Social Security

1
Social Security

• Contemporary Problems in Economics
• S. Cunningham

2
Origins

• 1935 Great Depression, FDR
• Social Security Act
• Created a system of federal old-age benefits
  (defined benefits program)
• 1956, added disability benefits
• Two parts
• Old age and survivors program
• Disability program
• Supplemental security income program for the
  aged, blind, and disabled (without regard to
  prior workforce participation, or
  pay-in)Administered by SSA, but not funded by
  SS taxes.

3
FICA and Medicare

• FICA Federal Insurance Contributions Act
• Medicare Medical Benefits for the Elderly

SS Medicare FICA (Total)
Employee Tax 6.2 1.45 7.65
Employer Tax 6.2 1.45 7.65
Total 12.4 2.9 15.3
4
FICA and Medicare (2)

• Threshold Any income earned above the threshold
  is not taxed
• 2005 -- 90,000
• 2000 -- 75,200
• 1935 -- 3,000
• SS Act of 1935, the tax rate was 2
• 1950 3
• 1960 6
• 1970 8.4
• 1980 10.2
• 1990 12.4
• 2000 12.4
• SS Taxes have been raised 20 times since 1937.

5
Entitlement?

• Daniel Shapiro, Making Sense of Social Security
  Reform.
• Perceived intergenerational character of SS.
• Each generation supports the generation before
• Feel entitled
• Operates like a large family
• But FICA collects a surplus now, and later will
  run a deficit.
• Is this a simple intergenerational transfer?
• This is not really pay-as-you-go

6
Redistribution

• If some receive more than they pay, then there is
  a distributional effectyou may gain or lose.
• Incentives change
• Is this forced saving?
• Can the government save?
• Saving is forgoing current consumption in order
  to finance future consumption.
• Is there actually saving in this system, a
  deferral of consumption?
• There may be individual saving, but is there net
  saving?

7
Incentive effects

• SS transfers wealth from some workers to
  othersit is redistributional
• It is a net wage tax to those who lose from it.
• It is a net wage subsidy to those who gain from
  it.
• It affects work decisions
• The SS tax reduces the immediate return to work
• Affects spouses decision
• Depends mostly on perceptionshas saving fallen
  because of SS?

8
Social Insurance?

• Insurance depends on statistical analysis of risk
• Individual outcomes are unpredictable, but large
  numbers of people will have outcomes that are
  statistically predictable.
• Pooling to protect against nonsystematic risk

9
Private Insurance

• Problems to privately provided insurance
• Insured losses must be measurable and verifiable.
• People must enter into the insurance contract
  before the insured event occurs.
• Must mitigate against adverse selection.
• Must mitigate against moral hazard.
• The cost of insurance must not be higher than
  people are willing to pay.

10
Public Insurance

• The rationale for govt provision of insurance
  must be that it can resolve some of these
  problems that private firms cannot.
• More complete pools. (Avoids adverse selection)
• Better information.
• Govt can force people to prepare for their
  retirement when they wont do it for themselves.
  (Issue of price.)
• Govt can prevent risk
• Auto safety
• Drinking and driving
• Outlaw smoking
• Laws against fatty foods? (Food and drug policy)
• Govt can force risk-reducing behavior.
• Each participant pays a premium that need not be
  equal to the expected value of the benefits.

11
Risk?

• Perhaps SS is not insurance because there is no
  risk to insure against.
• Is it simple redistribution?
• Is it insurance against income loss?
• Age is important factor
• Old are more risk-averse
• Less able to make up for losses
• Use age instead of health because it is more
  objective and less open to question

12
Plan Types

• Defined Contribution Plans
• Specifies what the payer must contribute
• Defined Benefit Plans
• Workers ultimate retirement benefit is specified
  in advance.
• SS tries to be both, but is clearly the
  secondbenefits are considered guaranteed.

13
Guarantees?

• According to a 1960 Supreme Court ruling,
  Americans have no ownership rights to the money
  they pay into Social Security.
• The federal government has no contractual
  obligation of any kind.
• The benefits you receive may be changed at any
  time by Congress.

14
Guarantees?

• According to the Social Security Administrations
  website,
• There has been a temptation throughout the
  programs history for some people to suppose that
  their FICA payroll taxes entitle them to a
  benefit in a legal, contractual sense Congress
  clearly had no such limitation in mind when
  crafting the law.
• Benefits which are granted at one time can be
  withdrawn
• Money that people pay in Social Security taxes is
  not saved for them and is not their property.

15
Pay As You Go?

• Workers currently pay more in SS taxes than is
  being paid out.
• The surplus is used to finance the federal debt.
• By 2017, by some estimates, the system will run a
  deficit.
• Problem
• in 1950, there were 16 workers/payers for every
  retiree on SS.
• Today there are 3.4 for each retiree.
• In 2030, there will be 2.1 for each retiree.
  (This will require a tax rate of 18.

16
Is the Trust Fund a Fraud?

• What happens when the SS draws on its Trust Fund?
  
• Surpluses have been held in treasury debt. How
  will the funds be retrieved when needed?
• Pay back SS from taxes? (raise taxes?)
• Sell more debt to pay off earlier debt?
  (roll-over, possibly raising interest rates)
• Is this just a hoax perpetrated on the U.S.
  public?

17
Nature of the Trust Fund

• According to the FY2000 Budget prepared by the
  Clinton Administration
• These Trust Fund balances do not consist of
  real economic assets than can be drawn down in
  the future to fund benefits. Instead, they are
  claims on the Treasury that, when redeemed, will
  have to be financed by raising taxes, borrowing
  from the public, or reducing benefits or other
  expenditures. The existence of Trust Fund
  balances, therefore, does not by itself have any
  impact on the governments ability to pay
  benefits.

18
Social Security as a Tax

• In 1936 beginning in 1949 you and your
  employer will each pay 3 cents on each dollar you
  earn, up to 3000 a year. That is the most you
  will ever pay.
• After adjusting for inflation, this would be
  1620 today. The actual maximum collected is more
  than 5 times this amount!
• In 2000, SS taxes accounted for 25 of all
  federal tax collections.
• The average worker pays an amount equal to 6
  weeks worth of their salary in SS taxes each year.

19
Benefits

• To qualify for old age benefits, a person must
  work 40 quarters (10 years), earning at least
  3,120 a year.
• The actual benefits are based upon a formula that
  takes into account the taxes paid by the worker.
• The formula penalizes workers for making more
  money or worker more years.

20
Benefits (2)
Average Annual Income Avg Annual Taxes Old Age Benefit
20,440 2,535 9,200
40,880 5,069 14,800
74,197 9,200 17,424

• Benefits are increased once a year based on cost
  of living.
• Receive full benefits at full retirement age,
  which is 65-67 depending on your year of birth.
• Can opt to retire with less at 62, or more later.

21
Benefits (3)

• If a married worker dies, their spouse receives
  50-67 of the couples combined benefits.
  Additional benefits to families with minor or
  disabled.
• Note that about 1/3 of Americans have no savings,
  and about 1/3 have less than 2,500 in savings.
• To qualify for disability benefits, a person must
  work for 5 years, and have been disabled for 5
  months.
• Disability benefits are higher than retirement
  benefits.

22
Distribution of Benefits
Retired Workers Their Families 67.4
Survivors of Deceased Workers 19.8
Disabled Workers Their Families 12.8
Data is from 1999.
As of June 2000, 45.2 million people were
receiving Social Security benefits.
23
Causes of the problem

• Increase in life expectancy without comparable
  increase in retirement age.
• Higher birth rate of baby boom generation
  compared with later generations.
• Increasing number of people receiving disability
  benefits.

24
Life Expectancy

• When SS started paying benefits in 1940, the
  average 65 year old male had a life expectancy of
  11.9 years.
• As of 2000, the average 65 year old male has a
  life expectancy of 15.9--an increase of 34.
• Women at 65 lived 13,4 more years, now 19.2 more
  yearsan increase of 43.

25
Birth Rates

• In the late 1940s until the early 1960s, the
  average birth rate per woman was 3.7.
• By 1976, the average birth rate had fallen to
  1.7.
• In 2000, it was 2.1.
• Around 2010, the baby boom generation will begin
  to retire.
• Between 2010-2030, the number of people eligible
  for old age benefits will increase by about 80.
• The number paying SS taxes will increase by 2.
• 1960-2000, U.S. population grew by 56.
• Number receiving disability benefits grew by 876.

26
Disability Benefits
Year Population Number on Disability Benefits
1960 180,000,000 687,000
2000 281,000,000 6,709,000

• Between 1960 and 2000, the population grew by
  56. The number of people receiving disability
  benefits grew by 876.

27
Trust Fund

• By law, SS surpluses must be invested in federal
  securities. That is, the only thing the SS
  program can do with its surplus money is to loan
  it to the federal government to be spent
  elsewhere.
• The federal govt is required to pay this money
  back to SS as necessary, with interest.
• Between 2015 and 2017, the annual shortfalls of
  SS will require the federal government to begin
  paying back the money.
• By 2037 (some estimates), the money and interest
  the federal govt owes to SS will be paid in
  full.
• Between 2037 and 2075, SS will run annual
  deficits totaling 30 trillion.

28
SS and Federal Debt

• Two kinds of debt
• Intragovernmental holdings or nonmarketable
  debtowed to federal entities.
• Debt held by the Public or Marketable Debtowed
  to non-federal entities. This is net debt.

Owed to Federal Entities 2.7 trillion
Owed to Non-Federal Entities 3.0 trillion
Total Debt 5.7 trillion
December 31, 2000
29
SS Debt (2)

• If Congress uses SS surpluses to pay off debt it
  owes to non-federal entities, this is called
  Putting Social Security into a lockbox.
• If Congress uses money from SS surplus to fund
  government programs, this is called Raiding the
  Social Security Trust Fund.
• When the govt does either, the finances of the
  Social Security program are not affected.
• There have been bills proposed to outlaw raiding
  the fund. None have passed.
• During the Clinton Administration, when many
  reported that the budget was balanced, it did
  not account for the interest owed on the debt to
  federal entities. The national debt has risen
  every year since 1960.

30
Privatization

• George W. Bush has proposed to give individuals
  the option to place 16 of their Social Security
  taxes into a private account, turning it into a
  forced saving program.
• People who do this could put their money into
  bank accounts or lower-risk investments.
• This proposal would have a negative effect on the
  short-term finances of the SS system because its
  receipts would fall.
• Longer term, it would have a positive effect on
  the system because the SS would pay less in
  benefits.
• People could pass on their SS savings to their
  heirs.

31
SS Trustees Report

• To cover Social Securitys total cash shortfalls
  in perpetuity would demand a lump-sum payment
  today of 11.9 trillion.
• To achieve permanent solvency under traditional
  SS financing would demand an immediate tax
  increase equal to 4.47 of payroll. This amounts
  to raising the SS part of FICA from 12.4 to
  16.87. Including revenue derived from income
  taxes on benefits, this becomes 18.93. (Add
  Medicare tax to this 18.93 2.9 21.83)
• By contrast, a number of personal account plans
  certified by SS actuaries achieve sustained
  solvency without large tax increases.
• The 2003 report includes a stochastic analysis
  that accounts for the infinite variability of the
  economic and demographic factors affecting SS
  finances.