Lecture 8. Chapter 8 Social Security

Transcription

1 Lecture 8 Chapter 8 Social Security

2 Social Security

3 Why we should care

4 Social Security The Future of Social Security Will the federal government be able to keep the promises made by the Social Security and Medicare programs? Problem: Retirees are promised more than the tax system can support Provide Obama a and Tax Biden Cut will for be Working honest with Families: the American Obama people and Biden about will the restore long-term fairness solvency to the of tax Social code Security and provide and the 150 ways million we can workers address the the tax shortfall. relief they Obama need. and Obama Biden and will Biden protect will Social create a new Security "Making benefits Work Pay" for tax current credit and of up future to $500 beneficiaries per person, alike. or And $1,000 they do per not working believe family. it is necessary The "Making or fair Work to Pay" hardworking tax credit seniors will completely to raise the eliminate retirement income age. taxes for 10 million Americans.

5 Introduction Social Security is a federal program that taxes workers to provide income support for the elderly. Over the next 75 years, the program has promised $ more in benefit payments than it plans to collect in taxes from workers. Age Distribution

6 Social Security Learning by Contrast Fully Funded Pension Systems Benefits are Paid out of a fund build up from contributions by members in the retirement system Dollar value of fund must equal the discounted present value of pensions promised in the future Pay-as-you-go pension systems Finance pensions for retired workers in a given year entirely by contributions or taxes paid by currently employed workers Workers currently paying payroll tax expect future generations will be taxed similarly so that when they retire, they will receive a pension under Social Security

7 Program Details Social Security began in 1935, during the height of the Great Depression. The main motivation was to provide a means of support for this unfortunate generation of elderly. How Is Social Security Financed? Almost all workers in the United States pay the Federal Insurance Contributions Act (FICA) tax on their earnings. 12.4% of gross earnings up to: $94,200 in 2005 $102,000 in 2008 $106,800 in 2009 Who Is Eligible to Receive Social Security? A person must have worked and paid this payroll tax for 40 quarters (10 years) over their lifetime, and must be age 62 or older. To get Full benefits you have to be 65 or older. (Rising to 67 for you and me)

8 Program Details When eligible, the Social Security claimant receives an annuity payment, a payment that lasts until the recipient s death. The payment is a function of average indexed monthly earnings, or AIME. Earnings are calculated from the of earnings. If the claimant worked less than years, those years are treated as 0. They are indexed for inflation. Can you Work and receive Social Security? ANS Retired workers subject to an earnings test, which reduces benefits by $1 for each $2 of earnings over a certain maximum amount of earnings. The benefits are returned later when workers earnings fall below the threshold

9 Program Details The benefit formula is a redistributive function of past earnings because: Workers who earn more get higher benefits But the benefits do not rise at nearly as fast as earnings. The replacement rate is the ratio of benefits received to earnings prior to the entitling event. For the average earner, the Social Security replacement rate is For low earners, it is closer to 60%. For high earners, it is closer to 20%.

10 Social Security Benefits (PIA) Figure 1 For the earnings above $4,228 in monthly earnings, benefits increase by just 15 for every dollar of earnings. Social Security Benefits as a Thus, For Function the the next total of $3,857 Earnings benefit from monthly earning $4,228 earnings per beyond month the is $1,924, initial $767, which equals workers 0.90*$767 receive only *$3, in benefits per dollar earnings. $1,924 This is the relationship between earnings and benefits. The x-axis measures Thus, Workers a worker who have earning monthly exactly earnings $767 per less month than $767 would receive get 0.90*$767, 90 in or $690 benefits in monthly for every benefits. $1 of earnings. real monthly earnings, The y-axis measures $690 known as AIME. Social Security benefits taken at the normal retirement age. $0 $0 $767 $4,228 Average Indexed Monthly Earnings (AIME)

11 Your Turn When you called your elderly friend last night, they confided that they are afraid to sell their home because doing so will affect their Social Security benefits. You told your friend that you would call them back after class today. What will you tell your friend? What will you say to them about how benefits will change when the house sells?

12 Program Details Gross Replacement Rate: A workers monthly retirement benefit divided by monthly earnings in the year prior to retirement Formulas contain built-in income redistribution: more generous replacement rates for lower earners

13 Program Details - Redistribution

14 Your Turn Senator Deal proposes to offer a choice to future retirees: If you retire before age 70, the benefits are calculated on the last 35 years of income; if you retire at age 73, however, you receive benefits calculated on only the last 15 years of income. Which option are high-income workers likely to choose? Why Which option are low income workers likely to choose? Why

15 Social Security and Demographic Change Maintenance of GRRs at legislated levels has required sharp increases in payroll taxes since 1970 to provide revenue for current and future pensions Issue is, the proportion of retirees relative to working population continues to increase In 2000, nearly 5 workers for each retiree By 2050, could fall to fewer than 2 workers per retiree Middle of this century, workers will be pay more for social security than they receive for it. The pay as you go Nature of social security creates intergenerational redistribution as well.

16 Number of elderly per 100 working age people 40 Ratio of Elderly to Working Age Population By 2025, there will be a larger share of elderly in the U.S. than the share currently in Florida. 35 The 30number of elderly, relative to workers, 25 has grown over time Year

17 Table 1 Period Social Security in a Two-Period World Number of young workers Earnings per young worker Taxes paid per young worker Total taxes paid Number of old retirees Benefits to old retirees Taxes paid by old retirees Rate of return $20, $21,000 $2,100 $220, $2, $22,050 $2,205 $242, $2,310 $2,100 10% $23,153 $2,315 $266, $2,420 $2,205 10% $24, $2,315 Lessons: 1. Return to middle generations depends on the and 2. Unfunded Social Security carries with it : The debt incurred by the government because early generations of beneficiaries received much more in benefits than they paid in taxes. -

18 Real World Application of Intergenerational Transfers Redistribution The very first beneficiary of Social Security was Ida May Fuller. May worked for only three years after the establishment of the Social Security system, and paid a total of $24.75 in Social Security taxes. The first Social Security check in U.S. history was issued to her on January 31, 1940, for $ May went on to live for 35 more years, dying at age 100 in Over those 35 years, she collected a total of $22, in Social Security benefits. Ida May is a striking example of the first generation of Social Security beneficiaries who were the big winners under this new social program.

19 Social Security as Insurance Why do individuals value insurance? To protect themselves against different states of the world. Diminishing Marginal Utility The more someone consumes of something, the smaller the extra benefit. What would you prefer? a. Two years of average consumption b. One year of excessive consumption and one year of starvation Individuals prefer two years of average because the excessive consumption doesn t raise their utility as much as the starvation lowers it. Insurance provides for average consumption even if we have a bad year.

20 Social Security Taxes Over Time

21 Social Security and Saving Behavior Savings Reduce Savings Asset-Substitution Effect: Social Security provides income in retirement and so there is less need to save Increase Savings Induced Retirement Effect: Social Security gives people incentives to retire early. In order to retire early individuals prepare by saving more Bequest Effect: Social Security is a transfer from workers to Retirees. This transfer increases the capability of retirees to save money for their children

22 Asset Substitution Effect Draw Together Empirical Evidence Induced retirement effect and the bequest effect seem to balance out the asset substitution effect Social Security appears to have a negligible impact on savings.

23 Rationales for Social Security Should the government intervene in people s retirement decisions? There is imperfect information in the Annuities market What is it called when one of the assumptions of a market fail? Market Failure Individual knows more about their expected longevity than does the insurance company This uncertainty from perspective of firm may cause such a high price for annuities that no one buys them. Paternalism Government wants people to save

24 Social Security Reform Reform Round I: The Greenspan Commission of 1983 Move from a unfunded system to a funded system Formation of the Social Security Trust Fund To provide money for the trust fund: Speed up tax increases Cut Benefits

25 Social Security Reform Incremental Reform Small Adjustments Raise Taxes further: A 27 % increase in payroll taxes from 12.4% to 16.1% is said to solve the funding issue. Extend Base of Taxable Wages Ease immigration for young workers Charge state and local workers the payroll tax Increase the max income for which social security is assessed Raise Retirement age If we are living longer, should we work longer too? Lower Benefits Reduce benefits for high income individuals?

26 Social Security Reform Fundamental Reforms Invest the Trust Fund in Stocks Bonds are low yield and low risk Stocks have a higher yield in the long run Problems Politicians might take the increase revenue from the fund and use it for their projects 6% of the entire stock market would be owned by the government. Politicians might seek to manipulate companies based on their large holdings.

27 Social Security Reform Privatization Individuals would control their accounts Advantages Funds would be out of the hands of the government Respect consumer sovereignty with respect to their investment decisions. Problems How can we have individuals saving for their own retirement AND continue to support the existing generation of retirees? Administrative cost of privatization likely to be higher than current program Why give consumers the right to save how they please when the government WANTS them to save more?

28 What is the Trust Fund? Social Security Trust Fund Why do we have a Social Security Trust Fund? US is taking in more money in SS taxes right now than they are paying out. Within 30 years, that trend will be reversed. The Trust Fund is the location where those extra funds are kept.

29 Social Security Trust Fund Problem with Trust Fund: Government uses that money for current spending. Example: In 2005 Government reported a Deficit of $318 billion Actual budget deficit was $494 billion But the government counted the Social Security Trust of $173 billion as a surplus. Social Security is displacing other government savings

30 Trust Fund Fact or Fiction? Scenario 1 (Trust Fund is an accounting fiction): 1980: $1 payroll tax collected in : $1 lent by Social Security to the federal government 1980: Federal government increases spending on government programs by $1 2020: Federal government raises taxes by $1 plus interest to repay the loan to Social Security 2020: $1 plus interest transferred from Federal Government to Social Security. Scenario 2 (Trust Fund represents real economic savings): 1980: $1 payroll tax collected in : $1 lent by Social Security to the federal government 1980: Federal government increases spending on government programs by $0 2020: Federal government raises taxes by $0 to repay the loan to Social Security. Any tax increases that occur in 2020 would have happened anyway without Social Security. 2020: $1 plus interest transferred from Federal Government to Social Security

31 Trust Fund Solvency As of 2005: An immediate 1.92 percent increase in Social Security Payroll taxes would allow the system to continue operating over 75 year period without reductions in replacement rates or shortfalls of revenue after trust fund is depleted. If we wait until 2041, the payroll tax would have to increase by 4.26 percentage points