The Economic Effects of Social Security

1. The Economic Effects of Social Security October 10-12, 2005

2. By the end of today, you should be able to: • Describe effect of Social Security on labor supply, and why we care • Describe effect of Social Security on national saving, and why we care

3. Social Security & Labor Supply • During working life • If 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 retirement • Social Security can effect decision about when to retire – the effect is complicated

4. Social Security & Retirement • Wealth effects • Social 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 work • Net effect of Social Security system on the value of working another year

5. SS Implicit Taxes • If 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 benefits • She gets a higher benefit level for the rest of her life due to the actuarial adjustment • The 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 attractive • Last 2 factors make work more attractive

6. “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)

7. Time Series Evidence on SS and Retirement • Social Security grew rapidly in the 1960s and 1970s • Labor force participation rates dropped over this same period • Not necessarily causal!

8. 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 age • Not necessarily causal • See figure 13-3 in Gruber reading

9. International Comparisons • France: 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

11. Net Effect of SS on Retirement • Evidence is pretty overwhelming that Social Security has a significant effect on retirement age • Do we care? • We may be underutilizing a significant economic resources  our experienced workers! • Losses in economic efficiency • Particularly important given that 77 million baby boomers are on the cusp of retirement!

12. National Savings • National saving = individual saving + gov’t saving • We care about national savings because it provides the “fuel” for investment, and thus long-term economic growth • Understanding 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)

13. SS and National Saving • Individuals have 12.4% of their income go to pay Social Security payroll taxes • In return, they receive retirement benefits in the future • This crowds out private saving • But there is no corresponding increase in government saving because of “pay-as-you-go” nature of the program

14. How Big is the “Crowd-Out”? • There is a substantial body of economic research examining this question using • Changes in savings over time • Differences across individuals • Differences 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!

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

16. What about the Trust Fund? • Any surpluses from Social Security are credited to a Trust Fund • Trust fund creates a legal liability for the U.S. Treasury • When SSA redeems the bonds, Treasury must find the money to pay for them • The bonds are an asset to SSA, but a liability for the U.S. Treasury

18. The Trust Fund and Savings • At end of 2004, the trust fund held nearly $1.7 trillion in government bonds • Does 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 $1 • But should we hold other spending constant?

19. TF and Budget Accounting • Social Security is “Off Budget” • But the “unified budget” includes Social Security • Any 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.

20. 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 spent • But the lock box was soon broken • Large deficit spending • Is there a better lock box?