Social Security and Education

Studies | Education | Social Security

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

Estimating the Appeal of Social Security for Individuals with Different Education Levels

"The level of education is a better predictor of lifetime Social Security taxes and benefits than current income."

The categories of workers we study are defined by their year of birth, sex, education and marital status.3 Rates of return and net present values of the Social Security investments for each group are calculated. The calculations require estimating taxes and benefits for all possible life spans. Tax payments are directly related to the group's life cycle earnings and the tax rates that they face over their lifetime. Benefits are calculated by applying the Social Security benefit formula to each stream of earnings. The future components of the benefit formula are derived using the Social Security Administration's intermediate estimates of wage and price growth.4

Estimating Life Cycle Earnings. Projected life cycle earnings are estimated by applying the historical growth rates estimated 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.5 The advantage of using life cycle earnings is that workers typically experience low inflation-adjusted earnings when young, rapidly rising earnings up to the middle to late thirties, continued rising earnings but at a slower pace up to the late forties to early fifties, and declining earnings from that point until retirement.6

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 10.6 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.7

"Net present value is the value (in current dollars) of expected benefits minus expected taxes."

Estimating Longevity. Mortality estimates in this study are drawn from several sources including the U.S. Census, the Social Security Administration and death-registration data. The analysis by racial groups, which is presented in a companion study, requires estimates for people born from 1935 to 1980 for both black and white men and women. The Census Bureau has estimated life tables in future years for racial groups and for the general public, which are the starting point for our estimates. To provide consistency between both studies, the analysis by education groups also uses the Census Bureau data. We adjust the Census Bureau's mortality estimates to reflect education-based differences in longevity. Social Security Administration estimates are used to supplement the Census data at higher ages.8

"To calculate net present value, we multiply the probability of living to every possible age times the taxes and benefits associated with each lifespan."

Calculating Expected Net Present Values and Expected Rates of Return. With education-specific mortality rates and earnings, it is possible to calculate each group's expected net present values and internal rates of return. As mentioned above, each possible life span is associated with a separate stream of taxes and benefits. Deaths at early ages result in survivors benefit payments to children and spouses based on a few years of tax payments. Deaths at later ages represent investments that involve many years of tax payments and benefits that include retirement pensions for the worker and possibly his or her spouse, as well as survivors benefits. Each of these streams of taxes and benefits has a well-defined net present value. To calculate the expected net present value for an individual, we multiply the probability of dying at each age times the tax and benefit streams. Summing across the present values gives the expected net present value for a group. The internal rate of return is the discount rate at which the present values of expected taxes and expected benefits are equal.9

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