the American Economy homework
Mary1997
ch_09_social_security.pptxSocial Security
1
Chapter 9
Why Social Security is Needed?
Externalities
market, left unregulated, will create impacts on people other than the buyer or seller
Workers may make a decision to rely on welfare and not save. That decision affects taxpayers.
People cannot overcome a poor decision not to save
Most decisions that adversely affect people can be changed.
The decision not to save cannot be reversed (because you cannot go back and live your life over again.)
Social Security’s History
The 1935 Social Security Act
Part of the FDR “New Deal”
Intended to be a “third leg” of retirement tripod
Social Security
Individual Savings
Company Pensions
An entitlement
Social Security Act of 1983
Created trust fund to fund baby boomer retirements
Raised retirement age
Taxing social security benefits
Changes to Social Security
Tax Rate
1935 1%; 2007 7.65% (6.2% plus 1.45% for Medicare)
Maximum Taxable Earnings
1935 $1000; 2015 $118,500 (at the 6.2% rate and unlimited at the 1.45% rate).
Retirement Age
Born 1935 or earlier: 65 years of age
Born 1936 to 1959: Gradual increase in full retirement age
Born 1960 or later: 67 years of age
Coverage
1935 Old age; 2007 Old age + Medicare + Disability + Survivor
How to Fund a Retirement System
Every retirement system must be funded by using currently generated money to pay current retirees OR use the balances of previously saved money to pay current retirees.
Pay-as-you-go : a system where current workers’ taxes are used to pay pensions to current retirees
Fully-Funded: system where for every benefit dollar it is required to pay in the future there is an off-setting amount currently invested that is sufficient to pay off that dollar
Social Security
Privatization
The transfer of government enterprises or responsibilities to the private sector
Entitlement
A payment that eligible citizens have a right to receive by law
Table 9-1: Characteristics of Social Insurance and Private Insurance
Social Security: A Social Insurance Program
Individual equity
The principle that benefits received are proportional to amounts paid in
Social adequacy
The principle that benefits are sufficient to provide a minimum level of economic security to the population as a whole
Table 9-2: Characteristics of Social Insurance and Public Assistance
Social Security Taxes and Benefits
Social Security and Medicare taxes
Account for about 1/3 of federal taxes collected
Tax rate
The % of tax base that must be paid to the gov’t
Tax base
The value of income, earnings, sales, property, or other valued items to which a tax rate applied
Social security: earnings through working
Social Security Taxes and Benefits
2015 tax rate
Total payroll tax rate = 7.65%
6.2% for Social Security
1.45% for Medicare
Both workers and employers = 15.3%
Self employed pay 15.3%
Social security tax rate is regressive
Social Security Taxes and Benefits
2015, tax base
Social Security tax base
The first $118,500 of each worker’s annual earnings
Medicare tax base
All of the worker’s earnings
Social Security Taxes and Benefits
Regressive taxes
Taxes that take a larger percentage of income from low-income people than high-income
Progressive taxes
Taxes that take a larger percentage of income from high-income people than low-income
Proportional taxes
Taxes that take the same percentage of income from people at all income levels
Social Security Taxes and Benefits
Social Security tax is regressive
Only the tax base is taxed in any given year
In 2015, only the first $118,500 earned by each worker was taxable
Lower wages—taxed entirely
Higher wages—taxed only to $118,500
Only earnings from working are taxable
Not other forms of income (rents, interest, capital gains, and stock dividends)
Effects of the social security tax on two hypothetical high- and low-income people in one year
Social Security Taxes and Benefits
Social Security benefits
Checks mailed by U.S. Treasury to beneficiaries
Medicare benefits
Payments to hospitals, doctors, and others for medical care
Replacement rate
The percentage of the worker’s last working year’s earnings that is replaced by Social Security retirement benefits.
Social Security Taxes and Benefits
Social Security retirement benefits
Qualify: fully insured worker / dependent
Benefit amounts
Prior Social Security tax contributions
Progressive
Low-earnings workers: higher replacement rate
Higher-income earners
Higher Social Security benefits
Smaller percentage of prior year’s earnings
The Problem
Long-run problem: an aging population
Average age of population is increasing
Fewer workers paying taxes
More retirees receiving benefits
More workers are retiring at earlier ages
Longer periods of retirement
Do not pay Social Security taxes
Receive benefits
Baby boomers (1946 to 1964)
Reason for creation of trust fund
The Problem
Social Security: pay-as-you-go system
1950, 16.5 workers paid Social Security taxes for every Social Security beneficiary
2014, 2.8 workers paid taxes for each beneficiary
2033, expected 2.1 workers per beneficiary
Implications
Unsustainable
Taxpayers must pay higher taxes, or cut benefits, or find another funding source
The Problem and the Response
Efforts to address the problem (1983)
To increase the normal retirement age
To begin building up trust fund accounts to take care of the increase in benefits expected when the baby boomers retire
To begin to tax a portion of Social Security retirement benefits for income tax purposes
The Problem and the Response
Increase the normal retirement age
Normal retirement age
The minimum age at which workers can retire with full Social Security benefits
Born before 1938: 65 years
Born after 1959: 67 years
Retire earlier = receive smaller benefits
Living longer on average -> working longer on average
The Problem and the Response
Building up trust fund balances for Baby Boomer benefits
Baby Boomers: large cohort born 1945-1965
Began retiring in 2010
Large burden on the Social Security system
Trust fund
Taxes collected and invested specifically to pay future Social Security benefits
2013: $2.76 trillion in the fund
The Problem and the Response
Taxing Social Security retirement benefits
Benefits originally untaxed
A person usually pays a tax on 50% of their benefits if combined income >$25,000
Combined income
Total gross income + ½ Social Security benefits
Low-income individuals
Pay little or no taxes
The Problem and the Response
Long-run financial viability of social security
The 2013 trustees’ report: the trust funds
Will continue to be built up over the next several years, and then begin to be drawn down
Exhausted in 2033 (tax revenues will cover 75% of benefits)
Return to a pay-as-you-go system resulting in
Higher Social Security taxes,
Decreased retirement benefits, and or
Increased government borrowing
Other Issues and Problems
Should Social Security be made voluntary?
Arguments
Greater economic freedom
Limitation of government’s role in our lives
Fairness of the Social Security system to younger workers
Other Issues and Problems
Should Social Security be made voluntary?
A voluntary program would make provision of a minimum level of economic security to the entire population more difficult
The poor could not afford to purchase private insurance or save to provide for their own economic security
A voluntary system would be subject to greater adverse selection
Other Issues and Problems
Adverse selection
A process by which insured people’s choices lead to higher-than-average loss levels for the program’s sponsor
Is Social Security unfair to younger workers?
The value of taxes paid to support current retired persons exceeds the value of benefits that can be expected to be received
Other Issues and Problems
Is Social Security unfair to younger workers?
The employer’s share of the tax provides benefits for social adequacy, not individual equity
Social Security also provides disability insurance and medical insurance through Medicare
Who Benefits from the Program?
Based on a present value approach, people who retired before 1980 received, on average, more than they would have in private alternatives.
People who retired between 1980 and 2000 received ______ than they would have in private alternatives
More (if they were poor)
Less (if they were wealthy)
People who retire today will receive less than they would have in private alternatives.
Using Present Value
To compute the value of Social Security to an individual, a person would
Use a reasonable low-risk real rate of interest (3-5%)
Compute the present value of expected Social Security taxes to be paid.
Compute the present value of expected Social Security benefits to be received.
Subtract the present value of costs from the present value of benefits to get the net present value.
A single worker beginning today can expect a negative net present value.
Other Issues and Problems
Does Social Security decrease savings?
Incentive to work (lower)
People retire earlier than they otherwise would have.
People work less that they otherwise would have.
Incentive to save (net effect is lower)
Asset Substitution Effect: government is saving for you, you will save less for yourself (-)
Induced Retirement Effect: because people need to save more if they are going to retire earlier than they would have without Social Security (+)
Bequest Effect: increases national savings because people save more so as to give larger gifts to their descendants (+)
Other Issues and Problems
Social Security’s treatment of women
Widow’s income gap
Monthly survivorship benefits
Until the youngest child reaches the age of 16
Again at the age of 60
Benefits will be lost if the surviving spouse remarries before reaching the age of 60
Surviving children—entitled to benefits until they reach the age of 18
Other Issues and Problems
Social Security’s treatment of women
Possible unfair treatment of working wives
Receive the highest retirement benefits
Based on own earnings, or
Spousal benefits
Some wives—never worked outside the home
Spousal benefits
Some wives—larger spousal benefits
Than benefits based on own earnings
Other Issues and Problems
Do other countries face similar problems?
World’s 65-and-older population
Will triple by midcentury to 1 in 6 people
Declining births, medical advances
Europe, Japan, China
More serious challenges than U.S.
Personal (privatized) saving accounts
Developing countries
Government or privatized programs
LO1
Source: The World Factbook, http://www.cia.gov. Data are 2009 estimates.
Total Fertility Rates, 2009
| Country | Total Fertility Rate |
| Australia | 1.78 |
| Canada | 1.58 |
| China | 1.79 |
| France | 1.98 |
| Germany | 1.41 |
| Hong Kong | 1.02 |
| Italy | 1.30 |
| Japan | 1.21 |
| Russia | 1.41 |
| South Korea | 1.21 |
| Sweden | 1.67 |
| United States | 2.05 |
15-36
Population expected to peak at about 9 billion around mid-century then start declining
36
This table shows many nations with fertility rates below the replacement rate of 2.1. Can governments raise birthrates? Proposed methods have not increased birthrates like second child bounties and increased child benefits. Possible future results might be too few young workers to support retirees and lack of soldiers.
Options for Fixing Social Security
Raising payroll taxes
Raise the tax rate
Eliminate the maximum taxable earnings
Make it progressive rather than regressive
Tax all income
Similar to Personal Income Tax
Raising the early and normal retirement ages (70?)
Options for Fixing Social Security
Reduce benefits
Across the board
Use a “means test”: Those with high incomes or substantial wealth would get less of their calculated benefits than those with lower incomes
Social Security would no longer be an entitlement
Eliminate benefits to wealthy individuals
Options for Fixing Social Security
Eliminate or reduce the adjustment for inflation (same as gradually reducing benefits)
Investing the trust fund in corporate stocks and bonds rather than government securities
Carving out some of the payroll tax for privatized individual accounts (privatization)
Criticism: How many people know how to manage money?
Redirecting legal immigrants to higher-skilled, higher paying work
Conservative versus Liberal
Liberals
Support social insurance
Worry about the regressivity of the Social Security payroll
Want to make changes to ensure the continued financial viability of the system
Don’t worry about
Size of the system
System represents big government
Conservatives
Social Security = big government
Better off if we did not have to pay Social Security taxes
Tax break, to provide for ourselves in retirement or disability through private investments
Partial or total privatization
Favor making Social Security voluntary
What is the #1 thing that should be done to fix the Social Security problem?
Raise the retirement age
Increase Social Security tax
Reduce benefits
Change to a needs based system
Change how funds are invested
Make it voluntary
