L21: Social Security Flashcards
life cycle model
predicts that individuals work and save when young, living off principal and interest on savings when old
justifications for social insurance and social security
myopia/lack of self-control
- individuals unable to save enough for retirement
lack of annuity markets
- uncertain life expectancy
inability to work
- early disability
samaritan’s dilemma
- individuals rationally save too little if there is means-tested old-age assistance
- SS forces them to save
social security details
individual has to have worked and paid payroll taxes for at least 10 years and must be 62+
financed through the federal insurance contributions act (FICA) tax on earnings
funded vs unfunded pension systems
funded
- contributions invested in financial assets that pay for benefits in the future
- each generation funds their own benefits
unfunded
- contributions pay for benefits of current recipients instead of being invested to pay for future benefits
funded system equation
current benefits = past contributions by benefit recipients + market returns on contributions
unfunded system equation
current benefits = current contributions
rate of return on contributions depends on growth of payroll = n + g (n as population growth and g as the rate of real wage growth per worker)
social security redistribution
across cohorts
- unfunded system gives windfalls to early generations and below-market returns to later ones
within cohorts
- replacement rates fall with income
social security wealth
expected PDV of a person’s future social security benefits - expected PDV of payroll tax payments
rationale for social security
individual failure as the main one
- people won’t save enough for retirement without being forced to do so
people who are forced to save aren’t harmed by it anyways
crowding out and myopia
large share of elderly rely almost exclusively on social security benefits
old-age poverty declined sharply over time as social security benefits increased
social security crowds out private saving but crowding out is incomplete
fall in expenditures at retirement, suggesting further drop without social security
another rationale for social security
form of an annuity paid while individual is alive
for myopic individuals, saving until retirement isn’t the only problem
- need to maintain resources in retirement
- prevents overconsumption of wealth in early years of retirement
private annuity market has the problem of information asymmetry
how does social security affect retirement behaviour?
generosity of benefits
availability of benefits at the early entitlement age
actuarial adjustment of benefits for those who delay retirement to full benefits age or maximum age
social security reforms
raise tax revenues collected and the tax rate on taxable wages
extend base of taxable wages
reduce benefits paid out
more fundamental reform: privatisation
replacing all or part of the public system with a system of private accounts like 401ks
issue with the privatisation argument
still needs to find alternative source of funding for legacy debt (existing unfunded liability)
- burden of this debt offsets higher market returns on private accounts
