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Chapter9–SocialInsuranceI:SocialSecurityandUnemploymentInsurancePublicEconomics1SocialInsuranceProgramsGenerallyshare4characteristics:ParticipationismandatoryEligibilityandbenefitsdependonpriorcontributionsBenefitsbeginwithanidentifiableoccurrenceProgramsarenotmeans-tested2WhyhaveSocialInsurance?RecallthattheFirstWelfareTheoremconcludedthatprivatemarketsgenerallyworkwell.Onecriticaldifferenceininsurancemarketsisasymmetricinformation–onepartyhasinformationthatisnotavailabletotheotherparty.3WhyhaveSocialInsurance?Ifaprivatefirmoffersinsuranceandcannotobservethehighrisksfromthelowrisks,likelytogetagroupofbuyersthatisadversetoitsinterests.Adverseselection–Individualwhoknowsheisespeciallylikelytocollectbenefitswillhaveanespeciallyhighdemandforinsurance.4WhyhaveSocialInsurance?Inaperfectlycompetitiveinsurancemarket,expectedprofitswillbedrivendownto$0.Adverseselectioncouldleadtoinsuranceplanslosingmoney,andraisingthepremiumsonlyexacerbatestheadverseselectionproblem.5WhyhaveSocialInsurance?Howcangovernmentinterventionimproveefficiency?Socialinsuranceprogramsarecompulsory:theadverseselectionproblemisavoidedbecausethelowrisksareforcedtopurchasetheinsurancepolicyaswell.Intheprivatemarket,thelowriskswouldbelesslikelythanthehighriskstopurchasetheinsurancepolicy.6WhyhaveSocialInsurance?OtherjustificationsLackofForesight/PaternalismForexample,someindividualsdoapoorjobofplanningfortheirretirement.MoralHazard“Gamingthesystem”EconomizeonDecision-makingcostsIncomedistribution7StructureofSocialSecurityManydetailsofSocialSecuritylaidoutinthefollowingslides.OnemotivationforpresentingthesedetailsisthatvirtuallyallcollegestudentsareaffectbySocialSecurity,thus,itisimportanttounderstandthedetails.8StructureofSocialSecurity:
BasicComponentsPay-as-you-goFinancingExplicittransfersBenefitstructureAgeatwhichbenefitsarewithdrawnRecipient’sfamilystatusFinancing9StructureofSocialSecurity:
BasicComponentsPay-as-you-goFinancingBenefitsforcurrentretireescomefrompaymentsmadebycurrentworkers.Earlyrecipientsreceivedveryhighreturnsontheircontributions.10StructureofSocialSecurity:
BasicComponentsExplicittransfersSupplementalSecurityIncome(SSI)wasenactedin1972,andisadministeredbytheSocialSecurityAdministration.Moreaccuratelyviewedasawelfareprogramratherthansocialinsurance.11StructureofSocialSecurity:
BasicComponentsBenefitStructureAverageIndexedMonthlyEarnings–areanindividual’saveragewagesthroughouttheirworkinglife.AdjustedforinflationWagesuptoaceilingOnlyhighest35yearsofearnings12StructureofSocialSecurity:
BasicComponentsOnlyhighest35yearsofearningscounttowardAIME.Considerapersonwithatypical“age-earnings”profile,whostartsworkatage22andretiresat67,andthereforehas45yearsoffull-timework.LikelythattheSocialSecuritytaxespaidfromages22-32willnotmatterforAIME.13StructureofSocialSecurity:
BasicComponentsBenefitStructureConvertAIMEintoPrimaryInsuranceAmount(PIA)–basicbenefitpayabletoaworkwhoretiresatthe“normalretirementage.”Benefitscheduleisprogressive,wherelower-earnersreceiveahigherproportionofpreviousearnings.14ExampleofBenefitCalculation(using2004rules)AverageAIMEMaximumAIME$2,774$5,892PIAformula90percentofthefirst$612ofAIME$550.80$550.8032percentofAIMEover$612andthrough$3,689691.84984.6415percentofAIMEover$3,6890.00330.45
Total1,242.641,865.89PIA1,242.601,865.8015StructureofSocialSecurity:
BasicComponentsTypicallow-earnerwhoretiredin2003received64%ofAIME.Averageearnerreceived48%Highearnerreceived40%.16StructureofSocialSecurity:
BasicComponentsAgeatwhichbenefitsarewithdrawnThenormalretirementageistheageatwhichanindividualqualifiesforfullSocialSecuritybenefits.Canretireasearlyasage62,butbenefitsarescaleddown.Benefitsarescaledupforretirementafterthenormalage.17StructureofSocialSecurity:
BasicComponentsNormalretirementageisbeingratchetedupfrom65to67foryoungergenerations.Implicitlyabenefitcut.18RetirementAgeisIncreasingYearofbirthNormalretirementage1937andprior65193865and2months193965and4months194065and6months194165and8months194265and10months1943-5466195566and2months195666and4months195766and6months195866and8months195966and10months1960andlater6719StructureofSocialSecurity:
BasicComponentsRecipient’sfamilystatusForasingleworkerwhoretiresatthenormalretirementage,themonthlybenefitequalsPIA.Aworkerwithadependentspouse(orchild)mayreceiveanadditional50%ofthePIA.20StructureofSocialSecurity:
BasicComponentsOtherdetailsUpto85%ofthebenefitscanbetaxedbyindividualswhoseincomeexceedcertainthresholds.Benefitsareindexedforinflation.Veryfewfinancialassetsofferthiskindofprotectionagainstinflation.Earningstestforretireeswhohavenotreachedthenormalretirementage.21StructureofSocialSecurity:
BasicComponentsFinancingPayrolltaxisaflatpercentageofanemployee’sannualgrosswagesuptoacap.Currently,theSocialSecuritypartofthepayrolltaxissplitequallybetweenemployerandemployee,witheachpaying6.2%ofgrosswages.Likelythatmuchoftheemployertaxisshiftedtoemployeesintheformoflowerwages.22StructureofSocialSecurity:
BasicComponentsFinancingPayrolltaxandthecaphaveincreaseddramaticallyovertime.InadditiontothecumulativeSocialSecuritypayrolltaxof12.4%,thereisalsoanuncappedMedicaretaxof2.9%,resultinginacumulativetaxof15.3%.23SocialSecurityTaxesareCappedMaximumEarningsTaxable:200220032004SocialSecurity(OASDIonly)$84,900$87,000$87,900MaximumTaxWithheld$5,263.80$5394$5,449.80Medicare(HIonly)NoLimitNoLimitNoLimit24StructureofSocialSecurity:
DistributionalIssuesSomepeoplebenefitmorethanothersfromSocialSecurityGiventhecomplexityoftheprogram,howdoeconomistsfigureoutwhowinsandwholoses?25StructureofSocialSecurity:
DistributionalIssuesSimulatelifetimenetbenefitsfordifferentrepresentativeindividualsSocialSecurityWealth:LifetimevalueofSocialSecuritybenefits,discountedtopresentLifetimecostsofbeinginthesystem–payrolltaxes.SeeTable9.326Table9.327StructureofSocialSecurity:
DistributionalIssuesConclusionsfromTable9.3:SocialSecurityredistributesacrossincomegroupsSocialSecurityredistributesacrossgenerations28StructureofSocialSecurity:
DistributionalIssuesSocialSecurityredistributesinotherwaysaswell,manyofwhichmaybeunintended.Lifeexpectancyvariesby:Race,gender,smokingstatusSocialSecurityredistributestogroupswithhigherlifeexpectancies29StructureofSocialSecurity:
DistributionalIssuesSocialSecurityalsoredistributesbylivingarrangementsduetothe50%PIAadjustment.Considerbenefitsforthreehouseholds:SingleIndividualMarried,1earnerMarried,2earners30StructureofSocialSecurity:
DistributionalIssuesMarriedcoupleswithuncoveredspousesgainrelativetosinglepeoplebecauseofthe50%PIAadjustment.Marriedcoupleswithuncoveredspousesgainrelativetomarriedcoupleswithtwoearners.IfthesecondaryearnerwouldhaveasufficientlylowPIA(e.g.,PIA2issmallrelativetoPIA1),thenthehigherPIA(PIA1)entirelydeterminesthebenefit.AllofthepayrollcontributionsforPIA2inthiscasearetaxedaway.31StructureofSocialSecurity:
DistributionalIssuesEconomicstatusoftheAgedElderlyusedtobearelativelydisadvantagedgroupElderlynowhavelowerpovertyratesthantheaveragehousehold32EffectsonEconomicBehaviorSavingbehaviorRetirementdecisions33EffectsonEconomicBehavior:SavingbehaviorLife-cycletheoryofsavingsstatesthatconsumptionandsavingsdecisionsarebasedonlifetimeconsiderations.Generallywantto“consumption-smooth”Thus,shouldsaveduringworkingyearswhenincomeishigh,anddissaveduringretirementyearswhenincomeislow.34EffectsonEconomicBehavior:SavingbehaviorSocialSecurityaffectstheseincentivesWealthsubstitutioneffect:Householdsviewthegovernmentasdoingsomeofthissavingforthem(↓S)Retirementeffect:SocialSecuritymayinducepeopletoretireearlier,thusmoreperiodsofretirementtofinance(↑S)Bequesteffect:SocialSecurityredistributesfromtheyoungtotheold,andparentsmayoffsetthiswithlargerbequests(↑S)35EffectsonEconomicBehavior:SavingbehaviorNeteffectofSocialSecurityonpersonalsavingsdecisionsisambiguous.EmpiricalworkfindsthatSocialSecurityincreasesconsumptionandreducessavings(e.g.,thewealthsubstitutioneffectdominates).CalculationssuggestSocialSecurityreducedpersonalsavingsfrom$744to$296billion.Hugenegativeimpact36EffectsonEconomicBehavior:RetirementdecisionsDramaticfallinlaborforceparticipationamongmenover65In1930,54%inlaborforce.In2001,18%inlaborforceManyfactorsmayhavecontributedtothis,includingSocialSecurity37EffectsonEconomicBehavior:RetirementdecisionsSocialSecurity’sadjustmentstobenefitscreateincentivestoretireat65Althoughthebenefitsareadjustedupwardafterthat,theadjustmentsareactuariallyunfair.Ageatwhichbenefitsarefirstavailablehasanimportanteffectonlikelihoodofretirement.38Long-TermStressesonSocialSecurityGivenitscurrentpay-as-you-gostructure,SocialSecurityisfinanciallyunstable.Instablesystem,benefitsreceivedequalspaymentscollected.Wecandecomposethesetwoparts.39Long-TermStressesonSocialSecurityBenefitsreceived:Paymentscollected:WhereNb=numberofretirees,B=averagebenefitperretiree,t=taxrate,Nw=numberofworkers,andw=averagewageperworker40Long-TermStressesonSocialSecurityForsolvency,wemusthave:Orrearranging:Thefirsttermontherighthandsideisthedependencyratio,andthesecondtermisthereplacementratio.41Long-TermStressesonSocialSecurityDependencyratiohasbeengoingdownbecauseofanagingpopulation.Currently3workersperretireeBy2030,0.5workersperretireeOnlywaytokeepsystemstablewouldbetoincreasetaxesorlowerbenefits.42SocialSecurityReformTweakthecurrentsystemRaisepayrolltax,increaseretirementagePrivatize
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