Lecture 17: Social Security

Transcription

1 Lecture 17: Social Security Nicolas Roys University of Wisconsin Madison Econ Spring 2015

2 Topics of today s class Last Lecture: I Consumption-Savings Decision Today: I Social Security

3 Social Security Introduced after the Great Depression: Pay-As-You-Go Social Security. Pay-As-You-Go Social Security: I currently working generation pays payroll taxes, whose proceeds are used to pay the pensions of the currently retired generation I current tax rate is around 15% (you pay half and your employer pay the other half) Population Ageing: I more retirees to whom benefits are owed I fewer workers to pay for these benefits Every US Presidents since Jimmy Carter (!) understood the problem but failed to reform the system

4 Social Security Overlapping Generations Model I Each agent lives two periods: Young and Old I In any period, there are people of different generations alive Population Evolution: N 0 = N(1 + n)

5 Social Security Introduce Pay-As-You-Go Social Security: I Old: Social security payments b I Young: tax t Budget Equilibrium: Nb = N 0 t Total social security benefits must equal total taxes on the young b 1 + n = t Social Security is a forced savings program.

6 Pay-As-You-Go Social Security for Consumers Who Are Old in Period T

7 Pay-As-You-Go Social Security When Pay-As-You-Go Social Security was introduced, The First Generation of Old Consumer clearly benefited from the program: I they did not pay taxes when they were young I they now have an additional source of income For everyone else, the effect on welfare is less obvious

8 Pay-As-You-Go Social Security Lifetime wealth of the consumer: we = y t + y 0 t r b = y 1 + n + y 0 + b 1 + r = y + y r + b(n r) (1 + r)(1 + n)

9 Pay-As-You-Go Social Security Lifetime wealth of the consumer: we = y + y r + b(n r) (1 + r)(1 + n) If n > r: Pay-As-You-Go Social Security improves welfare If n < r: Pay-As-You-Go Social Security decreases welfare Intuition: I If people save by themselves for retirement, return on their savings equals 1 + r I If people save via a social security system return equals: 1 + n

10 Pay-As-You-Go Social Security for Consumers Born in Period T and Later

11 Current Issues with Pay-As-You-Go Social Security Population Ageing: payroll tax = pension income I more retirees to whom benefits are owed I fewer workers to pay for these benefits Evolution of the Workforce: I 1940: ratio of workers to retirees=8 I 2000: ratio of workers to retirees=4 I 2040: ratio of workers to retirees=2 number of retirees number of workers But the problem is less severe than in most Europeans and Asian Countries (most notably Japan)

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13 Current Issues with Pay-As-You-Go Social Security I Over the past 70 years, contribution of workers is more than the benefits claimed of retirees I increase in the participation rate of women s, baby boomers generation, strong growth, immigration I This extra money has been placed in a trust fund that earns interest: $2.5 Trillion (invested in US government securities) I By 2015, Social Security surplus will turn into yearly deficits: Social Security costs will exceed tax revenue I Trust funds will be exhausted by 2035

14 Current Issues with Pay-As-You-Go Social Security payroll tax = pension income 3mainpossibilitiestobalancethebudget 1. raising retirement age I I number of retirees number of workers because life expectancy is increasing (by about 7 years) with hardship exemption

15 Current Issues with Pay-As-You-Go Social Security payroll tax = pension income 1. raising retirement age 2. reducing benefits number of retirees number of workers

16 Current Issues with Pay-As-You-Go Social Security payroll tax = pension income 1. raising retirement age 2. reducing benefits 3. more progressive payroll taxes number of retirees number of workers

17 Social Security Fully Funded Social Security I George W. Bush had proposed a transition to this system in 2005 I no taxes on the young and no transfers to the old I The current worker s contribution is invested and used to pay their own benefits in the future

18 Transition to Full Funding Main problem: Costly transition from pay-as-you-go to full funding. Missing generation I at the introduction of the system there was one generation that received social security but never paid taxes. I if pay-as-you-go disappears, there will be one generation that paid taxes but will not received social security. I Dilemma: 1. Currently young pay double 2. Default on the promises for the old 3. Increase government debt, financed by higher taxes in the future, i.e. by currently young and future generations. (Tax those who would benefit from switch.)