Social Security and Education

Studies | Education | Social Security

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


Introduction

Social Security provides retirement benefits, insurance against death prior to a worker's retirement and benefits for nonworking spouses who outlive the beneficiary. 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. Recently, however, people have begun to question the value of Social Security when viewed as an investment. 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.

In this paper we consider the value of the Old Age and Survivors Insurance (OASI) portion of Social Security as an investment for different classes of workers based on their level of education.1 Why education? Because among young workers, the level of education is a better indicator of potential lifetime earnings (and therefore expected Social Security taxes and benefits) than current wages.

"This study evaluates Social Security as an investment for workers based on their education."

Education also 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, and higher-income workers are treated less generously under Social Security's benefit formula. How any particular individual is affected also depends on such other factors as life expectancy, marital status, number of children and the life expectancy of a spouse.

Social Security redistributes income between generations - from young to old - because taxes paid by today's workers are used to pay benefits to today's retirees. Under the benefit formula, lower-income workers receive higher benefits in return for their tax dollars than do higher-income workers within each generation. However, although the benefit formula is designed to redistribute from high- to low-income workers, this redistribution is offset to some degree by the fact that lower-income workers tend to have shorter lives and consequently receive fewer benefit checks. Accordingly, a goal of this study is to identify how much redistribution actually takes place.

We evaluate Social Security as an investment by two measures: the expected rate of return on payroll taxes paid and the net present value of those payments. The net present value is the value today of expected future benefits minus expected costs, using a 4 percent interest rate, representing a measure of the real rate of return that private investments could yield. If the figure is positive, the investor gains; if negative, the investor pays more in taxes than he or she receives in benefits.


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