Transcript Slide 1

CHAPTER 11
SOCIAL
SECURITY
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Explicit Transfers

Benefits for Dependents and Survivors (1939)

Supplemental Security Income
11-2
600
6
500
5
400
4
300
3
200
2
100
1
0
0
1937
1942
1947
1952
1957
1962
1967
1972
1977
1982
1987
1992
1997
Expenditures as % of GDP
Real Expenditures (2005 $ Billions)
Figure 11.1: Social Security expenditures (1937-2005)
2002
Year
Real Expenditures (2006 $ Billions)
Expenditures as % of GDP
Sources: Expenditure data from Social Security Trustees [2006]. CPI data from Department of Labor's Bureau of Labor Statistics.
GDP data from Department of Commerce's Bureau of Economic Analysis.
11-3
Why Have Social Security?

Economic Status of the Aged

Consumption Smoothing

Annuity Market

Asymmetric Information

Adverse Selection
11-4
Other Justifications

Lack of Foresight

Paternalism

Moral Hazard

Economize on Decision-Making and
Administrative Costs

Income Redistribution
11-5
Fully Funded Plan
Each generation’s
benefits based on
deposits it made during
working life plus
accumulated interest
Period 1 Period 2 Period 3 Period 4
The Greatest
Generation
Work
Retire
contribute
benefits
The Baby Boom Childhood
Generation
Generation X
Unborn
Work
contribute
Childhood
Dead
Still
Dead
Retire
Dead
benefits
Work
contribute
Retire
benefits
11-6
Pay As You Go (or Unfunded) System
Each generation’s
benefits come from tax
payments made by
current workers
Period 1 Period 2 Period 3 Period 4
benefits
The Greatest
Generation
Work
Retire
contribute
benefits
The Baby Boom Childhood
Generation
Unborn
Generation X
Work
Dead
Still
Dead
Retire
Dead
contribute
benefits
Childhood
Work
Retire
contribute
benefits
11-7
Today’s Partially Funded System
Baby Boomers
and Gen X are
also contributing to
their own
retirement
The Greatest
Generation
Period 1 Period 2 Period 3 Period 4
benefits
Work
Retire
contribute
benefits
The Baby Boom Childhood
Generation
Unborn
Generation X
Work
Dead
Still
Dead
Retire
Dead
contribute
benefits
Childhood
Work
Retire
contribute
benefits
11-8
Calculating Benefits

AIME (Average Indexed Monthly Earnings)

average monthly earnings in 35 highest paid years

Wages Indexed for Inflation

Tax Ceiling on AIME
11-9
Benefit Structure
If AIME < $656  PIA = .90*AIME
If $656< AIME <$3955  PIA = .90*$656 + .32*(AIME - $656)
If AIME > $3955  PIA = .90*$656 + .32*($3955-$656) + .15*(AIME $3955)
2000
1800
1600
1400
1200
1000
800
600
400
200
0
First Bend Point
Second Bend Point
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
5500
11-10
Adjustments

Annual Inflation Adjustment

Age

Normal Retirement Age

Early Retirement


benefit reduced 5/9th of one percent a month for first
36 months preceding normal retirement age
Late Retirement

benefit increased 15/24th of one percent a month
11-11
Adjustments

Family Status




+50% for spouse or dependent child
If covered worker dies spouse receives 100% of worker’s benefit or
spouse’s benefit
Divorced spouse married at least 10 years gets spouse benefit if not
remarried while covered worker alive
Earnings test and taxing benefits



Benefits reduced $1 for every $2 earned above $12,480
Individuals losing benefits may have later benefits increased
Up to 85% of benefits taxed for recipients with income above a base
amount ($25,000 for single and $32,000 for married taxpayers.)
11-12
Financing


FICA (Federal Insurance Contribution Act)
2006 Social Security Tax rates



Employee
6.2% (OASI - 5.6%, DI - .6%) of first $94,200 of earnings on both
employee and employer
Self-employed


2006 Medicare Tax rates


12.4%
1.45% on both employer and employee with no earnings ceiling
Why not fund Social Security through general tax revenues?
11-13
Distributional Issues

Actuarially Fair Return

Intergenerational Redistribution


Total Benefits = Nb * B

Total Taxes = t * Nw * w

Nb * B = t * Nw * w

B = t * (Nw/Nb) * w
Ida Mae Fuller
11-14
Ida Mae Fuller
11-15
Social Security
Wealth for
Representative
Individuals
All values expressed in 2006
dollars.
400
400
200
200
0
Low
Average
-200
High
Max
-400
0
Low
Average
-200
High
Max
-400
-600
-600
-800
-800
19
40
19
60
19
80
20
00
20
20
20
40
20
60
See C. Eugene Stueuerle and
Jon M. Bakija [1994] for
original tables and
methodology.
Tw o-earner Couple
Thousands of 2006 Dollars
Source: Updated tables,
furnished by C. Eugene
Steuerle and Adam Carasso,
2006.
Thousands of 2006 Dollars
One-earner Couple
Year Cohort Turns 65
Year Cohort Turns 65
11-16
Other Distributional Issues


Redistribution within a generation

Differences by earnings

Differences by lifespan

Differences by living arrangements

Differences by number of earners in the family
Normative evaluation
11-17
The Social Security Trust Fund
Worker
Trust
Fund
Retiree

Social Security and National Saving

Budget Treatment of Social Security

Off budget

Unified budget
11-18
Social Security and Savings Behavior

Life-cycle theory of savings

Wealth Substitution Effect

Retirement Effect

Bequest Effect
11-19
Empirical Evidence

Martin Feldstein’s work

CONS = f(DI, W, SSW, X)

MPCssw = .028

60% reduction in personal saving

Others

Rosen: Social security has had a negative effect on
saving, but magnitude of effect is unclear
11-20
Effects on Retirement and Labor Supply

1930 LFPR 65+ was 54%

2001 LFPR 65+ was 18%

Effect of Social Security


Income Effect – SS raises retirement income

Substitution Effect – SS reduces the cost of retiring

Earnings test
Impact on Younger Workers?
11-21
Distribution of Wealth

Bequeathable v Annuitized Wealth

Effect of Social Security on Bequeathable
Wealth

Effect on Wealth Mobility
11-22
Future consumption (c1)
Budget Constraint for Present and Future Consumption
N
At endowment
point consumer
neither saves nor
borrows
D
(1+r)S
I1 + (1+r) S
B
I1
(1+r)B
F
S
I1 - (1+r) B
M
I0 - S
I0
Present consumption (c0)
11-23
Future consumption (c1)
Utility-maximizing Choice of Present and Future
Consumption
N
c1*
E1
A
I1
Saving
M
c0*
I0
Present consumption (c0)
11-24
Future consumption (c1)
Crowding out of private saving due to Social Security
N
E1
c1*
R
A
I1
Saving after
Social Security
Saving before
Social Security
(1+r)T
T
M
c0*
I0T
I0
Present consumption (c0)
11-25
Other ways Social Security Affects Saving

Retirement effect

Bequest effect

Empirical evidence
11-26
Retirement Decisions

Social security wealth and the retirement
decision

Empirical evidence

Diamond and Gruber [199]

Gruber and Wise [2004]
11-27
Long-Term Stresses on Social Security
Projected revenues and projected costs of Social Security as share of Gross Domestic Product
Source: Social
Security
Trustees [2006]
11-28
Long-Term Stresses on Social Security
B = t * (Nw/Nb) * w
t = (Nw/Nb) * (B/w)
Dependency Ratio
Replacement Ratio
11-29
Social Security Reform

Time horizon for solvency

Sustainable solvency
11-30
Maintain the Current System

Raise the payroll tax

Raise the Maximum Taxable Earnings Level

Raise the Retirement Age

Reducing the Cost-of-Living Adjustment

Change the Benefit Formula

Comparing the Options
11-31
Privatize the System

Personal Accounts

Pros and cons of personal accounts

Effect on Solvency

Effect on Saving

Carve-out accounts

Add-on accounts

Risk

Administration

Distribution
11-32
Policy Perspective: President Bush’s Social
Security Reform Proposal

Voluntary personal accounts

Carve-outs

Government management

Portfolio limitations

Benefit offsets

Inheritability

Achieving sustainable solvency

Progressive indexing
11-33
Empirical Evidence: Does Social Security
Reduce Saving?

Time-series evidence

Martin Feldstein (1974, 1996) v Leimer and
Lesnoy (1982)

Cross-section evidence

Evidence from other countries

Attanasio and Brugiavini (2003) and Italy
11-34