1. COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

2. Entitlements Social Security payment is an entitlement
Payment to which eligible citizens have a right to receive by law
Entitlements are huge share of federal budget, and because payments are mandated by law, they are outside discretionary control of Congress
Only way payments can be decreased is to change law that entitles citizens to them
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3. Social Security Act
Social Security Act of 1935 established Social Security program
Original law provided only retirement benefits at age 65 for most workers in industry and commerce
Since then, law has been amended many times
Social Security now has provisions for disabled workers and their dependents and for survivors of deceased workers
Covers virtually entire working population, including self-employed, and benefits are tied to consumer price index so they increase automatically with inflation in economy
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4. Social Insurance vs. Private Insurance
Program provided by government and funded by payroll taxes of employers, employees, or both
Social Security is good example of social insurance
Purpose is pooling of risk of losses
Private insurance
Private program provided by for-profit insurance companies and funded by premiums
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5. Social Insurance Social insurance is compulsory
If you are a covered worker, you must pay Social Security taxes and participate in program
Social Security Administration is sole provider of social insurance; is therefore a government monopoly
Revenue for social insurance programs is provided by taxes earmarked for providing benefits to those who qualify
Since funds are taken directly from paycheck, are referred to as payroll taxes
Taxes based on earnings from work, usually deducted directly from workers’ paychecks
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6. Social Insurance (cont.)
Social Security is pay-as-you-go-system
Current taxes pay current benefits
Rights to benefits under Social Security is a statutory right
Right specified by law
If Congress changes law to make benefits either more or less generous, right to benefits will change with law
Social insurance is based on principles of individual equity and social adequacy
Individual equity
Benefits received are proportional to amounts paid in
Social adequacy
Benefits are sufficient to provide minimum level of economic security to population as a whole
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7. Private Insurance Private insurance is voluntary
Private insurance industry composed of large number of competing firms, although dominated by much smaller number of large firms
Funds generated from premium payments made by policyholders
By law, private insurers must operate on fully funded basis
Having sufficient reserves to pay all expected liabilities
Rights to benefits are contractual right
Right specified in contract between parties
Company cannot unilaterally change terms of policy
Based on principle of individual equity
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8. Characteristics of Social Insurance and Private Insurance
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9. Public Assistance Programs
Any government program targeted to aid low-income people
Public assistance programs are needs-based
To receive benefits, person must demonstrate that he or she is poor or that assets and income are below certain level
Benefits are paid not from earmarked taxes, but from government’s general revenues
No relationship between taxes paid in, currently or in past, and benefits received by recipients
Public assistance programs are pure welfare programs
Because every worker is eligible for Social Security and Medicare, but only poor receive welfare, stigma is attached
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10. Characteristics of Social Insurance and Public Assistance
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11. Social Security Taxes Determined by tax base and tax rate Tax base
Income, earnings, sales, property, or other valued items that have tax rate applied to them
In case of Social Security tax, tax base is earnings subject to payroll taxes
As of 2006, Social Security tax base was only first $94,200 of each worker’s annual earnings
Tax rate
Percentage of tax base that must be paid to government as tax
As of 2006, tax rate is 6.2 percent for Social Security
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12. Types of Taxes Regressive taxes Progressive taxes Proportional taxes
Taxes that take larger percentage of income from low-income people than from high-income people
Social Security tax is regressive for two reasons:
Only tax base is taxed in given year
Only earnings from working are taxable for Social Security and Medicare
Progressive taxes
Taxes that take larger percentage of income from high-income people than from low-income people
Proportional taxes
Taxes that take same percentage of income from people at all income levels
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13. Social Security Benefits
Mainly in form of checks mailed by U.S. Treasury to beneficiaries on first of each month
To qualify for benefits, recipient must be fully insured worker or dependent of fully insured worker
Benefit amounts based on retired worker’s prior Social Security tax contributions
Complex formula that takes into account worker’s highest 35 years of earnings determines amount of worker’s monthly check
Benefits are progressive in that low-earnings workers receive higher replacement rate than high-earnings workers do
Replacement rate is percentage of final working year’s earnings that is replaced by Social Security benefits
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14. The Long-Run Problem: An Aging Population
Average age of U.S. population is increasing; implies we have fewer workers paying taxes and more retirees receiving benefits
More workers are retiring at earlier ages; early retirements imply longer periods of retirement during which workers do not pay Social Security taxes but do receive benefits
Baby boomers are expected to begin retiring in first decade of 21st century; that group has higher life expectancy and lower birthrate than previous generations, and will swell ranks of retired still more
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15. Worker to Social Security Beneficiary Ratio
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16. Social Security Act of 1983 Major provisions of amendment are:
To raise normal retirement age
To begin building up trust fund accounts to care for increase in benefits expected when baby boomers retire
To begin to tax portion of Social Security retirement benefits for income tax purposes
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17. Normal Retirement Age
Minimum age at which workers can retire with full Social Security benefits
For first 60 years of program, normal retirement age was 65
Workers can also retire at 62, but retirement benefits are proportionally reduced
1983 amendment to Social Security Act gradually raises normal retirement age
By 2022, normal retirement age will be 67
Workers will still be able to retire at age 62 if willing to accept lower monthly benefits for remainder of lives
Closer to normal retirement age that they are when they retire, smaller the reduction in benefits that they will incur
Increase in normal retirement age means that many workers will pay taxes for two years longer, and will collect retirement benefits for two years fewer
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18. Trust Funds
Other change begun in 1983 was partial departure from pay-as-you-go philosophy of Social Security
Tax levels set to increase trust fund (taxes collected and invested specifically to pay future Social Security benefits) balances to pay benefits to baby boomers
Government is now collecting more taxes than needed to pay benefits to current retirees
Surplus taxes invested in U.S. government securities; earn interest that is also credited to trust funds
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19. Taxing Social Security Retirement Benefits
Originally, Social Security retirement benefits were exempt from income taxation
In 1984, retirees first began to pay federal income tax on Social Security benefits
Taxes paid are credited to Social Security trust funds and are invested in U.S. securities
About one-third of current Social Security recipients pay taxes on benefits
As of 2006, individual federal tax return filers pay tax on benefits if total income is more than $25,000
For joint return filers, total income for both spouses must be more than $32,000
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20. Long-Run Financial Viability of Social Security
Board of trustees of Social Security program must file periodic reports about long-range (75-year) financial outlook
In preparing reports, analysts make assumptions about:
Growth in economy
Growth in workforce
Number of retirees
Length of time that retirees collect benefits
2006 Trustees report projected that trust funds would continue to be built up over next several years and then begin to be drawn down but would not be exhausted until 2040
After funds are exhausted, will return to pay-as-you-go system
Given increasing proportion of older people, change could lead to either higher Social Security taxes or decreased retirement benefits
BOTTOM LINE: In short term, Social Security program is solvent, but in long run, program is not expected to be financially sound
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21. Should Social Security Be Made Voluntary?
Many conservatives argue that Social Security should be made voluntary, rather than compulsory
Arguments based on principles of greater economic freedom and limitation of role of government in our lives
Arguments for compulsory Social Security program are:
Voluntary program would make provision of minimum level of economic security to entire population more difficult
Poor could not afford to purchase private insurance or save to provide for own economic security
Voluntary system would be subject to greater adverse selection
Process by which insured people’s choices lead to higher-than-average loss levels for program’s sponsor
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22. Is Social Security Unfair to Younger Workers?
One of most complex issues involved in Social Security program is whether young workers will receive their money’s worth from Social Security
These workers pay Social Security taxes to support currently retired persons, survivors, and disabled persons
Value of taxes paid by younger workers and their employers exceed value of benefits they can expect to receive
Some critics of Social Security argue that younger workers are being cheated and that they should be allowed to opt out of Social Security and purchase private insurance protection, where they will receive a fairer deal
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23. Is Social Security Unfair to Younger Workers? (cont.)
Most studies indicating that young worker is cheated under Social Security make assumption that individual employee is entitled to all of employer’s tax contribution
Based on belief that firms pay lower wages to workers in order to compensate for Social Security taxes they pay on behalf of employees
If this assumption is not valid, and workers do not receive lower wages because of employers’ Social Security contributions, then belief that system is unfair to younger workers is not justified
Many studies supporting “bad buy” argument consider only survivor and retirement benefits
Researchers assume that if individual worker were given taxes paid by both employer and employee, worker could purchase life insurance and retirement annuity more cheaply than could acquire same coverage through Social Security program
Does not account for all benefits provided by Social Security (i.e., disability coverage and medical insurance through Medicare)
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24. The Widow’s Income Gap
Widows (or widowers) of covered workers can collect monthly survivorship benefits based on earnings record of deceased spouse
Surviving spouse’s benefits are paid only until youngest child reaches age 16
At age 60, surviving spouse can again collect benefits on earnings record of deceased worker
Benefits will be lost if surviving spouse remarries before reaching age 60
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25. Unfair Treatment of Working Wives
Wife can receive retirement benefits based on own earnings record, or can receive retirement benefits based on husband’s record
Social Security Administration will pay highest retirement benefits after calculating benefits using own record and husband’s
Usually, spousal benefits will be one-half of what husband receives
Wives who have never worked outside the home, or who did not work enough to be fully covered for retirement benefits, are entitled to same spousal benefits as are wives who worked throughout married lives
Many working wives discover they are entitled to larger spousal benefits than if they were to receive benefits based on own earnings record
Appears as if tax contributions are lost, and, at least for Social Security retirement purposes, that years of working do not matter
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26. Does Social Security Decrease Savings?
Critics of Social Security program argue that it has decreased private savings in United States
Need to save for retirement privately is decreased because Social Security program exists
Called Social Security wealth effect
Causes us to spend more during working years on consumer goods, because we do not feel the need to save
Others argue that Social Security actually increases private savings by encouraging earlier retirements
Called early retirement effect
Workers who retire earlier must provide for longer period of retirement and therefore must save more during working years
Trying to measure portion of savings affected by Social Security as opposed to portion of savings not affected by Social Security is difficult; results are inconclusive
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27. The Future of Social Security
Some changes that might be made:
Altering Social Security tax
Cutting current Social Security benefits
Increasing retirement ages
Investing Social Security taxes in stock market
Partial privatization
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28. Altering the Social Security Tax
Instead of placing ceiling on amount of earnings taxed each year, put floor in place instead
Very-high-income earners would be taxed more heavily than low-income earners
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29. Cutting Current Social Security Benefits
Various proposals have been made to cut current Social Security benefits
Some proposals tinker with benefits formula to decrease benefits of particular earnings classes
Others eliminate adjustments for inflation
Eliminating such cost-of-living adjustments is form of benefits reduction
Cutting current benefits would make trust funds last longer
Proponents of cutting benefits argue that this would make system more progressive, keep minimum floor of income under lower and average earners, and cut costs of Social Security program
Critics argue that cutting benefits might threaten individual equity principle that makes Social Security a social insurance program instead of a welfare program
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30. Increasing Retirement Ages
Another suggestion to strengthen system is to raise both normal retirement age and early retirement age
Proponents of additional increase in normal retirement age point out that U.S. economy is evolving from manufacturing economy to service and information economy and, therefore, jobs are less physically demanding
Also argue that advances in health care have made U.S. workers healthier in fifties and sixties
Proponents of increase in early retirement age argue that workers who choose early retirement at reduced benefits often do so without realizing how long they will need to provide for themselves in retirement
Raising early retirement age would encourage workers to continue working—and paying Social Security taxes—longer
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31. Investing Social Security Taxes in the Stock Market
Trust funds must be invested only in government securities, but stocks in America’s corporations often pay investors far higher rates of return than do government bonds
Many critics argue that allowing managers of Social Security trust funds to invest portion of tax revenue in stock market would greatly increase investment earnings of funds
Others point out that investment in stock market is more risky than investing in government securities
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32. Partial Privatization
President Bush has proposed that portions of Social Security program be privatized
Original proposal was that 2 percent of worker’s earnings be put into investment accounts selected by worker
Instead of Social Security Administration investing all Social Security tax revenue in government securities, worker would direct portion to be invested in stocks or mutual funds
Critics argue that high-wage earners will receive more sophisticated investment advice than will low-income workers
Would increase retirement income of high earners and decrease retirement income of low-income earners
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33. The Economic Left and the Economic Right
THE ECONOMIC RIGHT (Conservative)
Argue that we would be better off if we did not have to pay Social Security taxes but were encouraged by some measure, such as tax break, to provide for retirement or disability through private investments
Favor partial or total privatization
Favor making Social Security voluntary
THE ECONOMIC LEFT (Liberal)
Support principle of social, not private, insurance to provide minimum floor of income support under total population
Worry about regressivity of Social Security payroll tax and want to make changes to ensure continued financial viability of system
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