Economics Today 18th Edition by Roger LeRoy Miller

Exercise 2

Do Social Security Payments Boost Real GDP?
Andrew Biggs, former principal deputy commissioner of the Social Security Administration, has just read claims about the effect of Social Security payments on U.S. economic activity. The American Association of Retired Persons (AARP) has issued a number of press releases arguing that Social Security payments stimulate economic activity in various states and in the United States as a whole. The AARP argues that every dollar the federal government pays to Social Security recipients generates about two dollars of private spending. The result, the AARP contends, is that Social Security adds about $1.4 trillion to U S. real GDP.
Biggs thinks that there are flaws in the logic laid out in the text of the AARP's press releases. First, Social Security payments to recipients are funded from payroll taxes on workers' wages. Each dollar of payments from which recipients can spend is one less dollar of earned income from which taxed workers can spend. Biggs finds a footnote in an AARP press release acknowledging this issue: "A net analysis would subtract the economic effects of payroll taxes from those of benefit payments." Second, if recipients and workers consume the same shares of income they receive, additional spending that Social Security payments make possible for recipients will exactly equal decreased spending by taxed workers. Thus, a counterargument to the claims of the press releases is that instead of adding $1.4 trillion to real GDP, the more likely actual effect is the addition of closer to $0 to real GDP.
If the assessment of Social Security payroll taxes on workers and payment of benefits to recipients tends to reduce the U.S. saving rate, could real GDP turn out to be lower in the long run? Explain.