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The Implications of Social Security Reform for Minorities. SOCIAL SECURITY INTRODUCTION. To understand the implications of any changes made to Social Security, we must first understand the current system. Technically, Social Security is “race-neutral.”
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SOCIAL SECURITY INTRODUCTION • To understand the implications of any changes made to Social Security, we must first understand the current system. • Technically, Social Security is “race-neutral.” • People in identical economic/family situations are treated equally. • Problem: all racial and ethnic groups aren’t equal. • Minorities have different earnings patterns, life expectancies, retirement savings, and disability rates. • Minorities rely more heavily than whites on Social Security benefits as an income source during retirement.
Reasons Minorities Need Social Security • Less likely to have pensions • This difference likely to continue far into future • Among current workers 21 years and older, fewer minorities have pension plans than whites. • Greatest difference: minorities less likely to have other assets that produce income.
Minority Gains from Social Security • The progressive benefit formula of the current program helps low earners. • A disproportionate share of low earners are minorities • Benefit formula gives low-earners a higher percentage of their pre-retirement earnings than high-wage workers. • BUT the payroll tax is regressive. • Since minorities’ wages are lower, on average, a high percentage of their earnings are likely to be within the taxable base. • The Earned Income Tax Credit (EITC) was originally designed to offset the regressive payroll tax for low-earning families with children.
Minority Gains from Social Security Benefits Depend on Earnings. There is a substantial difference in earnings by race. • Example: 1995 median earnings in Social Security covered employment: • White: $16,360 • Black: $11,991
Years in the Workforce • Years out of the workforce decreases Social Security benefits because they are calculated based on the average of a worker’s highest 35 years of earnings. • Minorities have more years out of the workforce than whites.
A larger percentage of whites receive retirement benefits than minorities. A larger percentage of minorities receive disability and survivor benefits than whites. Low-earners have higher rates of disability than high-earners. Types of Benefits Retirement Disability Survivors White 72% 12% 16% Black 53% 25% 22% Other 51% 32% 17% Benefits by Race
Life Expectancies by Race • People who live longer receive benefits for a longer period of time, so they have higher lifetime retirement benefits from Social Security. • Lower life expectancy groups receive more disability and survivors benefits.
Drawbacks for Minorities • African American males often pay more into the program than they ever receive in benefits • Even if they receive higher proportional benefits because of progressivity, they receive them for a shorter amount of time because of their shorter lifespan. • Survivor benefits are limited and benefits paid are not very high. • Personal accounts would allow workers to create a nest egg for their families.
Effects on Minorities • Because of their lower life expectancies, Blacks areaffected more greatly than whites by the inability to include the Social Security investments they have made over their lifetimes in their estates. • Upon death, the money they have invested will leave their spouse and family, except in the limited cases where their families receive survivor benefits. • This money then benefits groups with longer lifespan who receive benefits for a longer period of time.
The disability benefits come from a separate program that is financed by a separate tax. Disability benefits are received at a disproportionately higher rate by minorities, but the smaller disability benefits do not entirely make up for the fact that white workers receive more in retirement benefits. Disability Benefits
Wrap-Up of the Current System • The overall implications of the current Social Security system for minorities are unclear. • Minorities have lower life expectancies, so the total benefits they receive on average are less than those of Whites. • This drawback is partially offset by the progressivity of the system and by minorities’ greater receipt of survivor and disability benefits.
The Alternative: the President’s New System • The President’s Commission to Strengthen Social Security • 16-member bipartisan Commission made up of former U.S. Representatives, Consultants to the World Bank and the CEO of Black Entertainment Television • Established through Executive Order 13210 to provide recommendations for modernizing and restoring fiscal soundness to the Social Security System • Reported three reform models to the President, all involving personal accounts. • We will first focus on the structure and administration of personal accounts and then on the most popular proposal, Reform Model 2
Structure of Personal Accounts Centralized Approach • Payroll collections are transferred to a government–appointed central administrator using the existing Social Security payroll tax system • Worker’s choose among a limited number of low-cost, diversified investment index funds • Governing board contracts fund management to multiple private managers on a competitive basis
Structure of Personal Accounts Decentralized Approach • Payroll collections transferred directly from employers to diversified, private-sector investment funds that satisfy requirements • Workers have investment choices through their employers; a wide-range of private-sector funds are available and switching is permitted • Government still interacts with each fund and the employers to enforce compliance with regulations
The Two-Tier Approach • Developed to address foreseen problems with both centralized and decentralized approaches • Collections are transferred to central administrator using the existing payroll system; administrator verifies that correct amounts are submitted by each worker • Funds in both Tiers cannot charge fees for entry and exit, only an annual charge that is a percentage of assets • Investments for each employee are made through central administrator into Tier 1
Tier 1 • Workers select a balanced fund or any combination offered by the Thrift Savings Plan (TSP) for federal workers • Balanced fund include corporate and government bonds • Three risk levels (conservative, medium and growth) include varied combinations of government and corporate funds • TSP includes: Government Securities Fund; Fixed Income Index Investment Fund; Common Stock Index Investment Fund; Small Capitalization Stock Index Investment Fund; and International Stock Index Investment Fund • Inflation-protected Bond Fund allows participants to invest in Treasury Inflation Protected Securities • Fund management auctioned off to private-sector providers. For those who do not choose Tier 1, their contributions must be invested into a standard diversified fund on their behalf. • When employees reach a threshold balance, they are allowed to invest accumulated contributions in a Tier 2 qualified private-sector funds
Tier 2 • Private-sector fund managers may offer broadly diversified mutual funds certified by the Governing Board in addition to the Funds offered under Tier 1 • Funds must be diversified and reflect the performance of many companies spanning all major commercial sectors • Share of funds in individual corporations cannot exceed strict limits set by Governing Board • More competition and choice than Tier 1
Limitations in Changes to Investment Allocations • Personal retirement accounts not intended for long-term, short-sighted activities, such as “day trading” • Changes in investment allocations limited to once a year • Account information will be immediate through: • monthly mailed statements • online account access • automated calling
Access to Personal Accounts • Workers should not be allowed to consume funds in their personal accounts in a manner that would leave them impoverished during retirement and dependent on the government for additional resources • Personal accounts must provide a variety of withdrawal options upon retirement, including the ability to leave assets to loved ones upon death • Pre-retirement access to funds in personal accounts should not be allowed, including withdrawal by disabled persons • Commission suggests government action for those who experience financial need before retirement
Retirement Withdrawal Options • Individuals should have immediate right to their money only to the extent that they can support themselves in the future in order to avoid dependence on the government • Forced to take at least some of their money as an annuity or gradual withdrawals • Annuity • Pays fixed stream of money until person dies • Inflation-indexed that protect against loss of purchasing power • Standard annuities pay more early in retirement to prevent loss of purchasing power • Gradual Withdrawal • Allows individuals to receive fractions of their over their expected lifetime • Any money left after death can be fully bequeathed • Withdrawal schedule must be long enough to cover expected lifetime of retiree and spouse • Lump-sum payments allowed only to prevent impoverishment
Protection for Spouses • Personal account ownership must help provide for current and former spouses welfare in proportion to their contributions to the household • All account balances attributable to contributions during marriage, and all earnings on account balances brought into marriage, should be equally divided in the event of a divorce • Account balances brought into marriage should not be shared • Upon retirement, a two-thirds joint and survivor annuity should be required unless both spouses agree to an alternative consistent with the distribution rules discussed earlier
Reform Model 2 • Reform Model 2: Voluntary Progressive Personal Accounts combined with an Inflation-Indexed but More Progressive Traditional System • Pros: • Establishes voluntary personal accounts, without raising taxes or requiring additional worker contributions • Enables all future retirees to receive an inflation adjusted Social Security benefit • New poverty protection • Puts Social Security on fiscally sustainable path
Key Elements • Workers who have not reached age 55 (as of January 1, 2002) would be given the opportunity, starting in 2004, to redirect the lesser of $1,000/year or 4 % of their payroll taxes, to a personal account. • Traditional Social Security benefits would be reduced by personal account contributions compounded at a real interest rate of 2 %. • Traditional Social Security benefits would be indexed to price inflation rather than national wage growth beginning in 2009.
Key Elements Ctd. • A minimum benefit provision would increase benefits for 30-year minimum wage earners by approximately 40 percent by 2018 relative to the price indexed benefit level. • Benefits for widows would be increased to as much as 75 percent of the combined benefits that would be received by the couple if both were still alive, versus 50-67 percent under current law. • In order to maintain the ability to pay benefits throughout a 75-year period, additional revenue would likely be taken from the General Fund of the Treasury.
Benefits • Workers who opt for personal accounts • Expect to higher benefits than the inflation adjusted level currently paid, and the benefits the existing system can afford in the future. • Workers who are currently aged 35 who retire in 2032, will have benefits with 17-32 percent higher purchasing power than those received today. • More progressive because: • Workers can only redirect a maximum of 4 percent of payroll taxes on entire salary • Benefit levels paid to all low-waged workers are raised • Workers who do not opt for personal accounts • Initial benefit levels grow with inflation • Low-wage worker in 2052 would receive benefits that are 27 percent higher in real terms than those received by a low-wage worker today
Fiscal Sustainability Assessment • Model 2 improves Social Security’s financial health and greatly reduces burden on future workers • Current system is projected to show deficits as soon as 2016 • Model 2 eliminates permanent deficits after a 75-year valuation period without relying on general revenue transfers or higher taxes • Should eventually transform projected deficits into perpetually rising surpluses
Reduction in Rate of Growth in Long Term Costs • New system will lessen the burden on future generations of taxpayers from a projected 17% to 15% of taxable payroll by 2030 • By the end of the 75-year valuation period, the program’s expenditure as a percent of GDP would fall below its current level
Transition Financing • Would reduce fiscal pressures on the rest of the federal government relative to current law • No new “transition” cash would be needed before 2010 when $4 billion would be required and then would grow to a maximum $73 billion in the years 2015-2016 • Required “transition” funds would decrease until 2029, when the new system would be permanently less expensive than the old • Total transition investment would be approximately $900 billion (in present value terms)
Impact on Minorities: The Debate Despite the apparent benefits for all workers, the impact of private accounts on minorities is a hotly contested subject. To hear analysis by a panel of legislators, economists, and civil rights activists who met on Capitol Hill on March 1, 2005 use the following link: Panel Discussion: The Impact of Social Security Reform for African Americans
The Benefits of Personal Accounts for Minorities • Transformation from a defined-benefit to a defined-contribution plan would disconnect total benefits from life expectancy. • Under the current system, retirees who work all their life but die before retirement receive no benefits after paying into the system throughout their career. • Minorities have shorter average life expectancies, so the change would eliminate current inequality. • Overall, personal accounts have a fairer rate of return without bias in favor of citizens who live longer.
Effects of Life Expectancy • Even if black men only live two years less than white men, that is still 24 less Social Security checks received. • Due to differences in life expectancies and marriage rates, through Social Security there is a net income difference of $10,000 per person from blacks to whites (study by the RAND Corp.) • Social Security taxes crowd out other forms of savings and investment. Because more minorities live paycheck to paycheck, they are unable to accumulate assets and build wealth. • One in three black men will pay into the system but die before ever collecting benefits (Cato Institute).
Wealth Accumulation and Private Accounts • Under new system, individuals have property rights to their accumulated income. • These rights can be given to heirs if earning citizen dies before exhausting their account • Inheritance right is hugely important based on minorities shorter life expectancies. • Accounts give low income workers, who are largely minorities, the chance to accumulate capital and begin to bridge the black-white wealth gap.
Personal Accounts and Poverty • Not only would privatized system provide fairer benefits to minorities, but the rate of return would be far higher. • Private accounts have the power to lift African American seniors out of poverty • According to a Harvard Study, privatization would reduce poverty among married African American retirees by 23.4% and among widowed, divorced or never married African Americans by 61.5%. (Feldstein and Liebman, 2000)
Minority Support for Personal Accounts • 53.5% of blacks support privatization (Zogby survey, 2001). • 54% of Hispanics and 51% of black voters support the private individual accounts in Bush’s Social Security investment proposal (Washington Times survey, December 2004).
Problems with Reform Model 2 • Projected benefits in 2050 will be reduced to 88% of current benefits due to Model 2 transition from wage-indexed formula (including annuitized personal accounts) • Means lower total benefits to be provided, of which minorities benefits disproportionately more from and thus lose more. • Projected near poverty rates of minorities would be higher under the Model 2 than current system, even in the most optimistic personal account scenarios • Under pessimistic PA return scenarios, black near poverty rates would be even higher than under a uniform downward adjustment of benefits to achieve long term solvency (75 years). -Urban Institute’s model, DYNASIM3 simulation
Problems with Investment Risk • Investment experience and access to information: Minorities tend to have lower amounts of investment experience and less access to good financial advice, leading to lower returns on their personal accounts than whites. -1993 Merrill Lynch Household Survey (confirmed blacks score lower on tests of financial knowledge than whites.) • Risk Aversion: Minorities tend to be more risk averse. • Minorities depend on social security for larger percentage of retirement income • 76% of Hispanics over 65 receive at least 50% of income from Social Security, as do 88% of blacks. • Minorities may select low-risk funds with lower returns
Greater Investment Risk for Minorities • Minorities are less able to bear investment risks, and thus may have to opt for the standard plan rather than the voluntary personal accounts. • If these personal accounts function as planned, whites will disproportionately benefit from personal accounts while minorities will either not use the voluntary personal accounts or be forced to accept more stable investments with lower returns in the face of risking their retirement income.
Loss of Safety Net • With privatization of Social Security, government guaranteed minimum benefits do not provide a safety net against poverty in old age. • African American and Hispanic citizens are more frequently reliant on Social Security to avoid poverty so they are more likely to suffer in the absence of the safety net.
Inheritance Right Less Helpful to Minorities • Inheritance rights are ineffective for helping minorities accumulate capital if all savings are consumed during worker’s retirement. • Minorities depend on Social Security for subsistence more often than whites so it can be assumed more whites will take advantage of the inheritance right.
