CHAPTER 8- SOCIAL SECURITY AND SOCIAL INSURANCE

8/14/2019 CHAPTER 8- SOCIAL SECURITY AND SOCIAL INSURANCE

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Chapter 8

Social Security andSocial Insurance


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Social Security Act of 1935

Requirements at that time:

Retirement Age: 65

Payroll Tax:1% for employer and employee

Tax applied to the first $3000 of

earned income


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Other Nations and Social Insurance

Germany 1889

U.K. 1908 France 1910

Now more than 170 nations have someform of social security system.


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Social Security in the United States

OASDI: Old Age

Survivors

Disability Insurance

HI: Health Insurance (Medicare)

UI: Unemployment Insurance


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Social Security Throughout the World

Most systems throughout the world are similar tothe U.S. Social Security System.

Some make fixed payments not related to pre-retirement earnings.

The problem of supporting more retirees withfewer workers is greater in Japan and Western

Europe. Chile, Argentina, Peru, Sweden, and Mexico have

partially or fully privatized elements.


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FICAFederal Insurance Contribution Act

Employers and employees each currently contribute

7.65% of wages in FICA tax.

15.3 % for the self-employed

Taxes applied on earned income up to $87,000 in2003 (indexed).


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Fully Funded vs Pay-As-You-Go A Fully Funded

system: current fund

has balances sufficientto pay the presentvalue of all futureobligations.

A Pay-As-You-Gosystem: current

taxes pay forcurrent benefits.

The current U.S.system is a modified pay-as-you-go system with a trust fund as backup.


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Social Security Trust Fund Since 1982, Social Security taxes collected

have greatly exceeded benefits paid out.

The trust fund is an accounting mechanism

by which U.S. government debt is issued tothe Social Security Administration inexchange for SS fund surpluses.

This debt will be sold to the public when

taxes paid fall below what is needed to paybenefits.


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Retirement Age People born prior to 1935 can retire with full

benefits at 65. People born between 1936 and 1942 can

retire with full benefits at age 65 + 2 monthsfor every year after 1936 they were born.

People born between 1943 and 1954 canretire with full benefits at age 66.

People born between 1955 and 1960 can

retire with full benefits at age 66 + 2 monthsfor every year after 1955 they were born.

People born after 1960 can retire at fullbenefits at age 67.


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How Retirement Benefits are Computed

The AIME (Average Index of Monthly Earnings)calculates the highest 35 years of inflation-

adjusted earnings, expressed in monthly terms.

The PIA (Primary Insurance Amount) is theamount to which a individual is entitled given

their AIME.


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The Gross Replacement Rate is themonthlyretirement benefit divided by the monthly labor

earnings in the year prior to retirement. The Net Replacement Rate is themonthly after-

tax benefit divided by the monthly after-tax laborearnings in the year prior to retirement .

Replacement Rates


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Worker Status GrossReplacement Rate

Low Earner 53.6%

AverageEarner

39.9%

Maximum

Earner

24.8%

Gross Replacement Rates by Income

i 8 1 G f S i


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Figure 8.1 How Gross Replacement Rates for Social

Security Pension Recipients Vary with

Pre-retirement Earnings

GrossRe

pla

cemen

t

Rate

(Percent)

Gross Monthly Earning in the Year

Prior to Retirement (Dollars)

11010090807060504030

2010

01,000 2,000 3,000 4,000


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Spousal and Dependent Benefits

.5 of PIA is added for a spouseover age 65 and for each

dependent child


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Divorce and the Two-Income Family

The structure of the benefit formula is such that a womanwho worked while married to a high income-earninghusband will get nothing or virtually nothing for the taxes

she paid. She and her husband would get 1.5 times his PIAif she earned nothing and 1.5 time his PIA if she earned amodest income.

Divorced people are entitled to either their own PIA or half

the amount that they would have received as a couple hadthey not divorced. This applies to multiple spouses as well.Thus, breadwinners can have multiple people receiving halfor full pensions based on a single taxpayers earnings.


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Other Anomalies When one party in a marriage dies, the benefit to

the survivor depends on who made the money.

If both earned equal amounts, then when one dies theother receives their own amount.

If one earned all the money and the breadwinner dies,the survivor keeps the spouses pension (which isoften quite a bit more).

Singles fair substantially worse than do marrieddependent partners with deceased breadwinning

partners.


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The Importance of Social Security

Income to the Elderly 2/3 get more than half of their income from

Social Security.

Private pensions only account for 20% ofelderly income.

For low-income persons, Social Security is 80%

of their monthly income. More than 50% of the elderly would be below

the poverty line without Social Security.


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Cost-of-Living Adjustments Benefits are adjusted for inflation using

the CPI.

Because the CPI overstates inflation(by estimates in the neighborhood of

1.1 percentage points), Social Securitybenefits increase in real terms eachyear.


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How do Rates of Return Compare to

Private Pensions

Between 1950 and 1975, the rate of return for

Social Security was around 10%.

The predicted real rate of return will be around2% in the future.

Private pensions have historically yielded from 5to 10% over a similar period of time.


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Intergenerational Transfers Not only does Social Security transfer

income from those who are young to those

who are old, it transfers income from thegeneration born after 1945 to the generationborn before 1925. On average, those bornbetween 1925 and 1945 will see

approximately the same return they wouldhave received in a similarly safe asset.


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Demographic Changes

Birthrates have fallen such that the number

of workers supporting each retiree has fallenfrom more than 30 in the 1950s to below 5beginning in 1990. Projections show thatfewer than 3 workers will support eachretiree by 2030; shortly thereafter, fewer than2 workers will support each retiree.


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Algebraic Look at the Result of Demographic

Changes Under a Pay-as-You-Go system

t= (B R)/(W L)

Where:

t is total benefits paid

B is the average benefit

Ris the number of recipients

Wis taxable wages

L is the number of workers


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Algebraic rearranging

t = B/WR/L= the average replacementrate the dependency ratio

The dependency ratio was below .1; it is

currently above .3 and is steadily increasing,and will be at .5 in 2030.


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Year BasicOASDHI

TaxRate

Combined

Employer-

Employee Tax

Rate

Maximum

Taxable

Wages per

Worker

Maximum Tax

Based on

Combined

Rate

1937 1.00 2.00 $3,000 $60.00

1957 2.25 4.50 $4,200 $189.00

1967 4.40 8.80 $6,600 $528.00

1977 5.85 12.10 $16,500 $1,930.50

1987 7.15 14.30 $43,800 $6,263.40

1997 7.65 15.30 $65,000 $10,006.20

2003 7.65 15.30 $87,000 $13,615.50


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Proposals to Reform Social Security Maintain benefits

Increase taxability of benefits Invest Trust Fund in Corporate Securities Eventually increase payroll tax rate by 1.6 percentage

points Individual Accounts

Raise retirement age Reduce replacement rates for upper income people Allow 1.6 percent of payroll to be placed in special

retirement accounts Personal Security Accounts

Allow half of payroll taxes to be placed in individuallymanaged accounts

Reduce guaranteed benefit


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Impact of Social Security on Savings and

Work IncentivesIncome and Substitution Effects

The Substitution Effect leads to decreasedsaving and work.

The Income Effect may lead to an increase or

decrease in savings and work. Mosteconomists believe the income effect willdecrease savings and work.

Figure 8 2 Social Security Pensions and the


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Figure 8.2 Social Security Pensions and the

Work-Leisure Choice

A

B

G

A

B

0

B

24

Inc

omepe

rD

ay

Leisure Hours per Day

24

A

0 4 9 1914

U2

H

L2

E'

U2

L1

E

U1

$30

F

C

G

$30


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Working While Eligible for Social

Security Benefits

People may work and receive Social Security benefits.

If they receive benefits with the reduced benefits option at

age 62, they lose $1 in benefits for every $2 they earn overapproximately $10,000.

Those older than 65 may earn any amount and keep theirbenefits.

If they choose not to receive benefits, they receive agreater Social Security benefit when they decide to beginreceiving them.


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Savings Incentives of Social Security

Asset Substitution Effect: People save less than they would if

Social Security did not exist, because they are substitutinggovernment promises of a benefit for private savings. Statedsimply, people save less because government is saving forthem.

Induced Retirement Effect: People save more than theywould if Social Security did not exist because they would nothave retired or would not have retired as early had SocialSecurity not been there. Given that it does exist, peoplechoose to ultimately retire or retire earlier and save in order to

do so. Bequest Effect: People save more than they would have if

Social Security did not exist in order to bequeath more totheir children and grandchildren.

Fi 8 3 Th A t S b tit ti Eff t


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Figure 8.3 The Asset Substitution Effect

A

B

Consumptio

nperYe

ara

fterRe

tirement

Consumption per Year Prior to Retirement

0

A B

0

S

A

B

GF

TS'C

Social

Security

Pension

R

D

U1

E

U1

D

G2

T

SocialSecurity

Pension

F

SC

R2

U2

E


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The Net Effect of Social Security

on Savings

Feldstein: Social Security leads to asubstantial reduction in savings

Munnell: The net effect of the ASE, BE,and IRE is nearly zero


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Medicare

The program provides substantially subsidized health

insurance to those 65 and older. It is financed withpremiums, a 2.9% payroll tax (1.45% each foremployers and employees) and general governmentrevenue. Part A:

Mandatory Covers hospitalization Financed with payroll tax and premiums

Part B: Voluntary Covers doctors visits Financed from general federal revenue and premiums


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Unemployment Insurance

Covers nearly all full-time workers

Financed with a payroll tax on

employers up to $7000 of earnings

Gross Replacement Rate: 33%

Documents

CHAPTER 8- SOCIAL SECURITY AND SOCIAL INSURANCE