Social Security and Education
Wednesday, January 31, 2001
by Dr. Liqun Liu and Dr. Andrew J. Rettenmaier
Table of Contents
- Executive Summary
- Social Security's Costs and Benefits
- Estimating the Appeal of Social Security for Individuals with Different Education Levels
- Net Present Values
- Internal Rates of Return
- Costs and Benefits for Individuals Born in 1935 and 1980
- About the Authors
- Of the total payroll tax of 15.3 percent on employee and employer combined, 10.6 percent is for Old Age and Survivors Insurance. Of the remainder, 1.8 percent is for Disability Insurance and 2.9 percent for Medicare.
- Sylvester J. Schieber and John B. Shoven discuss this argument in The Real Deal: The History and Failure of Social Security (New Haven, Conn.: Yale University Press, 1999), p. 227.
- The birth years are every fifth year between 1935 and 1980. Within each birth year, individuals are further segmented into five education categories: less than high school, high school, some college, college graduates and graduate degrees.
- We deliberately chose education categories because they identify a persistent classification within a birth year. Because the average group member is the unit of observation, average earnings reflect those of all members of a group, including workers and nonworkers. Mortality rates are likewise based on the same reference point. Thus the results we obtain are representative of the outcomes for the average individual in a birth year by education group.
- We use data from 1963 to 1997. Actual average historical taxable earnings for each group are used in those years. A description of how we estimate life cycle earnings for each birth year is found in the Appendix.
- Several previous studies have used annual average Social Security earnings or some multiple or fraction of average earnings to represent the historical and projected experience of workers. Using the average based on all workers, young and old, overestimates earnings when workers are young and underestimates earnings when workers are in their prime earnings years. Using a fraction of the average in each year to represent lower-income workers does not allow for the natural progression of workers through the distribution of earnings over their lives. Using a multiple of the average to represent higher-income workers suffers from the same shortcomings.
- This assumption ignores the redemption of Trust Fund bonds but represents an intermediate case in which each generation bears the burden of financing the shortfall. Redemption of Trust Fund bonds means that the Treasury will have to collect additional revenues in the amount of the shortfall or increase debt, or Congress will have to reduce other government expenditures. Each option spreads the burden of financing Social Security across generations in a different way. Collecting additional general income taxes or reducing other government expenditures makes retirees bear some of the burden. This action effectively reduces their benefits, lowering their returns. The consequences of increasing the explicit debt to finance the redemption of the Trust Fund bonds are more difficult to pin down. In the simplest case, borrowing shifts the burden to future generations. However, if taxpayers are altruistic, that is, they care about their offsprings' future, they will recognize that the issuance of additional debt will burden their children. In that case, they might reduce their own consumption and save in order to leave a larger inheritance. The latter situation results in a tax burden that is equivalent to the case of a general tax increase.
- A description of how we arrive at our mortality estimates is found in the Appendix.
- A detailed description of the methodology can be found in Liu and Rettenmaier (2000).
- We ignore the small death benefit.
- We chose 4 percent as the discount rate because it represents a conservative estimate of the real rate of return workers could receive elsewhere.
- The net present values in Figure II reflect both the historical spreading in the distribution of earnings and our predictions based on the historical data.
- Beginning with individuals born in 1938, the retirement age for full Social Security benefits will increase over time until it reaches 67 for those born in 1960. The retirement age for full benefits for those born in 1938 is 65 years 2 months.
- For purposes of these estimates we have assumed that single and married individuals in each birth year have the same life cycle earnings. This assumption overestimates the earnings for single men - they typically earn less than their married counterparts - and underestimates the earnings of single women, who do not earn less than married women because they have stronger labor force attachment.
- We assume that wives collect benefits on their husbands' accounts. Additionally, we assume postretirement surviving spouse benefits are collected up to the normal life expectancy of women in the same birth year conditional on reaching age 25.
- A couple in which both spouses work would have a net present value that falls between the result for the singles and the married men as defined here.
- The decline is the result of increasing earnings within each education classification. Once the benefit formula is applied to the increased earnings, the replacement rate and the rate of return fall.
- The benefits in the table are those that accrue to a family with two children, born when the worker is age 25, with each child and the surviving spouse collecting benefits.
- Several factors explain the widening lifetime tax payments. One factor is the taxable maximum. The taxable maximums in force between 1953 and 2000, the years those born in 1935 are in the labor force, increased so as to capture an increasing share of the wage distribution. Thus a smaller share of the more highly educated workers' earnings was taxed in past years. Also as noted earlier, the earnings of more highly educated workers have grown relative to those with lesser educations. This more rapid growth is assumed to persist in our projections, and combined with a taxable maximum that keeps pace with earnings growth, the distribution in lifetime tax payments widens.
- See Andrew J. Rettenmaier and Thomas R. Saving , The Economics of Medicare Reform, Upjohn Institute for Employment Research, 2000, for a complete description of how life cycle earnings are forecast for successive birth years.
- Felicitie Bell, Alice Wade and Stephen Goss, "Life Tables for the United States Social Security Area 1900-2080," Actuarial Study No. 107, U.S. Department of Health and Human Services, Social Security Administration, Office of the Actuary, August 1992.