Rethinking Social Insurance (March 2005)

Social insurance is a subject I have been studying for nearly 40 years. The intellectual and policy revolution in social insurance that is occurring around the world is among the most significant and positive developments of current economics. Social insurance programs have become the most important, the most expensive, and often the most controversial aspect of government domestic policy, not only in the United States but also in many other countries, including developing and industrialized nations. In the United States, these programs include Social Security retirement, disability, and survivor insurance, unemployment insurance, and Medicare insurance for those age 65 and older. Together these programs accounted for 37 percent of federal government spending and more than 7 percent of GDP in 2003. These ratios have increased rapidly in the past and are projected to increase even faster in the future because of the more rapid aging of the population. I will discuss how the major forms of social insurance could be improved by shifting to a system that combines government insurance with individual investment-based accounts: unemployment insurance savings accounts (UISAs) backed up by a government line of credit, personal retirement accounts (PRAs) that supplement ordinary pay-as-you-go Social Security benefits, and personal retirement health accounts (PRHAs) that finance a range of Medicare choices. I think that such reforms would raise economic well-being and are also appealing on broader philosophical grounds. Several nations are now doing this for their retirement programs, including such diverse countries as Australia and Mexico, England and China, Chile and Sweden (Feldstein, 1998a; Feldstein and Horst Siebert, 2002). The focus by governments around the world on social insurance pension reform is driven in part by the realization that the aging of their populations implies that the tax rates required to fund social insurance pension benefits will rise rapidly if the programs are not changed. The impetus for broader social insurance reform comes from the recognition that existing programs have substantial undesirable effects on incentives and therefore on economic performance. Unemployment insurance (UI) programs raise unemployment. Retirement pensions induce earlier retirement and depress saving. And health insurance programs increase medical costs. Governments are driven by a desire to reduce the economic waste and poor macroeconomic performance that these disincentives create and to avoid the resulting tax consequences, as well as the increased tax cost, of the aging population. Economic research has helped policy officials to recognize these undesirable effects and to redesign social insurance programs. The pace of reform and the nature of the program changes differ from country to country, reflecting initial conditions and local political realities. Reforms are inevitably only partial and part of an ongoing process. But the reforms generally make the programs more economically efficient, providing more protection relative to the financial costs and the economic distortions. I will examine some of the favorable changes that have already occurred in U.S. unemployment, retirement, and health care programs. Before looking at these specific types of social insurance, I want to discuss three general † Presidential Address delivered at the one hundred sixteenth meeting of the American Economic Association, January 8, 2005, Philadelphia, PA.