## Social Security and Race

No. 236
Monday, October 02, 2000
by Liquin Liu and Andrew J. Rettenmaier

## Executive Summary

Social Security is a system in which people pay taxes during their working years and get back benefits in return. Accordingly, there are two interesting questions that can be asked:

• Are the benefits individuals can expect to receive greater than, less than or equal to the value of taxes they can expect to pay?
• Given expected benefits and taxes, what is the rate of return and how does it compare to the return on alternative private investments?

To answer these questions, we have made calculations for individuals born in different years based on their sex, race and marital status. In making these calculations, we estimate lifetime earnings patterns and life expectancies and identify tax rates for people born in different years. We estimate benefits based on Social Security's benefit formulas.

How do we know what expected taxes and benefits are for any given individual? After all, there is some chance the individual could die tomorrow, and some chance he or she could live beyond age 100. To deal with this problem, we have considered all possible life spans and the associated streams of tax payments and Social Security benefits. The expected outcome of participating in Social Security is the sum of all these potential outcomes, each weighted by its probability of occurring.

Present Values for Men. We find that most people who are currently working can expect to receive less in Social Security benefits than they have paid in payroll taxes. And there are differences in how the system affects racial groups. For example, consider people entering the workforce today at age 20:

• A black male can expect to pay \$61,645 in Social Security taxes during his working years, but will get back only \$20,666 in benefits (where both taxes and benefits are expressed in current dollars, measured at a 4 percent discount rate).
• For this worker, the consequence of participating in Social Security is a net lifetime loss of \$40,979.
• By contrast, a white male can expect to pay more than one-third more in taxes (\$84,891), receive almost twice as much in benefits (\$40,060) and experience a slightly larger net lifetime loss (\$44,831).

What explains this racial disparity? It is the outcome of two counteracting factors: one that favors blacks and one that favors whites. On the one hand, black workers are disadvantaged by the fact that they have a higher mortality rate at ever age. For example:

• Among 20-year-old white men, almost 84 percent are expected to reach the normal retirement age.
• By contrast, fewer than 64 percent of 20-year-old black men are expected to live that long.

Thus although he pays the same payroll tax rate while he is working, the average 20-year-old black male can expect to draw fewer monthly retirement benefit checks, on the average. On the other hand, the lifetime earnings of a young black worker are only 78 percent of those of his white counterpart, on the average. And since Social Security's benefit formula favors lower-income workers, it rewards the average black retiree's contributions more than the average white retiree's contributions, other things equal.

Present Values for Women. Because they tend to earn lower wages, women can expect to pay less in Social Security taxes than men over the course of a lifetime. However, since women have longer life expectancies, they can expect to cash more benefit checks. As a result, the expected losses for women entering the labor market today are smaller than for men, although they are larger for white women than for black women. On the average:

• A black female entering the labor market at age 20 can expect to pay \$31,913 more in taxes than she will get back in benefits.
• A 20-year-old white female can expect to pay \$34,920 more in taxes than she will get back in benefits.

As in the case of the men, white women can expect to live longer than black women. For example, about 90 percent of today's 20-year-old white females are expected to reach the retirement age in contrast to 79 percent of black females. This advantage is somewhat offset, however, by a benefit formula which, as we have seen, favors lower income earnings. On the average, the lifetime earnings of white females are expected to be about 25 percent greater than for black females.

Present Values for Married Couples. Social Security's survivors benefits and spousal benefits make all of these numbers look better - particularly if the workers are married to spouses who never work. For example, a nonworking wife is entitled to a spousal benefit equal to 50 percent of her husband's benefit and, if she survives him, 100 percent of his benefit for the remainder of her life. In this case, Social Security is a better deal, but still not a good one. For 20-year-olds in this case, the net lifetime loss is about \$14,000 for both races.

Of course, in today's labor market it is increasingly rare to find women who never work. Typically, those who do not work continuously, work part-time or move in and out of the labor market over the course of a work life. At the time of retirement, these women can claim a benefit based on their own taxes, or a spousal benefit based on their husbands' taxes, whichever is higher - but not both. Since they are entitled to the spousal benefit anyway, women who choose this option get nothing in return for the payroll taxes they have paid.

Changes Over Time. The pattern of net lifetime losses for today's older workers varies somewhat from that for younger workers, with racial disparities increasing for today's middle-aged men, but actually reversing signs among middle-aged women:

• Although for today's 20-year-olds, the net lifetime loss for white males is typically about 9 percent greater than for black males, among 40-year-olds the loss for whites is about one-third greater than for blacks.
• Although 20-year-old white females fare about 10 percent worse than blacks, today's 45-year-old white females fare about 7 percent better than blacks.

What explains these differences in racial discrepancies among different age groups? For men, the answer seems to be that incomes are converging with the passage of time. Among 65-year-olds, the life time earnings of the average black worker are only 71 percent of the average white worker. As noted above, among 20-year-olds, the discrepancy has narrowed to 78 percent. As wages converge, the outcomes will converge as well.

Among women there is a completely different pattern. Relative to black women, white women today are more likely to enter the labor market and remain there than their mothers and grandmothers. For example, although 20-year-old white women can expect 25 percent higher lifetime earnings than their black counterparts, but among 65-year-olds, white women have earned only 92 percent of what black women have earned.

Rates of Return for Men. Although whites typically do worse than blacks when measured in terms of present values, whites actually do better than blacks when measured in terms of rates of return. For example:

• A 20-year-old black male can expect a real rate of return on the payroll taxes he pays of only 0.73 percent; by contrast, a white male can expect a return of 1.82 percent - more than twice as much.
• Of course, in both cases, the return is well below what they should be able to earn by investing in stocks and bonds.

What explains racial disparities in rates of return? As was the case with present value, it is the outcome of conflicting factors. The net result is that:

• Twenty-year-old white males can expect back 47 cents in benefits for every \$1 they pay in taxes.
• By contrast, their black counterparts can expect to get back only 34 cents.

But if whites do better than blacks from a rate of return perspective, why do they do worse when measured by present value? One way to think about this result is to note that both white and black workers are receiving a return well below what could be earned on alternative investments. So both sets of workers lose money. However, the present value loss for the average white worker is greater because he is forced to "invest" more dollars in the system (\$85,000 in lifetime taxes versus \$62,000 for the average black worker.)

Rates of Return for Women and Married Couples. As in the case of present values, women do better than men based on rates of return; and couples with a nonworking spouse do better than singles. Yet in these cases, there remains a racial disparity that favors whites. Specifically:

• A black female can expect a rate of return of 1.7 percent, in contrast to the 2.2 percent expected for a white female.
• A black male with a nonworking wife can expect a return of 2.97 percent, whereas a white male with a nonworking wife can expect a return of 3.46 percent.

Changes Over Time. In general, older generations are receiving reasonable rates of return from Social Security, especially among couples with dependent spouses. For example, married men with nonworking wives retiring at age 65 today can expect a rate of return of 4.43 percent for blacks and 4.35 percent for whites. But almost all future retirees will, on the average, have worse rates of return than they would have received if their tax payments had been privately invested. And because the number of workers paying taxes to support each beneficiary will continue to fall, it is evident that tax rates will have to rise in coming years. Thus it is not surprising that many younger workers view Social Security as an ever-increasing tax burden rather than as an income security program.