Social Security and Education

Studies | Education | Social Security

No. 240
Wednesday, January 31, 2001
by Dr. Liqun Liu and Dr. Andrew J. Rettenmaier


Executive Summary

Since its inception, Social Security has been a popular program because most retirees have received reasonable rates of return on the payroll taxes they have paid. However, as the program matures and as future workers face the daunting task of paying for the retirement of the baby boom generation, taxes will rise and the investment value of Social Security will decline.

This paper considers Social Security as an investment for different classes of workers based on their level of education. Why education, rather than income? Everyone's income will vary a lot over the course of a 40- to 45-year work life. As a result, level of education is a better predictor of expected Social Security taxes and benefits than current wages.

Education affects a person's "investment" in Social Security in other ways. Someone who drops out of high school will pay payroll taxes for more years than someone who remains in school. Yet because of Social Security's peculiar rules, these extra years of payments do not add anything to retirement benefits. In this sense, Social Security penalizes those with less education. On the other hand, more education tends to produce higher income over an entire work life and higher-income workers are treated less generously under Social Security's benefit formula. How any particular individual is affected also depends on such factors as life expectancy, marital status, number of children and the life expectancy of a spouse.

We have made calculations for individuals born in different years with different levels of educational achievement. In each case, we have calculated the internal rate of return on payroll taxes paid and the net present value of Social Security: the value today of expected future benefits minus expected costs.

Among workers born in the same year, we find that in most cases those with less education receive a higher rate of return than those with more education. Using a conservative, inflation-adjusted discount rate of 4 percent, we find that the present values are negative in most cases regardless of age or education; but workers with less education have lower lifetime losses than those with more education.

Present Values for Single Men. For singles, our calculation assumes the worker's tax payments produce his own retirement benefits exclusively -with no spousal benefits, no surviving spouse benefits and no benefits to surviving children. We find that:

  • Regardless of the level of education and year of birth, single men would have done better if they could have invested their payroll tax dollars in the private capital market; however, those with more education do worse than those with less.
  • For example, a 20-year-old high school graduate can expect to pay $32,667 more in taxes than he receives in benefits.
  • A 20-year-old college graduate can expect a lifetime loss of $63,363.
  • A 20-year-old who stays in school and earns a graduate degree can expect a net loss of $93,170.
  • Social Security imposes not only a lifetime tax on workers, but also a loss that, while small or nonexistent during the program's early years, has grown through time.

Present Values for Single Women. There are similar differences in present values at various education levels for single women. However, their losses from Social Security are lower in general than for single men with the same education. The reason is that women have longer life expectancies (resulting in more monthly benefit checks) and lower predicted earnings (resulting in higher relative benefits and lower total taxes).

  • All single women born in 1950 and later would have done better if they could have invested their payroll tax dollars in the private capital market.
  • A 20-year-old high school graduate can expect to pay $20,858 more in taxes than she will receive in benefits over her lifetime.
  • A 20-year-old who goes on to graduate from college can expect a loss of $53,900.
  • A 20-year-old who obtains a graduate degree can expect a lifetime net loss of almost $76,900.
  • As in the case of men, the "tax" on education has grown over time and is much more significant today than it was 40 or 50 years ago.

Present Values for Married Couples. Our calculations for couples assume a male who works continuously over his work life and a female who never enters the labor market. This somewhat unrealistic picture produces the best possible outcome under Social Security's benefit formulas, relative to the results for singles. Even under these circumstances, today's 20-year-olds, other than those with less than a high school education, can expect a lifetime loss.

Rates of Return for Single Men Individuals with lower levels of education generally have a higher rate of return than do those with higher levels of education. Still, for single men at every age and educational level internal rates of return are well below what they could expect from a conservative investment in the private economy. For example:

  • A 20-year-old who earns a high school diploma can expect a 1.86 percent inflation-adjusted rate of return.
  • The rate of return drops to 1.4 percent for college graduates and to 0.96 percent for those who earn a graduate degree.
  • In general, these rates of return have declined over time; for example, the rate of return for a 65-year-old man with a graduate degree is 2.19 percent compared to 0.96 percent for a 20-year-old.

Rates of Return for Single Women. The rates of return start higher among older women and drop at every education level as age declines.

Rates of Return for Married Couples. Most married couples with nonworking spouses reaching retirement today can expect a real rate of return above 4 percent. However, among 20-year-olds only couples with less than a high school education can expect a real rate of return above 4 percent

The negative net present values and low rates of return for most education groups indicate that it is costly for workers to participate in Social Security. This holds for all groups except for some older people and those with the lowest levels of education.


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