Topic 2: The Role of Social Security

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Topic 2 The Role of Social Security

• 1. Rationale of government provided program
• 2. Role of Social security
• 3. The three-Tier System

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1. Rationale of government provided program

• High transaction costs
• Lack of indexing the inability of private market
  to insure social risks
  
• Adverse selection, differential risks and the
  cost of insurance
  
• Moral hazard and social security

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High transaction costs

• Trade-offs between reducing costs and increasing
  the scope for individual choice
  
• It is administratively less expensive to provide
  a uniform retirement program for all individuals
  than to have a large number of competing programs
  available, among which the individuals can
  choose.

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Lack of indexing

• Lack the inability of private market to insure
  social risks, such as war, inflation
  
• Government can provide insurance for social
  risks.
  
• raising taxes
• Engaging in risk sharing across generations.

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Adverse Selection

• differential risks and the cost of insurance
• information asymmetric
• the worst risks purchase private insurance

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Moral Hazard

• Insurance may reduce the individuals incentive
  to avoid the insured-for event.
  
• Example car insurance
• retirement insurance
• Government provided pension does not get rid of
  the moral hazard problem.
  
• The larger the fraction of working income that
  social security replaces, the weaker the
  incentive to work.
  

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2. Role of Social Security

• Annual income transfer (redistribution program)
• Forced saving plan
• Inflation-indexed annuity plan

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A. Redistribution Program

• Individual Equity
• Each worker should receive at least as much in
  benefits as he has contributed
  

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A. Redistribution Program

• Social Adequacy
• A welfare criterion that measures benefits
  against a standard of living beneath which
  society fells no one should fall

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A. Redistribution Program

• 1939 amendments in favor of social adequacy
• fair rate of return was eliminated
• Benefit based on average earnings during a
  shorter period of coverage
  
• Provision of dependents benefits
• Minimum benefits

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B. Forced saving plan

• Forced saving plan with certain insurance
  attributes
  
• For low-income workers mechanisms outside the
  social security program
  
• Tax side Earned Income Tax Credit (EITC)
• Benefit side Supplemental Security Income

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C.Community-rated inflation-indexed annuity
plan

• All individuals who make the same contributions,
  regardless of their health conditions and life
  expectancy, get the same benefits, with the level
  of those benefits insured against inflation.

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3. The three-Tier System

• Welfare programneeds-related programs
• Compulsory public pension plans
• Private provisions for retirement

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Needs-related programs

• Federal supplemental security Income program
• State public assistance programs

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Needs-related programs public assistance
programs

• For the needy aged, disabled and blind
• Federally supported
• State administered
• State variation

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Needs-related programs supplemental security
Income

• Federal program
• Administered by SSA
• Financed by general revenues
• Benefits levels, eligibility conditions and means
  tests are uniform nationwide.

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Compulsory public pension plans

• Replace wages for the largest segment of the
  retired population.
  
• Federal socials security programs (OASDI)
• Other federal pension plans, such as the civil
  service retirement system, the railroad
  retirement system, and military pensions
  

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Compulsory public pension plans

• Earnings-related
• Free of the means test

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SSI and OASDI

• OASDI, SSI, OR BOTH
• Aged Beneficiaries, December 2002
• Aged or survivors benefits were paid to 34.0
  million people aged 65 or older.
  
• About 1.2 million received both OASI and SSI.
• Beneficiary Number (thousands)
• Aged 65 or older, total (unduplicated)
  34,002
  
• OASI, total
  33,159
  
• Retired workers
  26,605
  
• Spouses
  2,372
  
• Nondisable widow(er)s
  4,113
  
• Disabled adult children aged 65 or older 65
• SSI, total
  1,995
  
• Receiving SSI only
  843
  
• Concurrently receiving both OASI and SSI 1,152

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Private retirement income

• Private pension plans
• Individual tax-free retirement savings plans
• Private savings

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Private pension plans

• Regulated by the government
• Pension Benefit Guaranty Corporation (PBGC)

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Individual tax-free retirement savings plans

• Individual Retirement Accounts (IRAs)
• Traditional IRA accounts up to 2000, neither
  the contribution nor the interest income was
  taxed until it was withdrawn