Lecture Title

1
Future of Social Security
Professor Jane Leuthold Department of
Economics University of Illinois
Economics 214
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Topic for today ...

• Problems facing Social Security
• - Changing family structures
• Threats of insolvency
• Disincentives to work and save
• Possible reforms
• Restore balance between benefits and taxes
• Increase rate of return

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Problems facing Social Security

• Changing nature of American families
• Maintaining solvency
• Maintaining incentives for work and saving

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Changing families

• In 1948, only 33 of women were in the labor
  force. Today, over 60 of women work outside the
  home.
• While only 6 of retirees were divorced in 1990,
  17 will be divorced by 2020.

Married adults
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Unintended consequences

• Increasing inequities for two-earner families,
  particularly for survivor benefits
• Social Securitys 10-year divorce rule results in
  bizarre and unequal treatment
• Increased overall poverty rates among the elderly

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Possible reforms

• Establish a minimum benefit for elderly who work
  the required number of years
• Adopt benefit sharing, which combines a couples
  earnings and divides the credits between them
• If they divorce, each half of the shared earnings
  or benefit is portable.
• Eliminate the arbitrary 10 year divorce rule.
• Couples A and B would receive the same benefits.

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With benefit sharing
Couple A One-earner couple, worker earns twice
average wageCouple B Two-earner couple, both
earn average wage
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Maintaining solvency

• The Social Security system is currently running
  large surpluses
• But changing demographics suggest that those
  surpluses may disappear by around 2040
• Longer life expectancies
• Fewer children

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Projected age shifts
Dependency 41.4 in 1997 44.09 in 2040
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Workers per SS beneficiary
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Funding Private Pensions
Premiums
Reserve Principal Interest
Beneficiary Payments
Fully funded system
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Funding Social Security
Social Security Payroll Tax
Social Security Trust Fund
Beneficiary Payments
PAYG (Pay as you go) System
Social Security is currently a partially funded
system.
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Projected balances
2015 - First year OASDI outgo exceeds tax income
2025 - First year OASDI outgo exceeds tax plus
interest income 2037 - Year OASI trust fund
assets are exhausted
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(No Transcript)
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Possible reforms

• Cut benefits and/or increase taxes
• Invest the social security trust funds in
  equities
• Privatize social security by allowing workers to
  allocate part (or all) of their earnings to a
  retirement saving fund

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Examples of structural changes

• Reduce SS benefits by raising the retirement age
  or by changing the cost-of-living adjustment
  (COLA)
• Increase the income tax on SS benefits
• Adopt benefit sharing
• Increase payroll taxes from 15.3 to over 20
  over the next 50 years and increase the taxable
  maximum

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Payroll tax
Tax
Increased tax
Current tax
11,769
76,200
Earnings
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Invest trust fund in equities (stocks)

• Proponents point out that over the long run,
  stocks have substantially outperformed government
  bonds
• Critics worry about increased risk and undue
  government influence on private business

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Real stock market returns
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Dow over past year
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Plans to privatize Social Security

• Bush favors allowing workers to divert 2 of
  their payroll tax into private accounts
• Gore favors supplemental private retirement
  saving accounts equal to 2 of earnings that are
  on top of Social Security (called Social Security
  Plus).

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What questions should we be asking?

• How much risk do we want?
• Who should bear the risk?
• How much redistribution do we want within the
  Social Security system?
• How do we handle the transition?

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Effect of SS on work

• The earnings tax that was just repealed strongly
  discouraged the elderly from working
• SS may discourage women from working because they
  lose dependents benefits when they work

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Labor force participation of elderly
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Effect of SS on saving

• SS may cause people to save less because they
  perceive less need to save (asset-substitution
  effect)
• SS may cause people to save more to provide for a
  longer retirement (induced-retirement effect)
• Because of SS, the elderly may save more to be
  able to pass it on to their heirs in order to
  offset the intergenerational redistribution
  (bequest effect)

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US savings rate
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Ask your parents or grandparents
Find out how your parents and grandparents feel
about social security reform.
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Soap Box
Both Presidential candidates favor partial
privatization of Social Security, but they differ
in how they would implement it. Learn more about
these two programs by searching the web and
provide one good economic argument either
favoring or opposing the Bush approach, the Gore
approach, or the whole idea of privatization of
Social Security.
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Next time ...
Health care A Government Problem? Text, Ch. 9
(323-348)