Social Security and Race

Studies | Social | Social Security

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

Estimating Social Security's Costs and Benefits for Groups of Workers

As the examples above illustrate, a well-defined stream of expected tax payments and expected retirement benefits exists for every worker. In each case, it is possible to calculate the internal rate of return and the net present value of the investment. For each individual, Social Security represents a different investment whose attractiveness depends on one's earnings, longevity, marital status, number of children and spouse's longevity.

"This study evaluates Social Security based on the internal rate of return and net present value of the investment."

In this study we analyze Social Security as an investment for individuals based on their birth year, sex, race and marital status. Rates of return and net present values for each group are calculated. Calculating the rates of return and net present values by group requires estimating the size and frequency of each stream of tax payments and benefits. Tax payments are directly related to the group's life cycle earnings and tax rates. Benefits are calculated by applying the Social Security benefit formula to each stream of earnings. Each group's specific mortality determines the magnitude and prevalence of tax payments and benefits. Specifically, retirement benefits are weighted more heavily for groups with longer expected life spans, while the life insurance benefits are more heavily weighted in the calculations for groups with higher mortality rates at younger ages.

Estimating Life Cycle Earnings. Projected life cycle earnings are estimated by applying historical growth rates derived from a Census Bureau data set known as the Current Population Survey (CPS). We use the annual March CPS supplements that include a wealth of labor market information at the individual level.3 The advantage of using life cycle earnings4 is that the average worker in each birth year and racial category progresses through the same inflation-adjusted earning cycle - typified by low earnings when young, rapidly rising earnings up to the middle to late thirties, continued rising earnings but at a lower pace up to the late forties to early fifties, then declining earnings until retirement.5

Economic Assumptions. As noted above, the benefit formula determines how much of an individual's income is replaced. For this study, the future components of the benefit formula are derived using the Social Security Administration's intermediate estimates of wage and price growth. Social Security benefits are also annually adjusted for inflation; we use the SSA's intermediate assumptions for inflation.

Projecting Tax Rates. Historical tax rates are used up to the present, and projected rates from the Social Security Trustees Report are used in future years. Today's older workers faced lower tax rates in their youth, while today's younger workers are likely to face higher rates in the future. The current payroll tax rate of 10.60 percent for OASI is set by law and is not scheduled to change. However, according to the 2000 Trustees Report, Social Security expenses will begin exceeding tax revenues in 2016. Although general tax revenues could be used to make up the shortfall, we assume workers will bear the full burden of financing future benefit payments through an increase in the payroll tax rate. This assumption ignores the redemption of Trust Fund bonds but represents an intermediate case in which each generation bears the burden of the financing shortfall.6

Estimating Longevity. For mortality estimates by racial groups, we need estimates for each birth year from 1935 to 1980 and for both black and white men and women. The Census Bureau has estimated life tables in future years by race and sex. These estimates are the starting point for the birth-year-specific estimates we use. Social Security Administration estimates by birth year are used to supplement the Census data for older individuals.7

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