CHAPTER11 SOCIALSECURITY WhyHaveSocialSecurity ConsumptionSmoothingandtheAnnuityMarketHowSocialSecurityworksAnnuityConsumptionsmoothingAdverseSelectionandtheAnnuityMarketAsymmetricinformationAdverseselection OtherJustifications LackofforesightandpaternalismMoralhazardEconomizeondecision makingandadministrativecostsIncomeRedistributionImprovetheEconomicStatusoftheAged FullyFundedPlan TheGreatestGeneration TheBabyBoomGeneration GenerationX Work Retire Dead Unborn Work Work Retire StillDead Dead Childhood Childhood Retire Eachgeneration sbenefitsbasedondepositsitmadeduringworkinglifeplusaccumulatedinterest TheGreatestGeneration TheBabyBoomGeneration GenerationX Work Retire Dead Unborn Work Work Retire StillDead Dead Childhood Childhood Retire benefits PayAsYouGo orUnfunded System 0 Eachgeneration sbenefitscomefromtaxpaymentsmadebycurrentworkers TheGreatestGeneration TheBabyBoomGeneration GenerationX Work Retire Dead Unborn Work Work Retire StillDead Dead Childhood Childhood Retire benefits Today sPartiallyFundedSystem 0 BabyBoomersandGenXarealsocontributingtotheirownretirement ExplicitTransfers Benefitsfordependentsandsurvivors 1939 SupplementalSecurityIncome Benefits HowtocalculatebenefitsAIME AverageIndexedMonthlyEarnings averagemonthlyearningsin35highestpaidyearsWagesindexedforinflationCeilingonAIME uptotaxceiling 0 BenefitStructure IfAIME 3955 PIA 90 656 32 3955 656 15 AIME 3955 FirstBendPoint SecondBendPoint 0 Adjustments AnnualinflationadjustmentAgeatwhichbenefitisdrawnNormalretirementageEarlyretirement benefitreduced5 9thofonepercentamonthforfirst36monthsprecedingnormalretirementageLateretirement benefitincreased15 24thofonepercentamonth 0 Adjustments FamilyStatus 50 forspouseordependentchildIfcoveredworkerdiesspousereceives100 ofworker sbenefitorspouse sbenefitDivorcedspousemarriedatleast10yearsgetsspousebenefitifnotremarriedwhilecoveredworkeraliveEarningstestandtaxingbenefitsBenefitsreduced 1forevery 2earnedabove 12 480IndividualslosingbenefitsmayhavelaterbenefitsincreasedUpto85 ofbenefitstaxedforrecipientswithincomeaboveabaseamount 25 000forsingleand 32 000formarriedtaxpayers Financing FICA FederalInsuranceContributionAct 2006SocialSecurityTaxratesEmployee6 2 OASI 5 6 DI 6 offirst 94 200ofearningsonbothemployeeandemployerSelf employed12 4 2006MedicareTaxrates1 45 onbothemployerandemployeewithnoearningsceilingWhynotfundSocialSecuritythroughgeneraltaxrevenues 0 DistributionalIssues ActuariallyfairreturnIntergenerationalredistributionTotalbenefits Nb BTotaltaxes t Nw wIftotalbenefits totaltaxes Nb B t Nw worB t Nw Nb wIdaMaeFuller SocialSecurityWealthforRepresentativeIndividuals OtherDistributionalIssues RedistributionwithinagenerationDifferencesbyearningsDifferencesbylifespanDifferencesbylivingarrangementsDifferencesbynumberofearnersinthefamilyNormativeevaluation TheSocialSecurityTrustFund SocialSecurityandNationalSavingBudgetTreatmentofSocialSecurityOffbudgetUnifiedbudget 0 SocialSecurityandSavingsBehavior Life cycletheoryofsavingsWealthSubstitutionEffectRetirementEffectBequestEffect EmpiricalEvidence MartinFeldstein sworkCONS f DI W SSW X MPCssw 02860 reductioninpersonalsavingOthersRosen Socialsecurityhashadanegativeeffectonsaving butmagnitudeofeffectisunclear EffectsonRetirementandLaborSupply 1930LFPR65 was54 2001LFPR65 was18 EffectofSocialSecurityIncomeEffect SSraisesretirementincomeSubstitutionEffect SSreducesthecostofretiringEarningstestImpactonYoungerWorkers 0 DistributionofWealth BequeathablevAnnuitizedWealthEffectofSocialSecurityonBequeathableWealthEffectonWealthMobility BudgetConstraintforPresentandFutureConsumption Presentconsumption c0 Futureconsumption c1 N M I0 I1 D I0 S I1 1 r S S 1 r S I1 1 r B F B 1 r B Atendowmentpointconsumerneithersavesnorborrows Utility maximizingChoiceofPresentandFutureConsumption Presentconsumption c0 Futureconsumption c1 N M I0 I1 E1 c1 A c0 Saving CrowdingoutofprivatesavingduetoSocialSecurity Presentconsumption c0 Futureconsumption c1 N M I0 I1 E1 c1 A c0 R T I0T 1 r T SavingbeforeSocialSecurity SavingafterSocialSecurity OtherwaysSocialSecurityAffectsSaving RetirementeffectBequesteffectEmpiricalevidence RetirementDecisions SocialsecuritywealthandtheretirementdecisionEmpiricalevidenceDiamondandGruber 199 GruberandWise 2004 Long TermStressesonSocialSecurity Source SocialSecurityTrustees 2006 Long TermStressesonSocialSecurity Since B t Nw Nb wRearrange t Nw Nb B w DependencyRatio ReplacementRatio SocialSecurityReform TimehorizonforsolvencySustainablesolvency MaintaintheCurrentSystem RaisethepayrolltaxRaisetheMaximumTaxableEarningsLevelRaisetheRetirementAgeReducingtheCost of LivingAdjustmentChangetheBenefitFormulaComparingtheOptions PrivatizetheSystem PersonalAccountsProsandconsofpersonalaccountsEffectonSolvencyEffectonSavingCarve outaccountsAdd onaccountsRiskAdministrationDistribution PolicyPerspective PresidentBush sSocialSecurityReformProposal VoluntarypersonalaccountsCarve outsGovernmentmanagementPortfoliolimitationsBenefitoffsetsInheritabilityAchievingsustaina