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Ch13 Handout Social Security

# Ch13 Handout Social Security

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01/04/2012

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Public Economics – Dr. Sauer
Chapter 13 : Social SecurityOver the next 75 years, Social Security has promised
\$5.6 trillion
more in benefits than it plans tocollect from worker taxes. Reforming Social Security is
difficult
because it is the largest source of income for the elderly.60% of beneficiaries derive more than half their income from it30% of beneficiaries derive 90% of their income from itFinancing:6.2% from employee6.2% from employer only on first \$106,800 of incomeBenefits:age 62, age 65worked and paid in during 40 quartersannuityFull retirement age benefit =
primary insurance amount
(PIA).formula based on your earnings history:- adjust for inflation- 35 top years- average monthly earnings
Step 1: Calculate Taxed Social Security Earnings
Find your taxed SS earnings for every year in your work history.- earnings up to the SS threshold (\$106,800)- start the year after you turn 21- statements come to you starting at 25
Earnings
are wages from employment and net earnings from self-employment.- not investment income

Adjust the earnings for earlier years to reflect inflation.- table- changes every year The indexing year is normally the year you turn 60.If you die or become disabled before age 62, the indexing year will be two years before the year of your death or disability.
Step 3: Select the 35 Highest Years
Select the 35 highest years based on the inflation-adjusted amounts.If you don't have 35 years with earnings, the calculation will include some years with zero earnings.
Step 4: Find the Monthly Average
Add up all the inflation-adjusted amounts for the 35 years that were selected and divide by 420.This is known as your
average indexed monthly earnings
(AIME).The calculation uses a smaller number of years for someone who dies or becomes disabled before age62.
Step 5: The Benefits Formula
3-tier formula: An AIME of less than \$749 means \$0.90 in benefits for each \$1 of AIME\$749 to \$4,517 means \$0.32 in benefits for each \$1 of AIMEover \$4,517 means \$0.15 in benefits for each \$1 of AIME
http://www.socialsecurity.gov/OACT/COLA/piaformula.html
How SS works: simple model
People live for two periods- young work - old retiredPopulation growth is 5% per year.Productivity growth is 5% per year.Consider 5 total periods.2

Period 1:- 100 young people work, earn \$20,000 in period- no social security (no retirees)Period 2:- 100 retirees- social security program implemented- 10% tax on workers- paid immediately to retirees- 105 workers, earntaxed- total tax collected- total payments per retiree- return on investment
Period# WorkersEarnings per worker Taxes per worker Total Taxes# RetireesBenefits per retireeTaxesPreviously paid byretireeRate of Return12345
Period 3:- 105 retirees- 105 x 1.05 = 110.25 = 110 workers- workers earn- workers pay- total taxes- benefit per retiree- return on investmentRepeat for Period 4 …In Period 5, workers do not pay in (there will be no period 6 where they will get benefits).The generation working in period 4 does not receive benefits.For unfunded social security programs,- initial generation benefits hugely- middle generations benefits depend on the growth of population and productivity3