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

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

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

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) 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

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

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 Law requires employers to collect half tax through payroll deduction, remit twice the amount to federal government

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

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

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

Individual Rates of Return Typical retiree pays years of taxes over a working lifetime Then receives years of retirement benefits

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

The Long-Run Deficit Social Security analysts project: Alternative I, II, III 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 Fertility rate – average number of children born to women in their lifetime

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

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