The Economic Effects of Social Security

October 10-12, 2005

By the end of today, you should be able to:

Describe effect of Social Security on labor supply, and why we careDescribe effect of Social Security on national saving, and why we care

Social Security & Labor Supply

During working lifeIf individuals do not see direct link between another dollar paid in taxes and an increase in future benefits, then it can operate like a pure tax, distorting labor supply decisions

At retirementSocial Security can effect decision about when to retire – the effect is complicated

Social Security & Retirement

Wealth effectsSocial Security makes some individuals “richer” and some “poorer” than they would otherwise due to redistribution• Those who feel “richer” will retire earlier• Those who feel “poorer” will retire later

Implicit taxes on additional workNet effect of Social Security system on the value of working another year

SS Implicit TaxesIf a 62 year old works one more year …

She pays an extra year of payroll taxes on her earnings She receives one fewer year of SS benefitsShe gets a higher benefit level for the rest of her life due to the actuarial adjustmentThe benefit (PIA) formula only counts highest 35 years of work – so she may replace a low year with a higher year, effecting benefit level

First 2 factors may work less attractiveLast 2 factors make work more attractive

“Earnings Test”

If those who are age 62-64 claim their benefits but continue to work, their benefit is reduced by 50 cents for every dollar of income over approximately $12,000.Widely viewed as a “pure tax”In fact, these benefits are “returned” later in life through higher benefits (actuarially adjusted)

Time Series Evidence on SS and Retirement

Social Security grew rapidly in the 1960s and 1970sLabor force participation rates dropped over this same period Not necessarily causal!

Evidence from Retirement Patterns

“Retirement hazard rate”: the percentage of people who are still working that retire at a particular age

Very strong pattern consistent with idea that retirement age is influenced by choice of early and normal retirement ageNot necessarily causal• See figure 13-3 in Gruber reading

International ComparisonsFrance: age 60 is the both the early and the normal (full benefits) retirement age

60% of those working when they turn 60 retire over the next year!30 years ago, when retiring at age 60 was not an option, only 10% retired at age 60. Instead, most worked until the previous early/full benefit retirement age of 65

Germany: Lowered its entitlement age from 65 to 60 in the year 1973. By 1980, the average age of retirement fell from 63 to 58!See figures 13-6 and 13-7 in Gruber reading

Net Effect of SS on RetirementEvidence is pretty overwhelming that Social Security has a significant effect on retirement ageDo we care?

We may be underutilizing a significant economic resources our experienced workers!Losses in economic efficiencyParticularly important given that 77 million baby boomers are on the cusp of retirement!

National SavingsNational saving =

individual saving + gov’t savingWe care about national savings because it provides the “fuel” for investment, and thus long-term economic growthUnderstanding effect of government policy is often difficult

Ex: Do 401(k) plans increase national savings?

• Individual saving rate clearly rises• But government revenues decline• Which is larger? (For 401(k)s, most believe there

is net increase)

SS and National Saving

Individuals have 12.4% of their income go to pay Social Security payroll taxesIn return, they receive retirement benefits in the futureThis crowds out private savingBut there is no corresponding increase in government saving because of “pay-as-you-go” nature of the program

How Big is the “Crowd-Out”?There is a substantial body of economic research examining this question using

Changes in savings over timeDifferences across individualsDifferences across countries

Each $1 of “Social Security Wealth” (i.e., the present value of future Social Security benefits) crowds out private saving by 30-40 cents.

Keep in mind, however, this is a huge program!

What difference does it make?Lower national saving rate less capital available for investmentLess investment lower rate of economic growthLower economic growth the “size of the economic pie” is smaller in the futureOne key issue to consider when discussing potential Social Security reforms is what effect it will have on national (public + private) saving

What about the Trust Fund?

Any surpluses from Social Security are credited to a Trust FundTrust fund creates a legal liability for the U.S. Treasury

When SSA redeems the bonds, Treasury must find the money to pay for themThe bonds are an asset to SSA, but a liability for the U.S. Treasury

The Trust Fund and Savings

At end of 2004, the trust fund held nearly $1.7 trillion in government bondsDoes this mean that the government “saved” $1.7 trillion over the past two decades?If we hold constant all non-SS spending and taxes, then running a $1 surplus in Social Security increases national saving by $1But should we hold other spending constant?

TF and Budget AccountingSocial Security is “Off Budget”But the “unified budget” includes Social SecurityAny analysts believe that the presence of large SS surpluses made it easier for Congress to spend more money in rest of the budget

Use the SS surpluses to hide deficits elsewhere“Raiding the trust fund” – technically, this did not happen. Economically, it might have.

The “Lock Box”

Featured prominently in 2000 election (and on Saturday Night Live!)Idea was to “lock the surpluses away” so that they would be saved, not spentBut the lock box was soon broken

Large deficit spending Is there a better lock box?