1. 20 CHAPTER Social Security PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe

2. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-2 Social Security  Largest redistribution program  Established in 1935, expanded in 1956 and 1965  Paid for by earmarked payroll tax  Pay-as-you-go program  Taxes and benefits have continually risen

3. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-3 Social Security Payroll Tax  Established to function as government- operated retirement program  No need-based requirement to collect transfer  Eligibility contingent on having contributed to program in past

4. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-4 Contributions  In form of payroll tax  Income taxed at constant rate up to specified maximum level  Employer/employee contribute equal amounts  Increase in tax rates and maximum wage that can be taxed

5. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-5 Contributions

6. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-6 Structure of the Tax  Social security payroll tax more than 39% of total federal taxes  Adheres to benefit principle  Criticized on regressive nature

7. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-7 Burden of Payroll Tax  Tax Shifting and Payroll Tax  Wages set by supply and demand  Who pays tax irrelevant to after-tax income of employee

8. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-8 Visibility of Payroll Tax  Tax levied on employer will be hidden from employee  Easy for taxpayers to estimate their share of cost to social security program  Double amount shown on W-2 form

9. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-9 Coverage  More than 90% of workers in paid employment are covered by social security program  Eligibility  Must have worked for 40 quarters in a covered job  Benefits paid do not reflect present value of past contributions

10. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-10 Redistributive Nature of Program  Reasons social security is compulsory:  Adverse selection  Low earners get paid more in proportion to social security taxes than high earners  Those who do not fare well likely to bypass system  Pay-as-you-go system  Requires new contributors to keep system solvent

11. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-11 Pay-As-You-Go System of Financing  Collects contributions from current workers, redistributes them to current retirees as benefits  Current contributions not invested  Dependent on new individuals entering system  Liabilities of social security system unfunded

12. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-12 Viability of Pay-As-You-Go  More new contributors entering system each generation  Affected by increasing benefit payments  Affected by demographic factors:  Population living longer  Baby boom  People have fewer children

13. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-13 Political Determination of Benefits and Costs  Expect rate of return on contributions to equal growth in national income  Program subject to change through political process  In self-interest for older generation to vote for higher taxes in exchange for higher benefits

14. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-14 Social Security and Capital Accumulation  Reduces incentive for private saving  Funded Pensions  Funds from pension substitute for private saving  No net effect on aggregate investment  Unfunded Pensions  Reduction in amount of investment

15. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-15 Social Security and Capital Accumulation

16. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-16 The Growth of the Social Security Program  Original tax was combined rate of 2 percent on income up to $3,000 annually  Today is 15.3 percent on income up to $84,900  In 1950, expenditures equaled 7.5 percent of assets  Today, 32.3 percent of assets

17. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-17 Social Security as an Investment  Social security as good investment depends on:  Structure of future system  Future tax rates  Higher rates imply higher benefits  Growth of future income in country

18. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-18 Future of Social Security  Will pay out more in benefits than it receives in revenues within a few decades  Possibility of tax increases  Possibility of benefit cuts

19. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-19 Proposals for Reform  System’s current status produced only through continual tax increases  Suggestions have been made for reform to overcome the system’s main weaknesses

20. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-20 Insurance and Welfare  Reformers have suggested separating insurance and welfare functions of the system  Insurance plan should pay benefits as a function of earlier premiums paid  Welfare system to pay additional benefits based on need

21. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-21 Other Reform Proposals  Raising the retirement age  Eliminating pay-as-you-go  Instituting mandatory private pension plans

22. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-22 Financing Program’s Deficit from General Revenues  Federal government could provide funds using general revenues to avoid bankruptcy of program  Most likely way future imbalance will be addressed

23. PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 20-23 Cost of Imbalance in Social Security Revenues and Expenditures  Federal government transferring assets among its own accounts  Social security trust fund is an asset and liability to federal government