1. Social Security and Social Insurance
Chapter 8
Social Security and Social Insurance

2. Social Security Act of 1935 Requirements at that time:
Retirement Age: 65
Payroll Tax:
1% for employer and employee
Tax applied to the first $3000 of earned income

3. Social Security in the United States
OASDI:
Old Age
Survivors
Disability Insurance 
HI: Health Insurance (Medicare) 
UI: Unemployment Insurance

4. FICA Federal Insurance Contribution Act
Employers and employees each currently contribute 7.65% of wages in FICA tax.
15.3 % for the self-employed
Taxes applied on earned income up to $87,000 in 2003 (indexed).

5. Fully Funded vs Pay-As-You-Go
A Fully Funded system: current fund has balances sufficient to pay the present value of all future obligations.
A Pay-As-You-Go system: current taxes pay for current benefits.
The current U.S.system is a modified pay-as-you-go system with a trust fund as backup.

6. Social Security Trust Fund
Since 1982, Social Security taxes collected have greatly exceeded benefits paid out.
The trust fund is an accounting mechanism by which U.S. government debt is issued to the Social Security Administration in exchange for SS fund surpluses.
This debt will be sold to the public when taxes paid fall below what is needed to pay benefits.

7. Retirement Age
People born prior to 1935 can retire with full benefits at 65. 
People born between 1936 and 1942 can retire with full benefits at age months for every year after 1936 they were born. 
People born between 1943 and 1954 can retire with full benefits at age 66.
People born between 1955 and 1960 can retire with full benefits at age months for every year after 1955 they were born. 
People born after 1960 can retire at full benefits at age 67.

8. How Retirement Benefits are Computed
The AIME (Average Index of Monthly Earnings) calculates the highest 35 years of inflation-adjusted earnings, expressed in monthly terms.
The PIA (Primary Insurance Amount) is the amount to which a individual is entitled given their AIME. 

9. Replacement Rates
The Gross Replacement Rate is the monthly retirement benefit divided by the monthly labor earnings in the year prior to retirement.
The Net Replacement Rate is the monthly after-tax benefit divided by the monthly after-tax labor earnings in the year prior to retirement .

10. Gross Replacement Rates by Income 2002
Worker Status
Gross Replacement Rate
Low Earner
53.6%
Average Earner
39.9%
Maximum Earner
24.8%

11. Gross Monthly Earning in the Year Prior to Retirement (Dollars)
Figure 8.1 How Gross Replacement Rates for Social Security Pension Recipients Vary with Pre-retirement Earnings
110
100 90 80 70
Gross Replacement
Rate (Percent) 60 50 40 30 20 10
1,000
2,000
3,000
4,000
Gross Monthly Earning in the Year
Prior to Retirement (Dollars)

12. Spousal and Dependent Benefits
.5 of PIA is added for a spouse over age 65 and for each dependent child

13. Divorce and the Two-Income Family
A woman who worked while married to a high income-earning husband will get nothing or virtually nothing for the taxes she paid. She and her husband would get 1.5 times his PIA if she earned nothing and 1.5 time his PIA if she earned a modest income.
Divorced people are entitled to either their own PIA or a spouse/widow benefit (whichever is larger). This applies to multiple spouses as well. Thus, breadwinners can have multiple people receiving half or full pensions based on a single taxpayer’s earnings.

14. Other Anomalies
When one party in a marriage dies, the benefit to the survivor depends on who made the money.
If both earned equal amounts, then when one dies the other receives their own amount.
If one earned all the money and the breadwinner dies, the survivor keeps the spouse’s pension (which is often quite a bit more).
Singles fair substantially worse than do married dependent partners with deceased breadwinning partners.

15. The Importance of Social Security Income to the Elderly
2/3 get more than half of their income from Social Security. 
Private pensions only account for 20% of elderly income. 
For low-income persons, Social Security is 80% of their monthly income.
More than 50% of the elderly would be below the poverty line without Social Security.

16. Cost-of-Living Adjustments
Benefits are adjusted for inflation using the CPI. 
Because the CPI overstates inflation (by estimates in the neighborhood of 1.1 percentage points), Social Security benefits increase in real terms each year.

17. Demographic Changes
Birthrates have fallen such that the number of workers supporting each retiree has fallen from more than 30 in the 1950s to below 5 beginning in Projections show that fewer than 3 workers will support each retiree by 2030; shortly thereafter, fewer than 2 workers will support each retiree.

18. Algebraic Look at the Result of Demographic Changes Under a Pay-as-You-Go system
t = (B × R)/(W × L)
Where:
t is total benefits paid
B is the average benefit
R is the number of recipients
W is taxable wages
L is the number of workers

19. Algebraic rearranging
t = B/W × R/L = the average replacement rate × the dependency ratio 
The dependency ratio was below .1; it is currently above .3 and is steadily increasing, and will be at .5 in 2030.

20. Combined Employer-Employee Tax Rate Maximum Taxable Wages per Worker
Year
Basic OASDHI
Tax Rate
Combined Employer-Employee Tax Rate
Maximum Taxable Wages per Worker
Maximum Tax Based on Combined Rate
1937
1.00
2.00
$3,000
$60.00
1957
2.25
4.50
$4,200
$189.00
1967
4.40
8.80
$6,600
$528.00
1977
5.85
12.10
$16,500
$1,930.50
1987
7.15
14.30
$43,800
$6,263.40
1997
7.65
15.30
$65,000
$10,006.20
2003
$87,000
$13,615.50

21. Proposals to Reform Social Security
Maintain benefits
Increase taxability of benefits
Invest Trust Fund in Corporate Securities
Eventually increase payroll tax rate by 1.6 percentage points
Individual Accounts
Raise retirement age
Reduce replacement rates for upper income people
Allow 1.6 percent of payroll to be placed in special retirement accounts
Personal Security Accounts
Allow half of payroll taxes to be placed in individually managed accounts
Reduce guaranteed benefit

22. Figure 8.2 Social Security Pensions and the Work-Leisure ChoiceB 24
Income per Day
Leisure Hours per Day A 4 9 19 14 C G
$30 G A B A B U2 H L2 E' U2
$30 F L1 E U1

23. Working While Eligible for Social Security Benefits
People may work and receive Social Security benefits.
If they receive benefits with the reduced benefits option at age 62, they lose $1 in benefits for every $2 they earn over approximately $10,000.
Those older than 65 may earn any amount and keep their benefits.
If they choose not to receive benefits, they receive a greater Social Security benefit when they decide to begin receiving them.

24. Savings Incentives of Social Security
Asset Substitution Effect: People save less than they would if Social Security did not exist, because they are substituting government promises of a benefit for private savings. Stated simply, people save less because government is “saving” for them. 
Induced Retirement Effect: People save more than they would if Social Security did not exist because they would not have retired or would not have retired as early had Social Security not been there. Given that it does exist, people choose to ultimately retire or retire earlier and save in order to do so. 
Bequest Effect: People save more than they would have if Social Security did not exist in order to bequeath more to their children and grandchildren.

25. Figure 8.3 The Asset Substitution Effect
Consumption per Year after Retirement
Consumption per Year Prior to Retirement A B A B A B R D U1 E S C R2 U2 E U1 D G2 T
Social
Security
Pension F G F T S' C
Social
Security
Pension S

26. The Net Effect of Social Security on Savings
Feldstein: Social Security leads to a substantial reduction in savings
Munnell: The net effect of the ASE, BE, and IRE is nearly zero 

27. Medicare
The program provides substantially subsidized health insurance to those 65 and older. It is financed with premiums, a 2.9% payroll tax (1.45% each for employers and employees) and general government revenue.
Part A:
Mandatory
Covers hospitalization
Financed with payroll tax and premiums
Part B:
Voluntary
Covers doctor’s visits
Financed from general federal revenue and premiums

28. Unemployment Insurance
Covers nearly all full-time workers
Financed with a payroll tax on employers up to $7000 of earnings
Gross Replacement Rate: 33%