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Social Security and Social Insurance

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Since 1982, Social Security taxes collected have greatly exceeded benefits paid out. ... of the elderly would be below the poverty line without Social Security. ... – PowerPoint PPT presentation

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Title: 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
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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 
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