Chapter 36 Social Security

1. Chapter 36Social Security

2. Chapter Outline • The Basics • Why Do We Need Social Security? • Social Security’s Effect On The Economy • Whom Is the Program Good For? • Will The System Be There For Me?

3. 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

4. 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

5. 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.

6. 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

7. 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

8. 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; 2011 (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; 2007 Old age + Medicare + Disability + Survivor

9. 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.)

10. 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

11. 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.

12. 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.

13. 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.

14. 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).

15. Estimates of Social Security’s Bankruptcy • An organization isbankrupt 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.

16. 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.