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Social security programs
Frances Perkins and Social Security
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Frances Perkins served as Secretary of Labor during the entire RooseveltAdministration, from 1933 to 1945, serving longer than any other Secretary inthe Department's history. She was the only woman in the Cabinet and the firstone ever appointed to such a high federal position.
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Of all the New Deal reform and relief programs, the most important anddurable was Social Security, and without Frances Perkins it might never havebeen enacted.–
Long a proponent of public old-age insurance, Perkins had only accepted her postat the Labor Department on the condition that FDR would back her in seeking thisgoal.
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She led a campaign to convince the nation that a pension system would both behumanitarian and also help prevent future depressions.
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By 1935 public opinion was thoroughly in favor of the idea. So was the Congress,goaded by fear of demagogues such as Francis Townsend who were mobilizingmillions of despairing elderly citizens with plans for large, guaranteed federalpensions.
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The Social Security Act passed in 1935 and provided direct aid for the destituteelderly and a pension program for many, but far from all, workers. It also providedfederal funding for state-operated unemployment insurance programs, as well asaid for the handicapped and for mothers with dependent children.
Social security program in the US
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The official name of social security program is Old-age,Survivors and Disability Insurance Program. It is managedby a independent agency called Social SecurityAdministration.
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Originally only formal worker receives benefitsproportional to his contribution. 1939 Act extended thebenefits to spouses (50% of the benefits of the primaryworkers) and widows (75% of the benefits of the primaryworkers).
Scheduled and actual payroll tax rate
Earnings test
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Originally, A recipient lost all his benefits for the monthduring which wages exceed a cutoff.
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Subsequent changes–
Recipient aged 75 and over are exempt in 1950. The age limited islower to 72 in 1954 and 70 in 1970.
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All or nothing approach is replace by a system in which benefits isreduced 1 for 1 with wages over an annual exempt amount in 1954.
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In 1972, the offset was lower to 1 for 2 and under 1983 acts, it waslowered to 1 for 3.
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The annual exempt amount as percentage of average wage hasincreased from 15% to above 47%.
Funded or Pay-as-you-go?
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US has pay-as-you-go system–
The current payroll tax payers support the payment to the current socialsecurity claimants. Any surplus (contribution minus benefits claims)generated is accrued to the social security trust funds.
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Government pools all the contribution and trust funds are managed bysocial security administration.
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Funds are exclusively invested in the US government bonds.
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Proposed reforms–
Fully-funded system: The current worker's contribution is invested andused to pay their own benefits in the future.
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This can be done by
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putting workers' contribution into individual accounts and managed byindividual workers (Privatization).
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government to pool all the accounts and managed by a designated agency.
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Funds can be invested in government bonds only or in diversifiedportfolio (Diversification).
Pay-as-you-go program in an overlapping generation model
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Demographics–
At the beginning of each period, a new generation is born. The size of thegeneration t is N
.t
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Each generation only live for two periods.
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At the period t, generation t and t-1 are alive.–
Generation t are young. They work and receives labor income y
.t
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Generation t-1 are old. They have no income without social security andeat up their savings.
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The population growth rate is n and the wage income growth rate is g.The growth of the wage income is mainly due to accumulation ofcapital and technological progress.–
N
t+
= (1+n)N
t
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yt+
= (1+g)y
t
Elderly living in Poverty
by Engelhardt and Gruber
ESTIMATE OF POVERTY THRESHOLDS FOR 2004
by bureau of census
Size of Family Unit
Estimated Threshold
1 person (unrelated individual)................................………….$9,
Under 65 years ............................................................…….9,82765 years and over .......................................................……..9,
2 people ............................................................................…..$12,
Householder under 65 years …...........................…………12,714Householder 65 years and over ..........................…………11,
Social security has helped cut the elderly poverty rate by 2/
Current social security program is also an income redistribution program•
Social security tax (payroll tax) rate in 2003–
Tax rate for employees and employers each 6.2%.
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Tax rate for the self-employed 12.4%.
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There is an upper bound on taxable income–
In 2003, it is $84,900, corresponds to a monthly income of $7,
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The upper bound increased faster than average wage
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Benefits as percentage of income decreases as income increases
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Income used to compute benefits is supposedly indexed by growth rateof wage.
Cap of the taxable wage income increased faster than average wage
$ $90,000$80,000$70,000$60,000$50,000$40,000$30,000$20,000$10,
1975
1980
1985
1990
1995
2000
2005
Average wage
Cap of SS taxable income
Benefits formula for 2004 cohort
A careful look at the actual return of current social security program
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Annual benefits = average benefits-income ratio*taxable income
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Annual contributions = payroll tax rate*taxable income
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Adjust for the fact that an average worker contribute for 40 year andreceive benefits only for 15 years.^ Gross accumulated return implied by benefit schedule =
number of years of benefitsaverage benefits-income ratiotaxable income
number of years of contributionspayroll tax ratetaxable income
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Adjust for the fact that the first contribution would have been sitting in thebank accumulated interest for 40 years if saved, the last only for a month.^ –
Average length of investment = ½*number of years of contributions
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Gross accumulated return = (1+annual return)
average length of investment
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Personal return = annual return implied by benefit schedule + real growth rateof benefits
Growth rate of SS benefits tracts inflation rate more than the
wage growth rate.
16 14 12 10 8 6 4 2 0 1975 -
1976
1977
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1980
1981
1982
1983
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1985
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1989
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1991
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2001
2002
growth of SS benefits
Average wage growth
Inflation rate (CPI)
Big winner in the pay-as-you-go social security program:
the initial old
Why social security needs to be “saved”?
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The theoretical return that balances budget for pay-as-you-go social securityprogram is growth rate of wage + growth rate of working population. Theactual return differs from that.
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Social security program started in 1930s. In the past 70 years, the actual returnis lower than the budget balance return due to huge increase of workingpopulation driven by increased female labor force participation and babyboomers.–
The average growth rate of wage (1975-2002) = 0.64%
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The average growth rate of working population (1965-1990) =1.68%
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Social security program has accumulated sizable trust funds, which ismandated to be invested in the US government securities. By the end of 2004,net value of the trust fund is $1.5 trillion, 13% of GDP.
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In the next 40 years, the promised return will be higher than the projectedbudget balance return. Social security trust funds will be exhausted by 2037, asprojected by the trustee reports of the social security program. From that timeon, social security program starts to accumulate deficits. In another word,social security program becomes insolvent or “bankrupt”.
Big swings in the US population growth
Numerical increse in millions
16
19
35302520151050
1900-10 1910-20 1920-30 1930-40 1940-50 1950-60 1960-70 1970-80 1980-90 1990-
Percentage increase
21
19
25 2015105 0
1900-
1910-
1920-
1930-
1940-
1950-
1960-
1970-
1980-
1990-
life-expectancy at age 65 increased and is expected to increase further
25 20 15 10 5 0 1940
1950
1960
1970
1980
1990
1992
1994
1996
1998
2000
2002
2005
2015
2025
2035
Male
Female
Baby boomers reaching retirement age and the increase of lifespan leads to dramatic increase of social security beneficiaries
The number of beneficiaries per 100 workers is projected to increase. 60 50 40 30 20 10 0 1945
1955
1965
1975
1985
1991
1993
1995
1997
1999
2001
2003
2010
2020
2030
2040
What are the consequences?
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To keep the promised benefits level, the burden on future generationsof working population increases, because–
due to lower population growth and baby boomers reaching retirement age,the number of newly added workers is less than the number of retirees.
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increased life-expectancy increases the years of benefits relative to yearsof contribution.
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The first reduces the budget balance return; the second increases theimplied return of the benefit schedule. When the implied return is higherthan the balance budget return, social security program runs deficits,which eventually has to be paid by taxes in the future.
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Don’t count on the social security trust funds. It is held in the form ofgovernment debt. It is money already spent. To use them, more generaltax has to be collected so that government can repay the debt.
To save social security
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Hope that the budget balance return increases–
Productivity increases at a much faster rate
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Fertility rate will not decline further
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Increasing working population through immigration
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Reduce the implied return of benefits schedule–
Increase payroll tax
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Increase the upper bound of taxable income (?)
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Reduce benefits-income ratio
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Increase the normal retirement age
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Index the benefits by inflation only
Under President Bush’s 2005 plan
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Who would open an account?
High income workers who are getting a lousy deal from
the current social security system.
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How much payroll tax would be diverted to individual investment accounts? Maximum allowed amount of the high income workers. Accumulated divertedcontributions over the next 10 years, $2 trillion. Market capitalization of NYSE listedstocks, $19.8 trillion at the end of 2002. (NASDAQ and AMEX are much smaller)
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Save the social security?
The solvency of social security is worsened. The next step is
to reduce benefits level, which mainly will affect the poor, because they opt to stay inthe old system.
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Reduce the burden of future generations?
Diverting funds from bond market to stock
market will increase the interest rate and increase the stock price. Current stock holdersenjoy a windfall of capital gain. Who are they? The old and rich. Increased governmentdebt and increased interest payments increases the tax burden of future generation.
Summary
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Characteristics of current social security system in the US
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Pay-as-you-go social security system vs. fully fundedsocial security system
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Why social security needs to be “saved”?
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Various reform proposal
Reminder
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Reading:–
History of the social security in the US (optional)
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Save social security is not enough (optional)
