SOCIAL SECURITY

1. SOCIAL SECURITY THE THIRD RAIL OF POLITICS

2. A BIT OF HISTORY • The first 3 decades of the twentieth century saw a large increase in life expectancy. • Infant mortality dropped precipitously. 1920 was the first time life expectancy at birth was greater than remaining life expectancy at age 10. • In 1900 life expectancy at age 10 was only 50 years. • By 1930 life expectancy at age 10 had increased to 55 years.

3. History, Cont. • In 1900 more than 60% of the population lived in rural areas. By 1930 less than 44% lived in rural areas • In 1920 the unemployment rate was 5.2%. In 1932 it was 23.6% • In the 1930s nearly 50% of American financial institutions went bankrupt and closed • In 1932 only about 5% of retired Americans received retirement pensions. • The best estimates are that in 1934 over half of the elderly in America lacked sufficient income to be self-supporting

4. Typical Letter

5. Letter, Con’t.

6. Franklin D. Roosevelt: Message of the President to Congress, June 8, 1934 • "Security was attained in the earlier days through the interdependence of members of families upon each other and of the families within a small community upon each other. The complexities of great communities and of organized industry make less real these simple means of security. Therefore, we are compelled to employ the active interest of the Nation as a whole through government in order to encourage a greater security for each individual who composes it.”

7. Title Two of Social Security act of 1935 • Benefits payable to primary earner • Benefits related to earnings • Benefit/wage ratio highest for lowest wage earners and progressively smaller as earnings increase • Benefits payable at age 65, provided recipient is not working • No benefits to be paid until 1942 • Tax on wages levied on both employer and employee

8. 1939 Amendments • Added two categories of benefits • Spousal and dependent benefits • Survivors benefits Program changed from retirement program to family-based economic security program • Benefits payable as of 1940

9. Objective of Social Security • "It is impossible under any social insurance system to provide ideal security for every individual. The practical objective is to pay benefits that provide a minimum degree of social security—as a basis upon which the worker, through his own efforts, will have a better chance to provide adequately for his individual security."

10. PAY –AS –YOU-GO: How It works • BENEFITS OF CURRENT RETIREES PAID BY TAXES ON CURRENT WORKERS • Total paid Out to retirees =Bt*Nt • Total Paid In by current workers = Tt+1*Nt+1, Where Bt=average value of benefits paid during retirement per current retiree, Nt = number of current retirees, Tt+1 = average taxes paid over working life per current worker Nt+1=number of current working generation Then Bt*Nt = Tt+1*Nt+1 And, dividing both sides by Tt and Nt yields Bt/Tt=(Tt+1/Tt)(Nt+1/Nt) where Bt/Tt is the benefits per dollar paid by a member of generation t This depends on two factors: (1) Tt+1/Tt , how much more the average current worker pays in taxes before retiring than did the average member of those who are currently (2) Nt+1/Nt, the number of current workers/number of current retirees

11. A GREAT DEAL WHEN IT STARTED • IN 1939 THE FIRST RETIREES PAID IN TAXES FOR ONLY 4 YEARS BUT WERE SUPPORTED BY TAXES PAID BY WORKERS WHO WOULD WORK MANY YEARS BEFORE RETIREMENT (Tt+1/Tt) WAS VERY HIGH . IT TOOK 40 YEARS BEFOREA RETIREE HAD PAID TAXES FOR A FULL WORKING LIFE. OVER THAT PERIOD, (Tt+1/Tt) >1 . THE TAX RATE ON WAGES HAS BEEN RAISED SEVERAL TIMES SINCE 1939. EACH TAX INCREASE INCREASED (Tt+1/Tt)

12. WORKERS/RETIREE

13. SOCIAL SECURITY TODAY • A LARGE LEGACY DEBT • A SMALL AND RAPIDLY SHRINKING FUND BALANCE • AN AGING POPULATION • HIGH RATE OF WAGE TAX • LOW EXPECTED RETURN/TAX DOLLAR FOR TODAY’S WORKERS BUT, FEW OLDER AMERICANS LIVING IN POVERTY FEW DEFINED BENEFIT PRIVATE PENSIONS . .

14. APPROACHES TO REFORM • TWO ISSUES: (1)HOW TO PAY THE LEGACY DEBT? (2) WHAT SYSTEM IS BEST FOR TODAY’S WORKERS? • CHOICES TO REDUCE THE DEBT: (1) REDUCE BENEFITS; (2) INCREASE TAXES REQUIRED BENEFIT REDUCTION: 27% …INCREASE ‘NORMAL RETIREMENT AGE …CHANGE INDEX OF BENEFITS GROWTH FROM CPI TO GROWTH IN AVERAGE WAGES …MAKE ALL SOCIAL SECURITY BENEFITS SUBJECT TO TAX FOR ‘HIGH INCOME’ RETIREES

15. APPROACHES TO REFORM, DEALING WITH LEGACY DEBT,CONT. • NEEDED INCREASE IN TAXES: 1.2% OF NATIONAL INCOME • REMOVE LIMIT ON WAGE INCOME SUBJECT TO TAX . DEDICATE INCREASED INCOME TAX TO DEBT REDUCTION . OTHER: INVEST IN SURPLUS IN HIGHER YIELDING PRIVATE INVESTMENTS

16. WHAT SYSTEM FOR TODAY’S WORKERS? • PRESIDENT BUSH: , “As we fix Social Security, we also have the responsibility to make the system a better deal for younger workers. And the best way to reach that goal is through voluntary personal retirement accounts…Here's why the personal accounts are a better deal. Your money will grow, over time, at a greater rate than anything the current system can deliver -- and your account will provide money for retirement over and above the check you will receive from Social Security. In addition, you'll be able to pass along the money that accumulates in your personal account, if you wish, to your children and -- or grandchildren. And best of all, the money in the account is yours, and the government can never take it away.”

17. HARRY REID’S RESPONSE • “…the Bush plan isn't really Social Security reform; it's more like Social Security roulette. Democrats are all for giving Americans more of a say and more choices when it comes to their retirement savings, but that doesn't mean taking Social Security's guarantee and gambling with it.” • The debate then, as now, involves what role personal retirement savings accounts financed by taxes ought to play in a reformed social security system.

18. KEEP THE CURRENT SYSTEM • ONCE THE LEGACY DEBT IS TAKEN CARE OF THE CURRENT SYSTEM IS SUSTAINABLE WITH BENEFITS GROWING AT THE RATE OF GROWTH OF WAGE INCOME/WORKER • THE CURRENT SYSTEM IS RE-DISTRIBUTIVE: IT GIVES LOW INCOME WORKERS AN ADEQUATE RETIREMENT INCOME TO KEEP THEM OUT OF POVERTY • THE CURRENT SYSTEM PROVIDES INSURANCE AGAINST COLLAPSE OF THE VALUE OF ASSETS

19. PRIVATIZE SOCIAL SECURITY • FIRST THE LEGACY DEBT MUST BE FINANCED, THEN • WORKERS PAY TAXES INTO A PRIVATE ACCOUNT • WORKERS CONTROL THE ALLOCATION OF THEIR MONIES AMONG ELIGIBLE INVESTMENT PORTFOLIOS • THESE INVESTMENTS GIVE WORKERS AN OPPORTUNITY TO EARN A HIGHER RETURN THAN THEY COULD GET IN THE CURRENT SYSTEM. • UPON RETIRING WORKERS CHOOSE HOW MUCH TO INVEST IN AN ANNUITY AND THE RATE AT WHICH THEY DRAW OUT THE REMAINING BALANCE.

20. CHILEAN EXPERIENCE • SYSTEM STARTED 1981 • PRIVATELY MANAGED FUNDS (Administradores de Pensiones (AFPs) • COMPUSORY CONTRIBUTIONS FOR EMPLOYED WORKERS, VOLUNTARY FOR SELF-EMPLOYED • Minimum Return Guarantee from the AFP • Commissions: There are no limits on the level of commissions • HIGH ADMINISTRATIVE COSTS: 30% OF WAGE TAX PAYMENTS • HIGH YEAR-TO-YEAR VARIABILITY IN RETURNS

21. BOTTOM LINE • “We find that the net returns to the affiliates in most countries are negative or negligible over the first 4-5 years, and do not beat returns from simple investments such as bank CDs, over the long haul. The regulation seems to create profound biases against competition, efficiency, specialization, or and in favor of excessive direct marketing expenses. The resulting losses, even if small, can seriously endanger the retirement nest egg, while subjecting the affiliates toinappropriate risk-reward tradeoffs in the interim.” (Hemant Shah, TOWARDS BETTER REGULATION OF PRIVATE PENSION FUNDS, World Bank Policy Research Working Paper No. 1791, June 1997