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
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
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.
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 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 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).
Changes to Social Security
• Tax Rate – 1935 1%
– 2001 7.65% (6.2% excluding Medicare)
• Maximum Taxable Earnings – 1935 $1000
– 2000 $78,600 (at the 6.2% rate and unlimited at the 1.45% rate).
• Retirement Age
– 1935 65 years of age;
– 2001 (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
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.
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.
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)
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.
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
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.
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 2030s.
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
• investing the trust fund in corporate stocks and bonds
