Post on 24-Dec-2015
CHAPTER 11
Social Security
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
11-2
Social Security Expenditures(1939-2007)
Source: Social Security Trustees [2008].
11-3
Why Have Social Security?
• Consumption Smoothing and the Annuity Market– How Social Security works– Annuity– Consumption smoothing
• Adverse Selection and the Annuity Market– Asymmetric information– Adverse selection
11-4
Other Justifications
• Lack of foresight and paternalism
• Moral hazard
• Economize on decision-making and administrative costs
• Income Redistribution
• Improve the Economic Status of the Aged
11-5
Fully Funded Plan
Period 1 Period 2 Period 3 Period 4
contribute benefits
contribute benefits
contribute benefits
The GreatestGeneration
The Baby BoomGeneration
Generation X
Work Retire Dead
Unborn
Work
Work
Retire
StillDead
DeadChildhood
Childhood Retire
Each generation’s benefits based on
deposits it made during working life plus
accumulated interest
11-6
Period 1 Period 2 Period 3 Period 4
The GreatestGeneration
The Baby BoomGeneration
Generation X
Work Retire Dead
Unborn
Work
Work
Retire
StillDead
DeadChildhood
Childhood Retire
contribute
benefits
contribute
benefits
contribute
benefits
benefits
Pay As You Go (or Unfunded) System
Each generation’s benefits come from tax
payments made by current workers
11-7
Period 1 Period 2 Period 3 Period 4
The GreatestGeneration
The Baby BoomGeneration
Generation X
Work Retire Dead
Unborn
Work
Work
Retire
StillDead
DeadChildhood
Childhood Retire
contribute
benefits
contribute
benefits
contribute
benefits
benefits
Today’s Partially Funded System
Baby Boomers and Gen X are
also contributing to their own retirement
11-8
Explicit Transfers
• Benefits for dependents and survivors (1939)
• Supplemental Security Income
11-9
Benefits
• How to calculate benefits– AIME (Average Indexed Monthly Earnings) –
average monthly earnings in 35 highest paid years• Wages indexed for inflation
• Ceiling on AIME – up to tax ceiling
11-10
Benefit Structure
If AIME < $711 PIA = .90*AIMEIf $711< AIME <$4288 PIA = .90*$711 + .32*(AIME - $711)If AIME > $4288 PIA = .90*$711 + .32*($4288-$711) + .15*(AIME - $4288)
11-11
Adjustments
• Annual inflation adjustment
• Age at which benefit is drawn– 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 8% a year
11-12
Adjustments
• Family Status
– +50% for spouse or dependent child
– If covered worker dies spouse receives 100% of worker’s benefit or spouse’s own benefit (whichever is higher)
– 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 $14,160
– 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.)
11-13
Financing
• FICA (Federal Insurance Contribution Act)
• 2008 Social Security Tax rates
– Employee
– 6.2% (OASI - 5.6%, DI - .6%) of first $102,000 of earnings on both employee and employer
– Self-employed
• 12.4%
• 2008 Medicare Tax rates
– 1.45% on both employer and employee with no earnings ceiling
• Why not fund Social Security through general tax revenues?
11-14
Distributional Issues
• Actuarially fair return
• Intergenerational redistribution– Total benefits = Nb * B
– Total taxes = t * Nw * w
– If total benefits = total taxes:Nb * B = t * Nw * w orB = t * (Nw/Nb) * w
• Ida Mae Fuller
11-15
Ida Mae Fuller
11-16
Social Security Wealth:
Representative
Individuals
-1000
-800
-600
-400
-200
0
200
400
Tho
usan
ds o
f 20
06 D
olla
rs
Year Cohort Turns 65
Single Male
Low
Average
High
Max
Single Female
-1000
-800
-600
-400
-200
0
200
400
Year Cohort Turns 65
Low
Average
High
Max
One-earner Couple
-1000
-800
-600
-400
-200
0
200
400
Year Cohort Turns 65
Tho
usan
ds o
f 200
6 D
olla
rs
Low
Average
High
Max
Two-earner Couple
-800
-600
-400
-200
0
200
400
Year Cohort Turns 65T
hous
ands
of 2
006
Dol
lars
Low
Average
High
Max
Source: Updated tables, furnished by C. Eugene Steuerle and Adam Carasso, 2006.
See C. Eugene Stueuerle and Jon M. Bakija [1994] for original tables and methodology.
All values expressed in 2006 dollars.
11-17
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
11-18
The Social Security Trust Fund
• Social Security and National Saving
• Budget Treatment of Social Security– Off budget– Unified budget
Worker RetireeTrust Fund
11-19
Social Security and Savings Behavior
• Life-cycle theory of savings
• Wealth Substitution Effect
• Retirement Effect
• Bequest Effect
11-20
Budget Constraint for Present and Future Consumption
Present consumption (c0)
Fut
ure
cons
umpt
ion
(c1)
N
M
I0
I1
D
I0 - S
I1 + (1+r) S
S
(1+r)S
I1 - (1+r) BF
B
(1+r)B
At endowment point consumer
neither saves nor borrows
11-21
Utility-maximizing Choice of Present and Future Consumption
Present consumption (c0)
Fut
ure
cons
umpt
ion
(c1)
N
M
I0
I1
E1c1*
A
c0*
Saving
11-22
Crowding out of private saving due to Social Security
Present consumption (c0)
Fut
ure
cons
umpt
ion
(c1)
N
M
I0
I1
E1c1*
A
c0*
R
T
I0T
(1+r)T
Saving before Social Security
Saving after Social
Security
11-23
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
11-24
Other ways Social Security Affects Saving
• Retirement effect
• Bequest effect
• Empirical evidence
11-25
Distribution of Wealth
• Bequeathable vs. Annuitized Wealth
• Effect of Social Security on Bequeathable Wealth
• Effect on Wealth Mobility
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
Source: Social Security Trustees [2006]
Projected revenues and projected costs of Social Security as share of Gross Domestic Product
11-28
Long-Term Stresses on Social Security
Since: B = t * (Nw/Nb) * w
Rearrange: 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