Social Security Expenditures (1939-2007)
Source: Social Security Trustees [2008].
Why Have Social Security?
Consumption Smoothing and the Annuity Market
How Social Security works
Annuity
Consumption smoothing
Adverse Selection and the Annuity Market
Asymmetric information
Adverse selection
Other Justifications
Lack of foresight and paternalism
Moral hazard
Economize on decision-making and administrative costs
e Redistribution
Improve the Economic Status of the Aged
Fully Funded Plan
Period 1
Period 2
Period 3
Period 4
contribute
benefits
contribute
benefits
contribute
benefits
The Greatest
Generation
The Baby Boom
Generation
Generation X
Work
Retire
Dead
Unborn
Work
Work
Retire
Still Dead
Dead
Childhood
Childhood
Retire
Each generation’s benefits based on deposits it made during working life plus accumulated interest
Period 1
Period 2
Period 3
Period 4
The Greatest
Generation
The Baby Boom
Generation
Generation X
Work
Retire
Dead
Unborn
Work
Work
Retire
Still Dead
Dead
Childhood
Childhood
Retire
contribute
benefits
contribute
benefits
contribute
benefits
benefits
Pay As You Go (or Unfunded) System
0
Period 1
Period 2
Period 3
Period 4
The Greatest
Generation
The Baby Boom
Generation
Generation X
Work
Retire
Dead
Unborn
Work
Work
Retire
Still Dead
Dead
Childhood
Childhood
Retire
contribute
benefits
contribute
benefits
contribute
benefits
benefits
Today’s Partially Funded System
0
Baby Boomers and Gen X are also contributing to their own retirement
Explicit Transfers
Benefits for dependents and survivors (1939)
Supplemental Security e
Benefits
How to calculate benefits
AIME (Average Indexed Monthly Earnings) – average monthly earnings in 35 highest paid years
Wages indexed for inflation
Ceiling on AIME – up to tax ceiling
0
Benefit Structure
If AIME < $711 PIA = .90*AIME
If $711< AIME <$4288 PIA = .90*$711 + .32*(AIME - $711)
If AIME > $4288 PIA = .90*$711 + .32*($42
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