Lecture Issues in economics today - Chapter 27

This chapter presents the following content: Marginal Revenue, profit maximization and loss minimization, the short-run supply curve, the long-run supply curve, the shut-down and break-even points, economic efficiency.

Chapter 27

Social Security

Chapter Outline

• THE BASICS

• WHY DO WE NEED SOCIAL

SECURITY

• SOCIAL SECURITY’S EFFECT ON

THE ECONOMY

• WILL THE SYSTEM BE THERE FOR

ME

Social Security’s Origin

• The 1935 Social Security Act

• Part of the FDR “New Deal”

• Intended to be a “third leg” of a

retirement tripod

– Social Security – Individual Savings – Company Pensions

How to Fund Social Security

• 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

The Current Funding System

• Social Security was, until 1982, a

pay-as-you-go system

• The baby-boom (1946-1964) created a

problem for the system starting in 2010

• Recognizing this, Congress created the

Social Security Trust Fund in 1982

– This makes Social Security a hybrid of a pay-as-you-go and fully funded system.

• $430 billion in spending, $530 in taxes

The Basics: Taxes

• Social Security is funded with a payroll tax

(taxes owed on what workers earn from their work)

• Employers and employees both pay an equal amount

• The amount for Social Security is 6.2%* of

payroll up to the Maximum Taxable Earnings

(the maximum of taxable earnings subject to the payroll tax)

• *the tax is 7.65% minus the 1.45% Medicare tax

The Basics: Benefits

• People who have reached the retirement age

(the age at which retirees get full benefits) are eligible for a benefit check

• The amount of the benefit check is a factor (1 plus the number of dependents) times the

Primary Insurance Amount (PIA, the amount single retirees receive in a monthly check if they retire at their retirement age)

• The PIA is a function of the Average Index of Monthly Earnings (AIME, the monthly average

of the 35 highest earnings years adjusted for wage inflation)

Changes to Social Security

• Tax Rate

– 1935 1%; 2001 7.65% (6.2% excluding Medicare)

• Maximum Taxable Earnings

– 1935 $1000; 2000 $78,600 (at the 6.2% rate and unlimited at the 1.45% rate).

• Retirement Age

– 1935 65 years of age; 2001 (Depends on the year

of birth) 1938->65+2 months; 1939->65+4 months; 1940->65+6 months; 1941->65+8 months; 1942->65+10 months; 1943-1954->66;

1955->66+2 months; 1956->66+4 months; 1957->66+ 6 months; 1958->66+8 months; 1959->66+10 months; 1960 on 67

• Coverage

– 1935 Old age; 2001 Old age + Medicare + Disability + Survivor

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 Impact on the

Economy

• Work (lower)

– People retire earlier than they otherwise would have.

– People work less that they otherwise would have.

• Saving (in net 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

Who is the Program Good For

• 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

Will the System Be There for Me?

• The Social Security Trust Fund

– a fund set up in 1982 in order to hold government debt which will be sold as necessary when tax revenues are less than benefits

– The trust fund is not an asset but more accurately the ability for the government to reborrow money it had previously repaid

Why is Social Security in Trouble

• The number of workers per retiree

– Was above 40 in 1940 – Fell to around 5 in the 1980s and 1990s – Will eventually fall to under 3

• This demographic problem resulted

from the baby-boom (1946-1964).

Estimates of Social Security’s

Bankruptcy

insufficient assets to pay off its obligations.

• Estimates suggest that Social Security will be “bankrupt” in the 2030s.

• “bankrupt” is not necessarily the correct term because the government could

borrow to continue to pay benefits.

Options of Saving Social Security

• raising payroll taxes

– Raise the tax rate – Eliminate the maximum taxable earnings

• raising the retirement age further

• cutting benefits with a Means Test

– those with high incomes or great wealth would get less of their PIA than those who depend on the monthly check

• investing the trust fund in corporate stocks

and bonds

• carving out some of the payroll tax for

privatized individual accounts