Transcript Chap034

Chapter 34
Social Security
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
• THE BASICS
• WHY DO WE NEED SOCIAL
SECURITY
• SOCIAL SECURITY’S EFFECT ON THE
ECONOMY
• WILL THE SYSTEM BE THERE FOR ME
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You Are Here
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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
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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
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The Current Funding System
• Social Security was, until 1982, a pay-asyou-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.
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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
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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 .5 times 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)
• Benefits adjusted each year for wage inflation
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Changes to Social Security
• Tax Rate
– 1935 1%; 2007 7.65% (6.2% excluding Medicare)
• Maximum Taxable Earnings
– 1935 $1000; 2007 $97,500 (at the 6.2% rate and
unlimited at the 1.45% rate).
• Retirement Age
– 1935 65 years of age; 2009 (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; 19431954->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; 2007 Old age + Medicare +
Disability + Survivor
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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.)
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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
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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.
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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 (35%)
– 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.
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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.
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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).
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Estimates of Social Security’s
Bankruptcy
• An organization is bankrupt if it has
insufficient assets to pay off its
obligations.
• Estimates suggest that Social Security
will be “bankrupt” in the 2040s.
• “bankrupt” is not necessarily the
correct term because the government
could borrow to continue to pay
benefits.
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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
• reduce the adjustment for inflation to price inflation rather
than wage inflation (perhaps only for upper income
recipients)
• investing the trust fund in corporate stocks and bonds
• carving out some of the payroll tax for privatized individual
accounts.
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