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The Economic Effects of Social Security

  • Kavya Nambiar
  • Sep 16, 2021
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The effects of social security systems on the economy is a controversial matter. The question is this- how does the expansion or reduction of social security benefits affect the economy of a country? Economists have been long disagreeing with the answer, and there is research on both sides- suggesting that expansion of social security benefits boosts economic growth, and that it hinders it.


Although reaching a well-informed and conclusive answer to the question is well beyond the scope of this article, we can look at the basics of social security, and present the different arguments about the matter of how the economy is affected by social security.


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What is Social Security?


Social security is a term used to cover government systems that provide economic assistance to people who have insufficient means of income. This usually means people who are past the age of retirement, differently-abled, unemployed, survivors, and so on. Everything from pension and unemployment benefits to free healthcare fall under this umbrella.


The social security systems set up by the governments of different countries are quite different, in terms of things like coverage offered and the criteria for eligibility. There are a lot of nations where social security systems are inadequate or non-existent.


The right to social security is recognized as a universal fundamental right by institutions including the UN. Yet, according to the International Labour Organization, only 20 per cent of the world's population has sufficient social security coverage, and over half do not have any sort of social security at all.


Europe has the highest social security expenditure at around 25 per cent of GDP, and North America is at 16.6%, compared to Africa which has the lowest expenditure at 4.3 per cent of GDP.


Like several developing countries, India does not have a uniform social security system. The closest thing is pension provided through the Employee's Provident Fund. There is also the National Pension System which allows companies to offer their employees the option to save for retirement. But due to lack of awareness and due to the structure of the program, the percentage of employees opting for this is small. Others like health insurance and medical benefits, disability benefits, and maternity benefits, are provided and are found to have slightly better reach. 


Since a large portion of the population of India is employed in the unorganized or informal sector, they don’t have access to the programs that do exist. It is estimated that only about 35 million out of the working population of 400 million have access to existing social security programs. A uniform system throughout the country with sufficient penetration to the lower classes still remains a pipe dream.


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The United States Social Security System


Most of the studies regarding social security and the economy have been done with the US and its OASDI program as the model. And so the issues with its current model of social security should be examined.


The United States Old-Age, Survivors, and Disability Insurance is their social security system, handled by the Social Security Administration (SSA). Approximately 1 out of 6 Americans receive social security benefits, and for a lot of them, it is the only thing keeping them fed and clothed.


To put it simply, the system uses the taxes collected from the current generation of workers to pay for the retirement of the elderly generation. The surplus funds collected from taxes are put into ‘trust funds’.


The system presents a problem as the demographics change. As the average life span increases and the age of retirement remains constant, the flaws become evident. In 1990, there were roughly 5 workers per social security recipient.


It is estimated that by 2035, there will be less than 3 workers for each social security recipient. So in 2023, total tax revenue will fall short of the benefits to be paid. The trust funds would then be exhausted by 2036 with the current structure.


Therefore there is a deficit between the tax revenue collected and the expenditure on social security benefits. As the trust funds are depleted, the government would need to reduce benefits, increase taxes, or adjust budgets to allocate more to social security.


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There are those who suggest that the best route of action is to raise taxes for those with higher incomes to pay for social security for the poor- but others argue that this hinders economic growth.


Another option is to increase the age of retirement- which is also heavily opposed, as studies show this might not be feasible. The debate around this got especially heated when the Social Security 2100 Act was introduced, which proposed raising taxes and expanding benefits.


The pandemic has also brought social security to a state of uncertainty with trust funds being exhausted sooner. Social security reforms are being brought to the table including a controversial act called TRUST (Time to Rescue United States’ Trusts) Act. Immediate changes to the policy are being demanded, as people are concerned about the status of their future.


“Social Security is meant to be the bedrock of retirement planning, but instead it’s turned into one of the greatest sources of uncertainty.”

- Shai Akabas, director of economic policy at the Bipartisan Policy Center, speaking to CNBC.


There is also the fact that the eligibility criteria for social security do not cover everyone. Those with unsteady work history may not garner sufficient credits in their life to qualify.


The system may also be non-inclusive of immigrants who may not have been in the country long enough to have enough credits. Therefore the eligibility criteria of social security also remain under scrutiny, and the economic repercussions of extending or not extending the coverage.


All of this has prompted a closer look at social security, and brought on even more discussions and analyses on the economic impacts of social security policies.



Economic Effects of Social Security


Henry J. Aaron, in his book Economic Effects of Social Security, published in 1982, talks about how the conclusions drawn by different economists about the influence of social security on personal saving, labour supply, and the distribution of income are contradictory. That still remains the case today.


Taking the same factors, let’s look at the impact they have on how social security affects the economy.

Factors to be considered when analysing the economic effects of social security include savings, labour supply, and income distribution.

Economic Effects of Social Security- Factors

  • Savings and Labour Supply


It is theorized that more generous social security programs decrease the incentive for people to accumulate personal savings and reduce the labour supply. Social security benefits are often dependent on the assets of a person, and this disincentivizes people from saving, especially as workers near the age of retirement.


A study using confidential SSA data on earnings histories and SSI (Supplemental Security Income) recipiency, came to the conclusion that the SSI program creates substantial labour supply disincentives. An earlier study also shows that social security has a negative impact on private savings, although they admit that exact figures cannot be produced as to the extent.


A possible approach to solve this is the implementation of personal retirement accounts over social security benefits. This would increase savings, and with personal ownership, people would be more incentivized, than in the case of taxes.



  • Distribution of Income


Social security systems are devised keeping the middle and lower classes in mind. Intuitively, it seems like expanding social security systems, especially by increasing the taxes of the higher income strata, would go towards bringing about a favourable distribution of income. And it would with a well-designed system.


But it is sometimes argued that the existing social security systems are in certain ways rigged against the poor. Although the benefits are progressive, taxation models are regressive.


Those on the financially weaker side are more likely to start working full-time earlier in life and have lower life expectancies. This means they pay into the system more, but end up drawing fewer benefits. Minority groups with below-average life expectancies are faced with the same problem.



Social Security- Good or Bad for the Economy?


The benefits that social security provides for middle and lower class society cannot be ignored. But the matter of if the system is good or bad for the economy of a nation is still being contested.


Responses to the Social Security 2100 Act shows people disagree on how these different factors affect economic growth. The act would increase payroll tax, especially those of higher earnings not currently taxed, and use that revenue for expanding social security benefits. It will also reduce the shortfalls the program now faces and reduce the deficit.


An analysis from the Penn Wharton Budget Model (PWBM) on the act claimed that it would reduce GDP by 1.1 per cent by 2049. It is also argued that tax increases reduce the labour supply, which combined with the reduction in savings and labour supply caused by a more extensive social security coverage, can greatly harm the economy and could shrink the economy by 1.6 trillion dollars.


But other economists claim the plan of action would expand aggregate demand because the extra spending by the receivers of the benefits would outweigh the reduction in spending caused by the higher payroll taxes.


The act also does not address the problem that the social security system of today is outdated due to longer life expectancies. But addressing this problem through the commonly suggested solution- raising the age of retirement- doesn’t seem feasible to all.


A recent study found that a large proportion of those still working at age 62 will be incapable of working even two more years, and therefore, increasing the age of social security eligibility may decrease the financial security of a significant part of the population. 


There are also overwhelmingly positive opinions in favour of social security. A report from 2013 states that in 2012, social security paid 774.6 billion dollars in benefits, which amounts to around 5 per cent of the GDP.


For that year, social security benefit payments supported about 1.4 trillion dollars in economic output, around 9.2 million jobs, approximately 774 billion dollars in value-added (GDP), over 370  billion dollars in salaries and other compensations, and over 444 billion dollars in total tax revenues.


They finally came to the conclusion that reducing social security benefits would only be detrimental to the US economy.


They concluded that a 25 per cent reduction of social security benefits- which is projected will occur around the year 2033 in the current system- could cost the US economy about 2.3 million jobs, 349 billion worth of economic output, 194 billion in GDP, and about 93 billion in wages.


But the slow eroding effects of generous social security on the economy- decreasing savings and labour supply- cannot be ignored.


It could be argued that the different detrimental ways that social security adversely affects economic growth are not indicators that social security coverage should be reduced, but rather that the system should be improved. Like it says in a 2019 article from the Economic Policy Institute -


“If an otherwise useful policy slows growth, this is not by itself reason to dismiss it out of hand. Growth and distribution both matter if the goal is improving the lives of the greatest number of people, and Social Security is modestly redistributive toward people with lower incomes.”



There is also the fact that the unprecedented turn of events last year- the pandemic- may invalidate a lot of these studies, and show new results that may be vastly different.


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So in summary, studies around social security, mostly based on the US Social Security system, show that the system does detrimentally affect the economy of a nation in some ways. But the social security system also keeps the population out of poverty. And it is clear that drastic reductions in social security will negatively impact the economy.


Regardless, at the end of the day, social security is a fundamental human right. Every human being, no matter their financial standing, deserves to have the basic means for sustenance.


The goal is to find a way to fix the flaws of the system while ensuring that no one gets left out. In countries like India, where poverty is commonplace, social security initiatives are of utmost importance and must be encouraged and given priority.

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