Introduction

Many government policies and programs that affect the economic well-being of Americans are under scrutiny today to assess their costs and benefits. In 1994, the debate was on how to provide health care at a reasonable cost; at present, there is intense debate about the costs and benefits of federal and state government welfare programs. Another area that is likely to be equally problematic and controversial is how best to ensure the income security of current and future generations of retirees.

There are a number of warning signs that suggest that the problems policy makers will confront in this area will be at least as difficult as those in health care or welfare reform. In particular, will the U.S. Social Security system be able to provide an adequate level of benefits in view of demographic trends that imply a steadily increasing ratio of beneficiaries to contributors? Can the United States maintain its commitment to a strong Social Security system while simultaneously trying to reduce the large U.S. budget deficit in an era of taxpayer revolt? Can employers be counted on to provide adequate pensions given growing financial pressures to reduce costs in the face of increasing international competition? Will income from private savings and transfers from family members enable retirees to have an adequate standard of living? Even if retirees have adequate incomes, will they still feel secure if they are uninsured against rising costs of health care and nursing services?

Policy makers have put the topic of retirement income security—at least the Social Security component—“off the table” for the moment. But the issues in this area cannot remain off the table indefinitely. Devising policies that appropriately balance benefits and costs will entail difficult choices, and the choices will only become harder the longer the policy debate is deferred.

The Pension and Welfare Benefits Administration in the U.S. Department of Labor asked the Committee on National Statistics at the National Research Council to establish a Panel on Retirement Income Modeling. The charge to the panel is to assess the current state of research, models, and data that can help guide policy makers on a broad range of issues related to retirement income and public and private pension policies. The National Institute on Aging and TIAA-CREF also provided support for the project.

The panel defines “retirement income” in broad terms as “retirement income security,” for which it is important to consider all sources of income and wealth for the elderly and the risks



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Toward Improved Modeling of Retirement Income Policies: Interim Report Introduction Many government policies and programs that affect the economic well-being of Americans are under scrutiny today to assess their costs and benefits. In 1994, the debate was on how to provide health care at a reasonable cost; at present, there is intense debate about the costs and benefits of federal and state government welfare programs. Another area that is likely to be equally problematic and controversial is how best to ensure the income security of current and future generations of retirees. There are a number of warning signs that suggest that the problems policy makers will confront in this area will be at least as difficult as those in health care or welfare reform. In particular, will the U.S. Social Security system be able to provide an adequate level of benefits in view of demographic trends that imply a steadily increasing ratio of beneficiaries to contributors? Can the United States maintain its commitment to a strong Social Security system while simultaneously trying to reduce the large U.S. budget deficit in an era of taxpayer revolt? Can employers be counted on to provide adequate pensions given growing financial pressures to reduce costs in the face of increasing international competition? Will income from private savings and transfers from family members enable retirees to have an adequate standard of living? Even if retirees have adequate incomes, will they still feel secure if they are uninsured against rising costs of health care and nursing services? Policy makers have put the topic of retirement income security—at least the Social Security component—“off the table” for the moment. But the issues in this area cannot remain off the table indefinitely. Devising policies that appropriately balance benefits and costs will entail difficult choices, and the choices will only become harder the longer the policy debate is deferred. The Pension and Welfare Benefits Administration in the U.S. Department of Labor asked the Committee on National Statistics at the National Research Council to establish a Panel on Retirement Income Modeling. The charge to the panel is to assess the current state of research, models, and data that can help guide policy makers on a broad range of issues related to retirement income and public and private pension policies. The National Institute on Aging and TIAA-CREF also provided support for the project. The panel defines “retirement income” in broad terms as “retirement income security,” for which it is important to consider all sources of income and wealth for the elderly and the risks

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Toward Improved Modeling of Retirement Income Policies: Interim Report facing each. Also important to consider are expenditures necessary to maintain or restore health, which, if they continue to escalate as in the past, may significantly undercut the adequacy of retirement income flows for other needs1 Finally, any consideration of retirement-income-related policy changes should take account of the associated costs for workers and the economy at large. The charge to our panel is not to recommend changes in public or private policies that affect retirement income security. Instead, our charge is to consider a critical adjunct to the policy process —namely, the policy models, databases, and research findings that are needed to provide reliable information about the likely short-and long-term costs and benefits of today's retirement-income-related policies and proposed changes to them. Without such information, decision makers fly blind and run the risk that the proposals they adopt may be ineffective or, worse, counterproductive. Modeling the likely future effects of any current policy or policy proposal is a difficult task at best (see Citro and Hanushek, 1991; Lewis and Michel, 1990). This is true when the policy involves income tax rates or eligibility or benefits for welfare programs. When the policy pertains to retirement income security, the task is even more difficult because of the need to project the effects of both current policy provisions and proposed changes to them over long periods of time. As just one example, to assess adequately the implications for post-retirement (and pre-retirement) living standards of tax law provisions to encourage contributions to 401(k) employer pension plans and individual retirement accounts (IRAs), the effects of those provisions on savings behavior must be played out over at least a generation. The long time horizon for retirement-income-related policy projections greatly increases the uncertainty of the estimates compared with, say, the 5-year projections that are typically prepared for tax law and welfare policy proposals. Further increasing the difficulty of the modeling task and the uncertainty of the estimates is the need to take account of all, or at least the main, sources of retirement income support. These sources include Social Security, employer-provided pensions, private savings, other transfers (e.g., public assistance and public and private disability payments), post-retirement earnings from part-time employment, and bequests and other transfers among family members. For some purposes, it may be appropriate—and challenging enough—to model one of the components in isolation: for example, the effects of changes in Social Security payroll taxes or benefits on the solvency of the Social Security trust fund and on the rates at which Social Security benefits are likely to replace earnings. However, such an analysis cannot provide an adequate picture of overall retirement income security if the Social Security changes in turn affect other components of retirement income (e.g., levels of employer pension coverage and other savings). Moreover, to the extent that there is interaction among the components, such an analysis may not provide an adequate picture of the effects of the changes on the Social Security system itself. Particularly when the analysis considers other sources of retirement income besides Social Security, there is an added difficulty due to the heterogeneity among workers and employers. Thus, while almost all workers are covered by Social Security, there is wide variation in the extent to which workers are covered by employer-provided pensions, the provisions of such coverage, and the amount of benefits received after retirement. There is also wide variation in private savings behavior, earnings capacity, and labor market opportunities. Policy models must reflect this heterogeneity, at least to some extent, or they may not show the range of 1   A yet broader interpretation of retirement income security could include such issues as whether there are adequate labor market opportunities for retirees who want to return to work on a full-time or part-time basis and whether there are adequate training and rehabilitation facilities for disabled older people.

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Toward Improved Modeling of Retirement Income Policies: Interim Report outcomes from policy proposals (e.g., whether a proposal helps some retirees but not others), which are as important to understand as the central tendencies. Indeed, much of the focus of government retirement policy is on ensuring some minimum living standard for the subset of elderly people who may have been unlucky or unwise in preparing for their post-work years. It is important that models produce estimates of the likely numbers of such people as well as estimates of the average experience. This report represents our interim findings and conclusions, based on our deliberations to date. We begin with a discussion of policy considerations, including brief reviews of the reasons for concern about the income security of future generations of retirees and the kinds of policy levers that affect retirement income (e.g., tax laws and pension regulations). We identify policy issues and options that we believe will be debated in the near term and the kinds of information on outcomes that will be needed to evaluate them. We then review types of analytical and policy models, list essential and desirable criteria for policy models that can usefully inform the policy debate, and provide an overall assessment of existing retirement-income-related policy models. Then we review types of data on individuals and employers and identify some key concerns. Finally, we make several recommendations for models and data. We also make recommendations about the need for more cost-effective organization of government support for research, data collection, and policy modeling in this area. Our recommendations at this stage are general rather than specific. They set forth some basic principles that are important but that have not generally been followed in modeling work to date. In the second phase of our work, we will draw on commissioned papers and other sources to explore in greater depth the requirements for improved models, data, and research to assess the likely costs and benefits of alternative retirement-income-related policy proposals. The papers we have commissioned review the following: existing retirement income models (Hollenbeck, 1995); overall policy modeling strategies for retirement income (Burtless, 1995); what we know and need to know about the economic condition of the elderly, taking account of all sources of income and wealth (Gustman and Juster, 1994); and the adequacy of research knowledge, data sources, and modeling techniques in several areas that are important to understand for at least some kinds of policy changes. These areas include retirement and other labor supply decisions of workers (Lumsdaine, 1995); savings behavior of workers (Poterba, 1994); employer behavior with regard to hiring and employee benefits (Parsons, 1995); and the intersection of health status, health care, and retirement income (Lee and Skinner, 1995; Moon, 1995). Our final report will make specific recommendations about modeling and data collection strategies and about priorities for research to support improved policy analysis in this area. We stress two major themes in this interim report: First, it is critically important that developers and users of retirement-income-related policy models give priority to model validation (including validation of the associated input data). Models must be evaluated with regard to their track record; also, estimates of the uncertainty associated with model outputs must be provided in terms that will be clear to policy makers. The validation task for retirement-income-related policy modeling is both particularly important and particularly difficult because of the long periods over which projections are typically required and the range of behaviors that must typically be addressed. Second, it is critically important to bring a broad perspective to retirement-income-related research and policy modeling. At present, federal government agencies analyze particular kinds of retirement-income-related policy alternatives with a narrow rather than a broad

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Toward Improved Modeling of Retirement Income Policies: Interim Report perspective and do not usually consider the full effects of proposed policy changes. Also, there is no mechanism for establishing priorities for model development, data collection, and research in a manner that considers the full range of policy concerns affecting retirement income security. A major issue is how the needed broad perspective can be brought to bear and the most cost-effective use made of scarce resources for policy analysis and modeling in this area.