Pub Econ Lecture 13 Social Security

8/3/2019 Pub Econ Lecture 13 Social Security

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Public Finance

Dr. Katie Sauer

Social Security


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Over the next 75 years, Social Security has promised

$5.6 trillion more in benefits than it plans to collect from

worker taxes.

Reforming Social Security is difficultbecause it is the

largest source of income for the elderly.

60% of beneficiaries derive more than half their

income from it

30% of beneficiaries derive 90% of their income

from it


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Financing:

6.2% from employee6.2% from employer

only on first $106,800 of income

Benefits:

age 62, age 65

worked and paid in during 40 quartersannuity


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Full retirement age benefit = primary insurance amount(PIA).

formula based on your earnings history:

- adjust for inflation- 35 top years

- average monthly earnings


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Step 1: Calculate Taxed Social Security Earnings

Find your taxed SS earnings for every year in your work

history.

- earnings up to the SS threshold ($106,800)

- start the year after you turn 21- statements come to you starting at 25

Earnings are wages from employment and net earnings

from self-employment.

- not investment income


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Step 2: Adjust for Inflation

Adjust the earnings for earlier years to reflect inflation.

- table

- changes every year


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The indexing year is normally the year you turn 60.

If you die or become disabled before age 62, theindexing year will be two years before the year of your

death or disability.


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Step 3: Select the 35 Highest Years

Select the 35 highest years based on the inflation-

adjusted amounts.

If you don't have 35 years with earnings, the calculation

will include some years with zero earnings.


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Step 4: Find the Monthly Average

Add up all the inflation-adjusted amounts for the 35 years

that were selected and divide by 420.

This is known as youraverage indexed monthly earnings

(AIME).

The calculation uses a smaller number of years for someonewho dies or becomes disabled before age 62.


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Step 5: The Benefits Formula

3-tier formula: An AIME of

less than $749 means $0.90 in benefits for each $1 of AIME

$749 to $4,517 means $0.32 in benefits for each $1 of AIME

over $4,517 means $0.15 in benefits for each $1 of AIME


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http://www.socialsecurity.gov/OACT/COL

A/piaformula.html


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$749 x 0.90 = $674.10

$4,517 x 0.32 = $1,445.44

$749 $4,517

$674

$1,445


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How SS works: simple model

People live for two periods

- young work

- old retired

Population growth is 5% per year.

Productivity growth is 5% per year.

Consider 5 total periods.


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Period 1:

- 100 young people work, earn $20,000 in period- no social security (no retirees)


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Period 2:

- 100 retirees- social security program implemented

- 10% tax on workers

- paid immediately to retirees

- 105 workers, earn $20,000 x 0.05 = $21,000

taxed $21,000 x 0.10 = $2100

- total tax collected $2100 x 105 = $220,500- total payments per retiree $220,500 / 100 = $2205


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Return on investment:

2205 - 0 / 0 x 100

= infinite

Period # WorkersEarnings per

worker

Taxes per

workerTotal Taxes # Retirees

Benefits per

retiree

Taxes

Previously

paid by

retiree

Rate of

Return

1 100 $20,000 $0 0 0 0 - -2 105 $21,000 $2,100 $220,500 100 $2,205 0 infinite

3

4

5


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Period 3:

- 105 retirees

- 105 x 1.05 = 110.25 = 110 workers

- workers earn

$21,000 x 1.05 = $22,050

- workers pay

$22,050 x 0.10 = $2,205 taxes

- total taxes

$2,205 x 110 = $242,550

- benefit per retiree

$242,550 / 105 = $2,310


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Return on investment:

2310 -2100 / 2100 x 100

= 10%


worker

Taxes per

workerTotal Taxes # Retirees

Benefits per

retiree

Taxes

Previously

paid by

retiree

Rate of

Return

1 100 $20,000 $0 0 0 0 - -

2 105 $21,000 $2,100 $220,500 100 $2,205 0 infinite

3 110 $22,050 $2,050 $242,550 105 $2,310 $2,100 10%

4

5


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worker

Taxes per

worker

Total Taxes # RetireesBenefits per

retiree

Taxes

Previously

paid byretiree

Rate of

Return

1 100 $20,000 $0 0 0 0 - -

2 105 $21,000 $2,100 $220,500 100 $2,205 0 infinite

3 110 $22,050 $2,050 $242,550 105 $2,310 $2,100 10%

4 115 $23,153 $2,315 $266,225 110 $2,420 $2,205 10%

5 121 $24,310 0 0 115 0 $2,315 -100%

Repeat for Period 4

In Period 5, workers do not pay in (there will be noperiod 6 where they will get benefits).

The generation working in period 4 does not receive

benefits.


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For unfunded social security programs,

- initial generation benefits hugely

- middle generations benefits depend on thegrowth of population and productivity

- final generation is harmed


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Redistribution in Practice

Redistribution is measured by comparing the Social

Security Wealth (SSW) accruing to different generations.

SSW = expected PDV of future lifetime SS benefits

- expected PDV of lifetime payroll taxes

Use expected value because death date is uncertain.


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SSW for unmarried males turning 65 in various years


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Females have larger SSW than males.

- pay same taxes

- live longer so receive more benefits

Married couples have larger SSW than single people.

- spouses of workers are entitled to 50% of

workers benefits

- surviving spouses receive 100% of workers

benefits


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Single-earner couples have larger SSW than dual-income

couples.

- full benefits for worker, paid in- half benefits for non-worker, not paid in


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Figure 13-2: Elderly Poverty and Social Security


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Social Security and Retirement

Two Theoretical Effects of SS on Retirement Decisions:

1. redistribution

- some groups become richer, some poorer

- groups that become richer will buy more

retirement


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2. implicit taxation

- reduce the value of SS benefits if retirement

is delayed

ex: work until 63 instead of 62

- pay an extra year of payroll taxes

- receive one year less of SS benefits

- get higher SS benefit level due to actuarial

adjustment

- get to replace a lower earnings year

Ultimate effect depends on if the first two factors

dominate the second two.


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Evidence:

1. time series Labor Force Participation

Figure 13-3: LFP and Social Security


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2. age pattern of retirement

The retirement hazard rate is the % of workers retiringat a certain age.

Figure 13-4: Retirement Hazard


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Maybe there are other reasons people choose to retire

at 62 and 65?

Check the retirement

hazard rate before the

Early Entitlement Age

of 62 was implemented

Figure 13-5: Hazard Rate,

Various years


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3. international comparisons

Figure 13-6: Hazard Rate in France


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Figure 13-7: Mean Retirement Age, Germany

- 1973 lowered age from 65 to 60


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Social Securitys Fiscal Imbalance

Figure 13-9: Ratio of Elderly to Working Age


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3 Factors:

1. increase in life-expectancy

2. reduction in birth rates

3. legacy debt (unfunded payments to first

generations)


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The deficit figure that gets reported in the news is$-1,294.1 billion.

Revenues Outlays = deficit

2,167.7 3,455.8 = - 1,294.1

misleading!


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Since Social Security runs a surplus, the government

borrows money from it.(the Postal Service runs deficits)

Revenues are really less:

81.7 4.7 = 77

The deficit is really more:

-1,294.1 77 = -1,371.1


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Weve borrowed a lot of money from Social Security!


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Reform

Incremental Reforms- raise payroll taxes

- 1.7 percentage points would get us 75 years

- 3.2 percentage points would get us forever

- extend the base of taxable wages

- raise retirement age

- lower benefits

- reduce benefits for high income

Documents

Pub Econ Lecture 13 Social Security