paper - one that has very low (or zero) contribution rates early in life - substantially enhances life-cycle patterns of consumption and labor supply by making more resources available to credit-constrained young workers. Simulations of a life-cycle model show that in welfare terms these PRAs significantly outperform conventional PRAs because of this enhanced intertemporal smoothing.