Transcript Workers Support Retirees - McGraw Hill Higher Education

Chapter 5: Social Security
Chapter 5
McGraw-Hill/Irwin
Social Security
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved
5-1.
Chapter 5: Social Security
Introduction
Four ways to prepare for retirement
The U.S. Social Security system
Reforming Social Security
5-2
Chapter 5: Social Security
Four Ways to Prepare for Retirement
Table 5.1
Workers Support Retirees
Each Generation is
Self-Sufficient
Individually
Collectively
Historical
U.S. Social Security
Recent
Possible
5-3
Chapter 5: Social Security
Four Ways to Prepare for Retirement
Workers support retirees
Individually
• Historical
• Compact between generations
• Advantages and disadvantages
Collectively
• U.S. Social Security
• Advantages and disadvantages
5-4
Chapter 5: Social Security
Four Ways to Prepare for Retirement
Each generation is self-sufficient
Individually
• Recent
• Individual savings or home ownership
Collectively
• Possible
• Government taxes all workers and saves
the revenue to be dispersed upon retirement
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Chapter 5: Social Security
The Rate of Return
There are two stages of life of equal length
RETIREMENT
WORK
r* = (B2 – T1) = B2 -1
T1
T1
T1 is the sacrifice made in the work stage and
B2 is the benefit received in the retirement stage.
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Chapter 5: Social Security
The Rate of Return when Workers Support Retirees
BR = tWL
•
•
•
•
•
B = benefit per retiree
R = number of retirees
t = payroll tax rate
W = wage of workers
L = number of workers
What determines the benefit you receive?
• Faster growth in the labor force
• Faster growth in the wage per worker
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Chapter 5: Social Security
The Rate of Return when Workers Support Retirees
Table 5.2
Period Workers
Wage
Tax
Revenue Retirees
Benefit
1
100
$10,000 $2,000
$200,000
---
---
2
125
$10,000 $2,000
$250,000
100
$2,500
1
100
$10,000 $2,000
$200,000
---
---
2
100
$12,000 $2,400
$200,000
100
$2,400
1
100
$10,000 $2,000
$240,000
---
---
2
125
$12,000 $2,400
$300,000
100
$3,000
r
25%
20%
50%
If the payroll tax rate, the growth rate of labor, and the growth
rate of the wage remain constant over time then:
r* = g L + g W + g Lg W
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Chapter 5: Social Security
The Rate of Return when Each Generation is
Self-Sufficient
Individuals save at banks or by buying stocks and bonds.
• Upon retirement, you receive principle plus interest
• Marginal product of capital (mpk)
• Is mpk greater than, less than, or equal to r*?
• Individual versus collective saving
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Chapter 5: Social Security
The Impact on the Economy
Imagine two economies being born
One is self-sufficient and one is a
workers support retirees economy.
Results
• No real capital accumulates in the
workers support retirees economy.
• The self-sufficiency economy operates
with permanent capital stock.
There are advantages and disadvantages to each system.
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Chapter 5: Social Security
Breaking Out is Hard to Do
To transition from a workers-support-retirees
to a self-sufficient economy is difficult.
Three transition options
1. The current workers must double-save
2. The current retirees are ditched
3. The sacrifice is spread out over several
generations of workers and retirees
Defined benefit versus defined contribution
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Chapter 5: Social Security
Defined Benefit versus Defined Contribution
Table 5.3
Collective Workers
Support Retirees
Each Individual is
Self-Sufficient
r* = gL+gW+gLgW = 3%
mpk = 6%
K and output of economy
Lower
Higher
Individual ownership and
control
No
Yes
Wage history,
defined benefit
Investment Income,
defined contribution
Risk of variation of r*
Low
High
Benefit is an annuity
Yes
No
Benefit is inflation protected
Yes
No
Redistribution from high to
low wage workers
Yes
No
Average rate of return
Benefit depends on
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Chapter 5: Social Security
The U.S. Social Security System
Background
• “New Deal” 1935
• Pay-as-you-go (PAYGO)
• Use current payroll taxes to pay current benefits.
Key PAYGO Equation
BR = tWL
•
•
•
•
•
B = benefit per retiree
R = number of retirees
t = payroll tax rate
W = wage of workers
L = number of workers
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Chapter 5: Social Security
The Ratio of Workers to Retirees
Figure 5.1
Workers per beneficiary
10
Historical
Estimated
Over the next
25 years, the
ratio of workers
to retirees is
projected to fall
from 3 to 2.
9
8
7
6
5
4
3
2
1
0
1955
1975
1995
2015
2035
2055
2075
Source: 2007 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors
Insurance and Disability Insurance Trust Funds, Table IV.B2.
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Chapter 5: Social Security
Description of the Current U.S. Social Security System
• Payroll tax rate has increased over time
• Payroll tax ceiling
Table 5.4
Year
Employee
Tax Rate
Taxable
Ceiling
Maximum
Employee Tax
Combined
Tax Rate
Maximum
Combined Tax
1983
5.4%
$35,700
$1,928
10.8%
$3,856
1984
5.7%
$37,800
$2,155
11.4%
$4,309
1990
6.2%
$51,300
$3,181
12.4%
$6,361
2007
6.2%
$97,500
$6,045
12.4%
$12,090
2008
6.2%
$102,000
$6,324
12.4%
$12,648
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Chapter 5: Social Security
Description of the Current U.S. Social Security System
• A person must pay payroll taxes for at least 40
quarters to be eligible.
• Earliest Eligible Age (EEA) is 62.
• The retiree’s monthly benefit is called the
Primary Insurance Amount (PIA).
• The PIA depends on the person’s wage history,
their Average Indexed Monthly Earning (AIME).
• The retiree receives the full PIA if they wait until
the Full Benefits Age (FBA).
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Chapter 5: Social Security
Description of the Current U.S. Social Security System
Figure 5.2
PIA
A progressive
benefit formula
favors low-earners
more than highearners.
$1,785
$640
$711
$4,288
AIME
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Chapter 5: Social Security
Description of the Current
U.S. Social Security System
Sources and uses of Social Security revenues in 2006 ($744.9 billion)
Sources
Interest,
14%
Figure 5.3
Uses
Trust
Fund,
25%
Tax
benefits,
2%
RR, 1%
Payroll
taxes,
84%
Benefit
pmts,
73%
Admin.,
1%
Source: Fast Facts & Figures about Social Security 2007, p.34
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Chapter 5: Social Security
Description of the Current
U.S. Social Security System
The impact on work
• Spousal benefit
The impact on saving, investment, and
capital accumulation.
• Present value of Social Security wealth
The impact on retirement.
• “Normal” retirement age
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Chapter 5: Social Security
Reforming Social Security
Benefits and Taxes
Figure 5.4
F
G
T
• If benefits remain
constant, the trust fund will
run out in 2040
B
• Slowing benefit growth
and increasing taxes
would grow the trust fund
U.S. Bonds in
SS Trust Fund
2000
2010
• Current taxes and
benefits and the amount
in the trust fund
2020
2030
2040
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Chapter 5: Social Security
Reforming Social Security
Treating the 2040 problem
Ways to raise tax growth:
• Increase the payroll tax rate
• Payroll tax ceiling can be increased
• Payroll above the ceiling can be taxed
Ways to slow benefit growth:
• Increase the FBA
• Reduction in the replacement rate for high earners
• Wage indexing compared to price indexing
• Progressive indexing
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Chapter 5: Social Security
Reforming Social Security
Making each generation self-sufficient
• Collective self-sufficiency
• Individual self-sufficiency
• individual investment accounts
Combinations and compromises
• Combine measures from each solution: Treating the
2040 problem, collective self-sufficiency, and individual
self-sufficiency
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Chapter 5: Social Security
Summary
Four ways to prepare for retirement
The U.S. Social Security system
Reforming Social Security
5 - 23
Chapter 5: Social Security
Preview of Chapter 6:
Health Insurance
Principles of health insurance
Features of the health sector
The role of government
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