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1 Chapter9 SocialInsuranceI SocialSecurityandUnemploymentInsurance PublicFinance AaronS Yelowitz Copyright2003 McGraw Hill 2 SocialInsurancePrograms Generallysharefourcharacteristics ParticipationismandatoryEligibilityandbenefitsdependonpriorcontributionsBenefitsbeginwithanidentifiableoccurrenceProgramsarenotmeans tested 3 WhyHaveSocialInsurance RecallthattheFirstWelfareTheoremconcludedthatprivatemarketsgenerallyworkwell Onecriticaldifferenceininsurancemarketsisasymmetricinformation onepartyhasinformationthatisnotavailabletotheotherparty 4 WhyHaveSocialInsurance Ifaprivatefirmoffersinsuranceandcannotobservethehighrisksfromthelowrisks likelytogetagroupofbuyersthatisadversetoitsinterests Adverseselection Individualwhoknowsheisespeciallylikelytocollectbenefitswillhaveanespeciallyhighdemandforinsurance 5 WhyHaveSocialInsurance Inaperfectlycompetitiveinsurancemarket expectedprofitswillbedrivendownto 0 Adverseselectioncouldleadtoinsuranceplanslosingmoney andraisingthepremiumsonlyexacerbatestheadverseselectionproblem 6 WhyHaveSocialInsurance Howcangovernmentinterventionimproveefficiency Socialinsuranceprogramsarecompulsory theadverseselectionproblemisavoidedbecausethelowrisksareforcedtopurchasetheinsurancepolicyaswell Intheprivatemarket thelowriskswouldbelesslikelythanthehighriskstopurchasetheinsurancepolicy 7 WhyHaveSocialInsurance OtherjustificationsLackofForesight PaternalismForexample someindividualsdoapoorjobofplanningfortheirretirement MoralHazard Gamingthesystem Economizeondecision makingcostsIncomedistribution 8 StructureofSocialSecurity ManydetailsofSocialSecuritylaidoutinthefollowingslides OnemotivationforpresentingthesedetailsisthatvirtuallyallcollegestudentsareaffectbySocialSecurity thus itisimportanttounderstandthedetails 9 StructureofSocialSecurity BasicComponents Pay as you goFinancingExplicittransfersBenefitstructureAgeatwhichbenefitsarewithdrawnRecipient sfamilystatusFinancing 10 StructureofSocialSecurity BasicComponents Pay as you goFinancingBenefitsforcurrentretireescomefrompaymentsmadebycurrentworkers Earlyrecipientsreceivedveryhighreturnsontheircontributions 11 StructureofSocialSecurity BasicComponents ExplicittransfersSupplementalSecurityIncome SSI wasenactedin1972andisadministeredbytheSocialSecurityAdministration Moreaccuratelyviewedasawelfareprogramratherthansocialinsurance 12 StructureofSocialSecurity BasicComponents BenefitStructureAverageIndexedMonthlyEarnings areanindividual saveragewagesthroughouthisorherworkinglife AdjustedforinflationWagesuptoaceilingOnlyhighest35yearsofearnings 13 StructureofSocialSecurity BasicComponents Onlyhighest35yearsofearningscounttowardAIME Considerapersonwithatypical age earnings profile whostartsworkatage22andretiresat67 andthereforehas45yearsoffull timework LikelythattheSocialSecuritytaxespaidfromages22 32willnotmatterforAIME 14 StructureofSocialSecurity BasicComponents BenefitStructureConvertAIMEintoPrimaryInsuranceAmount PIA basicbenefitpayabletoaworkwhoretiresatthe normalretirementage Benefitscheduleisprogressive wherelower earnersreceiveahigherproportionofpreviousearnings ExampleofBenefitCalculation Using2004Rules 16 StructureofSocialSecurity BasicComponents Typicallow earnerwhoretiredin2003received64 ofAIME Averageearnerreceived48 Highearnerreceived40 17 StructureofSocialSecurity BasicComponents AgeatwhichbenefitsarewithdrawnThenormalretirementageistheageatwhichanindividualqualifiesforfullSocialSecuritybenefits Canretireasearlyasage62 butbenefitsarescaleddown Benefitsarescaledupforretirementafterthenormalage 18 StructureofSocialSecurity BasicComponents Normalretirementageisbeingratchetedupfrom65to67foryoungergenerations Implicitlyabenefitcut RetirementAgeisIncreasing 20 StructureofSocialSecurity BasicComponents Recipient sfamilystatusForasingleworkerwhoretiresatthenormalretirementage themonthlybenefitequalsPIA Aworkerwithadependentspouse orchild mayreceiveanadditional50 ofthePIA 21 StructureofSocialSecurity BasicComponents OtherdetailsUpto85 ofthebenefitscanbetaxedforindividualswhoseincomeexceedscertainthresholds Benefitsareindexedforinflation Veryfewfinancialassetsofferthiskindofprotectionagainstinflation Earningstestforretireeswhohavenotreachedthenormalretirementage 22 StructureofSocialSecurity BasicComponents FinancingPayrolltaxisaflatpercentageofanemployee sannualgrosswagesuptoacap Currently theSocialSecuritypartofthepayrolltaxissplitequallybetweenemployerandemployee witheachpaying6 2 ofgrosswages Likelythatmuchoftheemployertaxisshiftedtoemployeesintheformoflowerwages 23 StructureofSocialSecurity BasicComponents FinancingPayrolltaxandthecaphaveincreaseddramaticallyovertime InadditiontothecumulativeSocialSecuritypayrolltaxof12 4 thereisalsoanuncappedMedicaretaxof2 9 resultinginacumulativetaxof15 3 SocialSecurityTaxesAreCapped 25 StructureofSocialSecurity DistributionalIssues SomepeoplebenefitmorethanothersfromSocialSecurity Giventhecomplexityoftheprogram howdoeconomistsfigureoutwhowinsandwholoses 26 StructureofSocialSecurity DistributionalIssues Simulatelifetimenetbenefitsfordifferentrepresentativeindividuals SocialSecurityWealth LifetimevalueofSocialSecuritybenefits discountedtopresentLifetimecostsofbeinginthesystem payrolltaxes SeeTable9 3 Table9 3 28 StructureofSocialSecurity DistributionalIssues ConclusionsfromTable9 3 SocialSecurityredistributesacrossincomegroupsSocialSecurityredistributesacrossgenerations 29 StructureofSocialSecurity DistributionalIssues SocialSecurityredistributesinotherwaysaswell manyofwhichmaybeunintended SocialSecurityredistributestogroupswithhigherlifeexpectanciesLifeexpectancyvariesby Race gender smokingstatus 30 StructureofSocialSecurity DistributionalIssues SocialSecurityalsoredistributesbylivingarrangementsduetothe50 PIAadjustment Considerbenefitsforthreehouseholds SingleIndividual Married 1earner Married 2earners 31 StructureofSocialSecurity DistributionalIssues Marriedcoupleswithuncoveredspousesgainrelativetosinglepeoplebecauseofthe50 PIAadjustment Marriedcoupleswithuncoveredspousesgain relativetomarriedcoupleswithtwoearners IfthesecondaryearnerwouldhaveasufficientlylowPIA e g PIA2issmallrelativetoPIA1 thenthehigherPIA PIA1 entirelydeterminesthebenefit AllofthepayrollcontributionsforPIA2inthiscasearetaxedaway 32 StructureofSocialSecurity DistributionalIssues EconomicStatusoftheAgedElderlyusedtobearelativelydisadvantagedgroupElderlynowhavelowerpovertyratesthantheaveragehousehold 33 EffectsonEconomicBehavior SavingbehaviorRetirementdecisions 34 EffectsonEconomicBehavior SavingBehavior Life cycletheoryofsavingsstatesthatconsumptionandsavingsdecisionsarebasedonlifetimeconsiderations Generallywantto consumption smooth Thus shouldsaveduringworkingyearswhenincomeishigh anddissaveduringretirementyearswhenincomeislow 35 EffectsonEconomicBehavior SavingBehavior SocialSecurityaffectstheseincentivesWealthsubstitutioneffect Householdsviewthegovernmentasdoingsomeofthissavingforthem S Retirementeffect SocialSecuritymayinducepeopletoretireearlier thusmoreperiodsofretirementtofinance S Bequesteffect SocialSecurityredistributesfromtheyoungtotheold andparentsmayoffsetthiswithlargerbequests S 36 EffectsonEconomicBehavior SavingBehavior NeteffectofSocialSecurityonpersonalsavingsdecisionsisambiguous EmpiricalworkfindsthatSocialSecurityincreasesconsumptionandreducessavings e g thewealthsubstitutioneffectdominates CalculationssuggestSocialSecurityreducedpersonalsavingsfrom 744to 296billion Hugenegativeimpact 37 EffectsonEconomicBehavior RetirementDecisions Dramaticfallinlaborforceparticipationamongmenover65 In1930 54 inlaborforce In2001 18 inlaborforceManyfactorsmayhavecontributedtothis includingSocialSecurity 38 EffectsonEconomicBehavior RetirementDecisions SocialSecurity sadjustmentstobenefitscreateincentivestoretireat65 Althoughthebenefitsareadjustedupwardafterthat theadjustmentsareactuariallyunfair Ageatwhichbenefitsarefirstavailablehasanimportanteffectonlikelihoodofretirement 39 Long TermStressesonSocialSecurity Givenitscurrentpay as you gostructure SocialSecurityisfinanciallyunstable Instablesystem benefitsreceivedequalspaymentscollected Wecandecomposethesetwoparts 40 Long TermStressesonSocialSecurity Benefitsreceived Paymentscollected WhereNb numberofretirees B averagebenefitperretiree t taxrate Nw numberofworkers andw averagewageperworker 41 Long TermStressesonSocialSecurity Forsolvency wemusthave Orrearranging Thefirsttermontherighthandsideisthedependencyratio andthesecondtermisthereplacementratio 42 Long TermStressesonSocialSecurity Dependencyratiohasbeengoingdownbecauseofanagingpopulation Currently threeworkersperretireeBy2030 0 5workersperretireeOnlywaytokeepsystemstablewouldbetoincreasetaxesorlowerbenefits 43 SocialSecurityReform TweakthecurrentsystemRaisepayrolltax increaseretirementagePrivatizethesystemContributionsearmarkedforaccountwherethepersoncouldinvest