[Show abstract][Hide abstract] ABSTRACT: In this paper, I develop a quantitative macroeconomic model with endogenous health and endogenous longevity and use it to study the impact of Social Security on aggregate health spending. I find that Social Security increases the aggregate health spending of the economy via two channels. First, Social Security transfers resources from the young with low marginal propensity to spend on health care to the elderly (age 65+) with high marginal propensity to spend on health care. Second, Social Security raises people's expected future utility and thus increases the marginal benefit from investing in health to live longer. In the calibrated version of the model, I show that the positive impact of Social Security on aggregate health spending is quantitatively important. The expansion of US Social Security since 1950 can account for approximately 43% of the dramatic rise in US health spending as a share of GDP over the same period (i.e. from 4% of GDP in 1950 to 13% of GDP in 2000). I also find that this positive impact of Social Security has two interesting policy implications. First, the negative effect of Social Security on capital accumulation in this model is significantly smaller than what previous studies have found, because Social Security induces extra years of life via health spending and thus encourages private savings for retirement. Second, Social Security has a significant spill-over effect on public health insurance programs (e.g. Medicare). As Social Security increases health spending and longevity, it also increases the insurance payments from these programs, thus raising their financial burden.
[Show abstract][Hide abstract] ABSTRACT: This paper studies the impact of US Social Security and Medicare on health care spending in a modified version of the Grossman (1972) model in which both longevity and health care spending are endogenous. In the model, Social Security affects health care spending primarily through two channels. First, Social Security annuities provide people with an incentive to increase longevity through higher health care spending since they then benefit from more Social Security payments. Second, by lowering the capital stock and thus increasing the market interest rate, Social Security causes people to al-locate more resources to the later stages of life. This reallocation increases health care spending as it increases people's expected future utility and thus the return from investing in health. Medicare subsidies lower the cost of health care for the elderly thus inducing them to consume more health care. More interestingly, Social Security and Medicare interact in the model. The incentive effects of Social Security on health care spending are amplified by Medicare subsidies because these subsidies reduce the cost of increas-ing longevity. In a calibrated version of the model, I show that these mechanisms are quantitatively important. I find that in the model the expansion of Social Security and Medicare from 1950 to 2000 can generate a substantial rise in health care spending which accounts for about half of the rise in US health care spending as a share of GDP over the same period. Over half of the rise comes from the expansion of Social Security and its interaction with Medicare. The contribution of this paper is twofold. First, it is the first study to assess the quantitative importance of the impact of Social Security on health care spending. Second, it provides a new explanation for the rise in health care spending over the last half century: the expansion of Social Security and Medicare.