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Disability Insurance and the Dynamics of the Incentive-Insurance Tradeoff

Mar 2014
Policy Brief
By  Luigi Pistaferri
The Social Security Disability Insurance (DI) program in the United States is a large and rapidly growing social insurance program offering income replacement and health care benefits to people with work- limiting disabilities. In 2012, the cash benefits paid by the DI program were more than three times larger than those paid by Unemployment Insurance ($128 billion vs. $40 billion –– not including in-kind health care benefits provided by Medicare to DI beneficiaries). Moreover, between 1985 and 2007, the proportion of DI claimants in the United States has more than doubled (from about 1.8 percent to 4.4 percent of the working- age population). The growth can be explained by the interaction of demand and supply effects. The rise in wage inequality in the United States, coupled with the progressivity of the formula used to compute DI payments, have implicitly increased replacement rates for people at the bottom of the wage distribution (a “demand” effect). In addition, starting in 1984, the entry criteria into the program were made more liberal (a “supply effect”). The key questions in thinking about the size and growth of the program are whether program claimants are genuinely unable to work, whether those in need are receiving insurance, and the value of the insurance provided in relation to the inefficiencies created by the program. This brief summarizes the results of a study that evaluates the welfare consequences of reforming some key aspects of the DI program. Such reforms alter the dynamics of the trade- off between costs and insurance aspects of the program (Low and Pistaferri, 2013).