Lecture 24 Public Finance and Risk Management

Origins of Social Insurance German social thinkers in 1870s: Lujo Brentano, Gustav Schmoller, Adolph Wagner. Stressed insurance principles. Otto von Bismarck’s government: instituted sickness insurance (Krankenversicherung) 1883, accident insurance (Unfallversicherung) 1884, old-age insurance (Invaliden und Altersversicherung), Unemployment insurance, UK, Lloyd George, 1911.

Gustav Schmoller Reviews 19 th Century “The triumph of insurance in every imaginable area was one of the century’s great advances in social progress. It was an entirely logical development that insurance spread from the upper classes to the lower classes, that it had to attempt, as far as possible, to eliminate poverty; and that the older charitable relief funds for the workers were more and more constructed on the sound principle of insurance.”

Social (Governmental) Insurance Progressive Taxes (US 1913) Free public education and services Social Security: OASDI, Old Age, Survivors and Disability Insurance (US 1935) Health Insurance: Medicare, Medicaid (US, both 1965) US is only major developed country without comprehensive health insurance. Workers Compensation (US before 1920)

Government Insurance, continued Aid to Families with Dependent Children (1935) abolished 1996, in reaction to accelerating “moral hazard” problem. Unemployment insurance (US 1935) Survivors Insurance (US 1939)

Survivors Insurance Created in 1939 Amendments to the Social Security Act Government life insurance For most people, bigger than their life insurance Surprising lack of opposition from insurance industry in 1939 Framing: calling it survivors insurance

Welfare Reform Act of 1996 Republican bill, Clinton signed it because of pledge to “end welfare as we know it,” after vetoing two earlier bills Ended Roosevelt’s “New Deal” after 60 years Lifetime 5-year lifetime limit on welfare Denies aid to immigrants who are not citizens Unemployed childless adults limited to 3 months food stamps out of 36 months, immigrants get none. Hungry people helped by churches, charity

Social Security Crisis Pay-as-you-go systems US social security liabilities equal $9 trillion, to be paid for out of future taxes Social security trust fund, approx $1 trillion invested in government bonds will be exhausted by 2032 Will be many more old people relative to young people in twenty years.

Birth Rates around the World

George Bush Proposals for Social Security Solemn commitment: no reduction in benefits to retirees Personal retirement accounts (PRAs) Opposes any tax increase for social security. Gore’s complaint: how will Bush pay for the PRAs?

Overlapping Generations Model and Burden of Past Commitments First generation (working in 1930s) receives windfall of promised benefits B. Next generation (in 1960s) pays B to the now- retired first generation, is promised B when retired. Same for each generation. Cost per generation is rB. Present value of cost is rB/(1+r)+rb/(1+r) 2 + By consol formula, burden is B.

Social Security as Formalization of Ancient Family Risk-Sharing Traditional society: middle aged care for both young and feeble elderly Faults of traditional risk sharing: unreliability Advantages of traditional risk sharing: responsiveness to relative needs Social security should be designed to meet these risk-sharing purposes.