Social Security: Where Are We? Where Are We Going?

1. Social Security:Where Are We?Where Are We Going? Melanie Griffin

2. Principal Features of Social Security • Social Security refers to the federal Old-Age and Survivor’s Insurance (OASI) portion • Social Security payroll tax is the second largest source of federal government revenue • Revenue from the payroll tax is deposited in the OASI Trust Fund • From that fund benefits and administrative costs are paid, and the remaining is invested in long-term U. S. Treasury bonds

3. Key Terms: • Pay-as-you-go fund - fund with a balance that can cover future benefits and expenses for only a few years • Fully-funded fund – fund with a balance that can cover future benefits and expenses for many years • Indexing factor – ratio of average national wages in two different years used to index actual annual earnings

4. More Key Terms: • Average Indexed Monthly Earnings – actual average monthly earnings for the highest 35 years of earnings, adjusted by an indexing factor • Primary Insurance Amount – monthly social security benefits at the normal retirement age • PIA = .9(First $592 AIME) + .32($592 < AIME < $3567) + .15(AIME over $3566) • Early Retirement Penalty – amount by which social security benefits are reduced for people who retire before the normal retirement age

5. Social Security Benefits are Indexed for Inflation • Inflation Indexing – annual upward adjustment in social security benefits to cover the increase in the consumer price index • Delayed Retirement Credit – amount by which retirees’ benefits are increased for each year that retirement is delayed up to age 70

6. Who Pays the Social Security Tax? • OASI is financed primarily by 10.6 percent tax levied on taxable payroll • Law requires employers to collect half tax through payroll deduction, remit twice the amount to federal government

7. S1 Wage Per hour ($) W1 W2 D1 D2 Hours Worked Effect Social Security Payroll Tax has on Hours Worked

8. Social Security and Early Retirement • Factors of reduced labor force participation by older people include: • Rising income • Growth in private pensions • Increased availability of government • Changing lifestyles • SOCIAL SECURITY

9. Social Security and Household Savings • Wealth substitution effect – an effect that induces workers to substitute Social Security wealth for other types of wealth • Social Security wealth – present value of Social Security benefits minus present value of Social Security taxes • Induced retirement effect – increase in household savings to offset early retirement induced by Social Security

10. Individual Rates of Return • Typical retiree pays 40-50 years of taxes over a working lifetime • Then receives 15-20 years of retirement benefits

11. Is That All There Is To It? • Social Security’s old-age insurance reduces income and inflation risk which other individual investors would be exposed • Risk reduction benefit – value of lower risk of loss of Social Security benefits relative to risk of loss of income from private securities • Inflation Protection – value of inflation indexing of Social Security benefits

12. The Long-Run Deficit • Social Security analysts project: • Alternative I, II, III • By 2041, the Trust Fund will be exhausted and insufficient to pay all promised benefits and expenses • Alternative II relies on assumption about key economic and population variables • Fertility rate – average number of children born to women in their lifetime

13. What Can Be Done About The Deficit? • Benefit Reduction: • Start now, reducing benefits • Starting after OASI Trust Fund assets are exhausted, reducing benefits • Use more accurate measure of inflation to index benefits • Change method used to index preretirement earnings of middle and upper income retirees • Increase in normal retirement age

14. What Can Be Done About The Deficit? • Revenue Increases: • Increase in taxes, starting now • Increase in taxes, starting after OASI Trust Fund assets are exhausted • Increase in investment, financed by Social Security surplus • Privatization of Social Security