1. Copyright (c) 2000 by Harcourt Inc. All rights reserved. Next page Slides to Accompany “Economics: Public and Private Choice 9th ed.” James Gwartney, Richard Stroup, and Russell Sobel Social Security: —The Nature of the Problem and the Alternatives for Dealing With It Application 4

2. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 1. Introduction to the Social Security Program in the U.S.

3. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Introduction to the Social Security Program in the U.S. n Offers protection against the loss of income that usually accompanies old age or the death of a breadwinner. n It is a pay-you-go system. It is not based on saving-and-investment model. n Primarily an intergenerational income ‑ transfer program: Most taxes collected from the present generation of workers are used to finance current benefits. n Because of the pay-as-you-go nature of the program, it is influenced by changing demographics.

4. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Workers Per Social Security Beneficiary In 1950, there were 16 workers per social security beneficiary. By 1998, the figure had fallen to only 3.1 By 2025, there will be only 2 workers per retiree. As the worker / beneficiary ratio falls, a pay-as-you-go system becomes less viable.

5. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 2. Why Is Social Security Headed for Problems?

6. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 50 40 30 20 10 0 N umber of Americans Older than 70 (millions) Sources: Bipartisan Commission on Entitlement and Tax Reform, Final Report to the President (Washington, D.C.: GPO, 1995), p.13; & 1995 Annual Report of the Board of Trustees of the Federal Old Age and Survivors Insurance and Disability Insurance Trust Funds, p. 21. 19952000201020202030 34.8 25.8 24.1 27.3 47.8 The Increase in the Number of People Age 70 and Over Baby Boomers moving into the retirement phase of their life will place strong pressure on the Medicare program as well as the social security retirement system.

7. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Sources: Bipartisan Commission on Entitlement & Tax Reform, Final Report to the President (Washington, D.C.: GPO, 1995), p.22. 16 14 12 10 19931998200320082013201820232028 P ercentage of OASI Taxable Payroll The Forthcoming Deficit Between Payroll Tax Revenues and Benefit Expenditures Currently, taxes exceed outlays (expenditures); operating surpluses exist. Social security outlays Social security payroll tax + benefits tax Operating deficits deplete trust fund assets When outlays exceed taxes, operating deficits will exist. The current surplus of revenues from the payroll tax relative to the promised retirement benefits will dissipate around 2014. Operating surpluses build trust fund assets

8. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 3. Will the Trust Fund Lighten the Future Tax Burden?

9. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Will the Trust Fund Lighten the Future Tax Burden? n Current revenues exceed expenditures on benefits by about $100 billion per year. n This surplus is put in a trust fund “invested” in government bonds. n Because the federal government both pays and receives the interest on these bonds, they are not like the bonds, stocks, and physical assets held by a private insurance company. n The Social Security Trust Fund (SSTF) bonds are an IOU from the Treasury to the Social Security Administration. Thus, their net asset value to the federal government is zero

10. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 4. The Real Social Security Problem

11. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. The Real Social Security Problem n A crisis will face the pay-as-you-go system around 2014 when the revenues from the payroll tax will begin to fall short of the benefits promised to retirees. n There are 4 ways of dealing with the future shortfall of revenues relative to promised benefits: 1. Reduce benefits (lower monthly benefits or increase retirement age). 2. Raise taxes and/or cut government expenditures in other areas in order to provide additional funds for the program 3. Borrow from the general public (this implies higher future taxes). 4. Reform the system so workers can earn a higher rate of return

12. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. n The presence of Social Security Trust Fund bonds does not change these alternatives or make it easier to deal with future social security deficits. n The problem is not depletion of the trust funds, but the burden of soaring social security deficits on the economy beginning in about 15 years. The Real Social Security Problem

13. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 5. Reform Alternatives

14. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Reform Alternatives n Government investment in the stock market: u States have invested employee retirement funds in the stock and bond markets for many years, but are small compared to the SSTF. u Political pressures could cause several problems from such a large government investment. u The record of government directed funds in other countries has been poor.

15. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. Reform Alternatives n The use of payroll taxes to fund personal retirement accounts : u Individuals might be allowed to fund their own retirement by channeling a portion of their payroll tax to a personal retirement saving account. u As retirement accounts grow, individuals could allocate more of the payroll tax into them in exchange for the receipt of lower social security benefits. u Rather than the government managing these funds, individuals would be permitted to choose among various stock and bond mutual funds. u Private accounts would encourage more savings, investment, and ownership of capital by future retirees.

16. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 6. Making Social Security an Option: The Experience of Chile and Other Countries

17. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. n Chile's pioneering plan, first adopted in 1980, provides a pattern for others. n The basics of the Chilean plan are: u a defined contribution system, and, u privately owned and managed investment accounts. n The Chilean plan forces employees to save, but gives them a property right to the funds in their retirement account. n The Chilean plan has worked well for both the participants and the economy. Making Social Security an Option: The Experience of Chile and Other Countries

18. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 7. Social Security Fairness Issues

19. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. n Generations born after World War II would be better off without social security. n Social security discriminates against middle-income recipients. n Social security discriminates against married women in the work force. n Political dependency results from the system. Social Security Fairness Issues:

20. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. 1. Is the social security system based on the same principles as private insurance? Why or why not? Questions for Thought: 2. Why does the social security system face a crisis? Will the surplus that is currently being built up in the Social Security Trust Fund help to avert the crisis? 3. Do you think workers should be permitted to invest all or part of their social security contribution in private investment funds? What are the advantages and disadvantages of a private option system? If given the opportunity, would you choose the private option or stay with the current system? Why?

21. Jump to first page Copyright (c) 2000 by Harcourt Inc. All rights reserved. End Application 4