Social Security and Social Insurance

1
Chapter 8

• Social Security and Social Insurance

2
Social Security Act of 1935

• Requirements at that time
• Retirement Age 65
• Payroll Tax
• 1 for employer and employee
• Tax applied to the first 3000 of earned income

3
Social Security in the United States

• OASDI
• Old Age
• Survivors
• Disability Insurance 
• HI Health Insurance (Medicare) 
• UI Unemployment Insurance

4
FICA

• Federal Insurance Contribution Act
• Employers and employees each currently contribute
  7.65 of wages in FICA tax.
• 15.3 for the self-employed
• Taxes applied on earned income up to 87,000 in
  2003 (indexed).
•  

5
Fully Funded vs Pay-As-You-Go

• A Fully Funded system current fund has balances
  sufficient to pay the present value of all future
  obligations.
•  

• A Pay-As-You-Go system current taxes pay for
  current benefits.

The current U.S.system is a modified
pay-as-you-go system with a trust fund as backup.
6
Social Security Trust Fund

• Since 1982, Social Security taxes collected have
  greatly exceeded benefits paid out.
• The trust fund is an accounting mechanism by
  which U.S. government debt is issued to the
  Social Security Administration in exchange for SS
  fund surpluses.
• This debt will be sold to the public when taxes
  paid fall below what is needed to pay benefits.

7
Retirement Age

• People born prior to 1935 can retire with full
  benefits at 65. 
• People born between 1936 and 1942 can retire with
  full benefits at age 65 2 months for every year
  after 1936 they were born. 
• People born between 1943 and 1954 can retire with
  full benefits at age 66.
• People born between 1955 and 1960 can retire with
  full benefits at age 66 2 months for every year
  after 1955 they were born. 
• People born after 1960 can retire at full
  benefits at age 67.

8
How Retirement Benefits are Computed

• The AIME (Average Index of Monthly Earnings)
  calculates the highest 35 years of
  inflation-adjusted earnings, expressed in monthly
  terms.
• The PIA (Primary Insurance Amount) is the amount
  to which a individual is entitled given their
  AIME. 

9
Replacement Rates

• The Gross Replacement Rate is the monthly
  retirement benefit divided by the monthly labor
  earnings in the year prior to retirement.
• The Net Replacement Rate is the monthly after-tax
  benefit divided by the monthly after-tax labor
  earnings in the year prior to retirement .

10
Gross Replacement Rates by Income2002
11
Figure 8.1 How Gross Replacement Rates for Social
Security Pension Recipients Vary with
Pre-retirement Earnings
110
100
90
80
70
Gross Replacement Rate (Percent)
60
50
40
30
20
10
0
1,000
2,000
3,000
4,000
Gross Monthly Earning in the Year Prior to
Retirement (Dollars)
12
Spousal and Dependent Benefits

• .5 of PIA is added for a spouse over age 65 and
  for each dependent child

13
Divorce and the Two-Income Family

• A woman who worked while married to a high
  income-earning husband will get nothing or
  virtually nothing for the taxes she paid. She and
  her husband would get 1.5 times his PIA if she
  earned nothing and 1.5 time his PIA if she earned
  a modest income.
• Divorced people are entitled to either their own
  PIA or a spouse/widow benefit (whichever is
  larger). This applies to multiple spouses as
  well. Thus, breadwinners can have multiple people
  receiving half or full pensions based on a single
  taxpayers earnings.

14
Other Anomalies

• When one party in a marriage dies, the benefit to
  the survivor depends on who made the money.
• If both earned equal amounts, then when one dies
  the other receives their own amount.
• If one earned all the money and the breadwinner
  dies, the survivor keeps the spouses pension
  (which is often quite a bit more).
• Singles fair substantially worse than do married
  dependent partners with deceased breadwinning
  partners.

15
The Importance of Social Security Income to the
Elderly

• 2/3 get more than half of their income from
  Social Security. 
• Private pensions only account for 20 of elderly
  income. 
• For low-income persons, Social Security is 80 of
  their monthly income.
• More than 50 of the elderly would be below the
  poverty line without Social Security.

16
Cost-of-Living Adjustments

• Benefits are adjusted for inflation using the
  CPI. 
• Because the CPI overstates inflation (by
  estimates in the neighborhood of 1.1 percentage
  points), Social Security benefits increase in
  real terms each year.

17
Demographic Changes

• Birthrates have fallen such that the number of
  workers supporting each retiree has fallen from
  more than 30 in the 1950s to below 5 beginning in
  1990. Projections show that fewer than 3 workers
  will support each retiree by 2030 shortly
  thereafter, fewer than 2 workers will support
  each retiree.

18
Algebraic Look at the Result of Demographic
Changes Under a Pay-as-You-Go system

• t (B R)/(W L)
• Where
• t is total benefits paid
• B is the average benefit
• R is the number of recipients
• W is taxable wages
• L is the number of workers

19
Algebraic rearranging

• t B/W R/L the average replacement rate
  the dependency ratio 
• The dependency ratio was below .1 it is
  currently above .3 and is steadily increasing,
  and will be at .5 in 2030.

20
(No Transcript)
21
Proposals to Reform Social Security

• Maintain benefits
• Increase taxability of benefits
• Invest Trust Fund in Corporate Securities
• Eventually increase payroll tax rate by 1.6
  percentage points
• Individual Accounts
• Raise retirement age
• Reduce replacement rates for upper income people
• Allow 1.6 percent of payroll to be placed in
  special retirement accounts
• Personal Security Accounts
• Allow half of payroll taxes to be placed in
  individually managed accounts
• Reduce guaranteed benefit

22
Figure 8.2 Social Security Pensions and the
Work-Leisure Choice
23
Working While Eligible for Social Security
Benefits

• People may work and receive Social Security
  benefits.
• If they receive benefits with the reduced
  benefits option at age 62, they lose 1 in
  benefits for every 2 they earn over
  approximately 10,000.
• Those older than 65 may earn any amount and keep
  their benefits.
• If they choose not to receive benefits, they
  receive a greater Social Security benefit when
  they decide to begin receiving them.

24
Savings Incentives of Social Security

• Asset Substitution Effect People save less than
  they would if Social Security did not exist,
  because they are substituting government promises
  of a benefit for private savings. Stated simply,
  people save less because government is saving
  for them. 
• Induced Retirement Effect People save more than
  they would if Social Security did not exist
  because they would not have retired or would not
  have retired as early had Social Security not
  been there. Given that it does exist, people
  choose to ultimately retire or retire earlier and
  save in order to do so. 
• Bequest Effect People save more than they would
  have if Social Security did not exist in order to
  bequeath more to their children and
  grandchildren.

25
Figure 8.3 The Asset Substitution Effect
26
The Net Effect of Social Security on Savings

• Feldstein Social Security leads to a substantial
  reduction in savings
• Munnell The net effect of the ASE, BE, and IRE
  is nearly zero 

27
Medicare

• The program provides substantially subsidized
  health insurance to those 65 and older. It is
  financed with premiums, a 2.9 payroll tax (1.45
  each for employers and employees) and general
  government revenue.
• Part A
• Mandatory
• Covers hospitalization
• Financed with payroll tax and premiums
• Part B
• Voluntary
• Covers doctors visits
• Financed from general federal revenue and
  premiums

28
Unemployment Insurance

• Covers nearly all full-time workers
• Financed with a payroll tax on employers up to
  7000 of earnings
• Gross Replacement Rate 33