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SOCIAL SECURITY
Chapter 11
Social Security Expenditures
(1939-2011)
Source: Social Security Trustees [2012].
11-*
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-*
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-*
Fully Funded Plan
Period 1 Period 2 Period 3 Period 4
contribute
benefits
contribute
benefits
contribute
benefits
The Greatest
Generation
The Baby Boom
Generation
Generation X
Work
Retire
Dead
Unborn
Work
Work
Retire
Still Dead
Dead
Childhood
Childhood
Retire
11-*
Each generation’s benefits based on deposits it made during working life plus accumulated interest
Period 1 Period 2 Period 3 Period 4
The Greatest
Generation
The Baby Boom
Generation
Generation X
Work
Retire
Dead
Unborn
Work
Work
Retire
Still Dead
Dead
Childhood
Childhood
Retire
contribute
benefits
contribute
benefits
contribute
benefits
benefits
Pay As You Go (or Unfunded) System
0
11-*
Each generation’s benefits come from tax payments made by current workers
Period 1 Period 2 Period 3 Period 4
The Greatest
Generation
The Baby Boom
Generation
Generation X
Work
Retire
Dead
Unborn
Work
Work
Retire
Still Dead
Dead
Childhood
Childhood
Retire
contribute
benefits
contribute
benefits
contribute
benefits
benefits
Today’s Partially Funded System
0
Baby Boomers and Gen X are also contributing to their own retirement
11-*
Explicit Transfers
Benefits for dependents and survivors (1939)
Supplemental Security Income
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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
0
11-*
Benefit Structure
If AIME < $711 PIA = .90*AIME
If $711< AIME <$4288 PIA = .90*$711 + .32*(AIME - $711)
If AIME > $4288 PIA = .90*$711 + .32*($4288-$711) + .15*(AIME - $4288)
11-*
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-*
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
0
11-*
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 or B = t * (Nw/Nb) * w
Ida Mae Fuller
11-*
0
Ida Mae Fuller
11-*
Social Security Wealth: Representative
Individuals
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-*
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-*
The Social Security Trust Fund
Social Security and National Saving
Budget Treatment of Social Security
Off budget
Unified budget
0
11-*
Social Security and Savings Behavior
Life-cycle theory of savings
Wealth Substitution Effect
Retirement Effect
Bequest Effect
11-*
Budget Constraint for Present and Future Consumption
Present consumption (c0)
Future consumption (c1)
N
M
I0
I1
D
I0 - S
I1 + (1+r) S
S
(1+r)S
I1 - (1+r) B
F
B
(1+r)B
At endowment point (A) consumer neither saves nor borrows
11-*
A
Utility-maximizing Choice of Present and Future Consumption
Present consumption (c0)
Future consumption (c1)
N
M
I0
I1
E1
c1*
A
c0*
Saving
11-*
Crowding out of private saving due to Social Security
Present consumption (c0)
Future consumption (c1)
N
M
I0
I1
E1
c1*
A
c0*
R
T
I0T
(1+r)T
Saving before Social Security
Saving after Social Security
11-*
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-*
Other ways Social Security Affects Saving
Retirement effect
Bequest effect
Empirical evidence
11-*
Distribution of Wealth
Bequeathable vs. Annuitized Wealth
Effect of Social Security on Bequeathable Wealth
Effect on Wealth Mobility
11-*
Retirement Decisions
Social Security wealth and the retirement decision
Empirical evidence
Diamond and Gruber [1999]
Gruber and Wise [2004]
11-*
Long-Term Stresses on Social Security
Source: Social Security Trustees [2012]
Projected revenues and projected costs of Social Security as share of Gross Domestic Product
11-*
Long-Term Stresses on Social Security
Since: B = t * (Nw/Nb) * w
Rearrange: t = (Nw/Nb) * (B/w)
Dependency Ratio
Replacement Ratio
11-*
Social Security Reform
Time horizon for solvency
Sustainable solvency
11-*
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-*
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
11-*

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