Arnold Kling  

Social SecurityAnalysis

Who Bears the Tax Burden?... Statistical Jargon...

The 2004 Economic Report of the President also discusses Social Security. One issue is measuring the Social Security shortfall. Most economists reject the so-called "actuarial shortfall" as a measure. One alternative is the Gokhale-Smetters present value estimate. The 2004 Economic Report comes up with its own measure.

The income rate is the total amount of tax revenue collected (from both the payroll tax and the income taxation of Social Security benefits for moderate- and high-income beneficiaries) divided by the total amount of payroll on which taxes are levied. The cost rate is the total amount of scheduled benefits divided by the total payroll on which taxes are levied. The annual balance is the difference between the income rate and the cost rate in a given year.

...For 2003, the annual balance is 1.81 percent of taxable payroll...The
substantial increase in the cost rate relative to the income rate in the future causes this annual balance to change from surplus to deficit by 2018 and to widen considerably thereafter. In 2080, the annual balance will be -6.67 percent of taxable payroll...

The annual deficit of 6.67 percent of payroll is the most straightforward
way to represent the long-term fiscal challenge confronting the Social
Security program. To describe a proposed reform as having restored solvency
to Social Security, the reform must greatly reduce or eliminate these annual

Overall, my sense is that this chapter seems very consistent with my "lockbox" model of Social Security privatization. My one disappointment is that talking about future increases to the retirement age remains the "third rail" of entitlement reform.

For Discussion. How does the "annual balance" concept help to clarify discussions of Social Security's finances?

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CATEGORIES: Social Security

COMMENTS (17 to date)
mcwop writes:

Arnold writes: My one disappointment is that talking about future increases to the retirement age remains the "third rail" of entitlement reform.

You are 100% correct. There will be a revolt of the age is raised. I work in retirement planning, and have conducted 900+ seminars to over 40,000 people. In meeting surveys retirement savers are willing to invest more aggressively (entertain something more than cash), save more, but they are unwilling to retire later.

In fact many have overly optimistic desired retirement ages. This is also evidenced in the fact that the vast majority of social security recipients take their benefits early.

Boonton writes:

Perhaps this indicates a willingness to lower retirement income in favor of a longer retirement by many people. I wonder if it also represents an irrational expectation that people could just go back to work if they found themselves short of money after retiring. When you are young it is pretty hard to imagine a time when it will be difficult to do the things you do everyday.

Boonton writes:

Perhaps this desire could be exploited by SSI to implicitly reduce costs. Offer a 'super young retirement' option that would allow people to collect benefits earlier (such as age 60) but the benefits would be reduced enough to represent a net savings over the average person who waited for 65 or 63.

Hopefully this option could be used by those who have been successful in their private savings & would like to retire early with an element of 'guaranteed income' to supplement their asset based income off of stocks and bonds.

mcwop writes:

The age 60 option is an interesting proposal. Many would take it. Of course there is a break-even point depending on life expectancy. A concept many retirees do not understand. It can be more profitable to take Social Security early than later if you don't expect to pass the average life expectancy by much.

To calculate the break-even age take the total benefits expected in the year you begin benefits and age 65. Then divide the total funds received between the benefit start age and 65 by the additional monthly benefit at normal retirement. The result is in months, which is converted to years and added to the age 65.

So, if I start at age 60 and get $1000 a month, my total benefits to age 65 is $60,000. Let’s say if I waited until 65 for benefits I would receive an additional $400 per month. 60,000/400 = 150 months. Or 12.5 years, which makes the breakeven age 77.5 years of age.

Unfortunately, many retirees get into big trouble taking their benefits early (I have personally seen this many times). For a married couple without substantial savings and/or pensions it is generally a bad idea, as one person will probably surpass the average life expectancy.

Boonton writes:

You seem to be impling that many people behave in an irrational manner. Perhaps a 'super early retirement' option would be a bad idea then. It would help SSI's books but end up hurting people who should not opt for such a call.

It isn't said very often but SSI is beneficial in the sense that it forces people to make some allocation for retirement. This wouldn't be needed in a world full of 'economic men' who behaved rationally but your experience seems to indicate a serious problem with people's long term rationality.

that being said I'm not going to give up on traditional economics entirely. I think many people are willing to accept a lower income in exchange for more retirement (at this point let's also note that Americans take a lot less vacation than their European counterparts, perhaps Americans consider retiring at 63 a way of taking all that missed vacation time). Some of the literature I've seen seems to assume the goal is to retire for 20 years with nearly the same income as during the person's working years. Maybe many Americans are acting on different goals.

Mcwop writes:

People's rationality is difficult to assess, and what makes behavioral economics so interesting. What might seem rational at one moment can prove to be irrational. Usually, people are making retirement decisions without all the information, so I would say their decision is misinformed rather than irrational. Explaining, the break-even age is a nightmare.

Eric Krieg writes:

Guys, Social Security is indexed to inflation. So what are you really giving up by retiring early? If you can afford to retire at 62, living off of that dimished Social Security check, the indexing makes sure that you will continue to be able to make ends meet.

So, yes, the early retiree is probably leaving money on the table over the long term. But maybe they are still making a rational decision. After all, wouldn't you like to retire early, as long as you could afford to do it? Your life at 62 or 63 is probably a lot more enjoyable than in later years.

Boonton writes:

mcwops analysis used constant dollars so it implicitly did take inflation into account by pretending none exists. The breakeven age is very valid.

For those who do not expect to live very long, an early option could be very valuable. I do think that a lot of people will get themselves into trouble with it. I'm uneasy about the fixing SSI's books by having the gov't rely upon people to make foolish decisions (we are doing enough damage already with lotteries).

Eric Krieg writes:

After the day I had today, retiring at 60 rather than 62 or 65 or 67 (or, as some would have me, 70!) sounds good!

Again, as long as you can afford to retire early, why not do it? Yes, you are losing money by doing so, but you are doing it for the extra couple of years of retirement that you get.

Early retirement SHOULD cost you money! It is desireable.

Boonton writes:

Correct me if I'm wrong but opting for the early retirement not only means a smaller check until you hit the 65 mark but also a smaller check from that point onwards. As mcwop's breakeven formula shows, whether this pays off for you or not really depends on how old you live to. If you're going to live to be 110 you are better off waiting till 65.

Bernard Yomtov writes:

I'm all for using present values, but it's important to remember that when you're discounting cash flows that occur more than 75 years from now you are really making what should almost be described as order of magnitude calculations.

Gokhale and Smetters more or less admit this, of course, but there are other reasonable criticisms as well. One has to do with their treatment of Medicare B which, unlike SS and Medicare A, is not intended to be pay as you go.

Most of it is funded from general revenue. So it is silly to talk of a negative PV - what they label a negative FI. You might as well talk about a negative PV for national defense, or any other program funded from general revenue, rather than from a dedicated revenue stream. Instead, Medicare B ought to be lumped with "rest of government," contributing to FI of minus $16 trillion.

S-G are right to talk about PV's. It's too bad that that the desire to cater to AEI's ideologies caused them to misstate things somewhat.

Robert Schwartz writes:

I like the metric because it exposes the real issue (net tax burden). Since the net tax burden will go up and since the ability of the Government to push federal tax collections much above 20% of GDP is unproven, then benefits will go down. Age increases? How about means testing?

Eric Krieg writes:

>>Correct me if I'm wrong but opting for the early retirement not only means a smaller check until you hit the 65 mark but also a smaller check from that point onwards.

Yes, it means a smaller check as long as you live. But if you can live on that smaller check (and it is indexed to inflation, so there is no inflation risk), then the 3 years of retirement that you gain may be worth the loss in lifetime income.

There is something that you have to understand about today's retirees. They are quite wealthy. One reason for this is that Social Security is a lot more generous than it used to be.

In the past, people were forced to move to low cost areas when they retired, to try and preserve what little income they had. That isn't the case anymore.

I think that it is possible that the difference in income between retiring at 62 or 65 is not enough to make a difference to most people, so they retire early and enjoy an extra 3 years of retirement.

mcwop writes:

Be careful on SSI inflation indexing. The inflation rate for rent (homeowners or usually ok), and medical expenses in retirement is far higher than the CPI. For many lower income retirees that pay rent, they deal with a higher inflation rate becasue most of their money goes to rent and medical expenses.

In fact there is a CPI for people 62+ years, which I think is called the CPI-E. It is usually higher than the CPI. Example, Social Security beneficiaries recently received a 2.1% COLA effective January 1, 2004. However, Medicare premiums increased 13.5%. This mostly effects low income seniors.

Eric Krieg writes:

>>In fact there is a CPI for people 62+ years, which I think is called the CPI-E. It is usually higher than the CPI

Yeah, I've seen that argument. I don't know if I believe it or not. The three biggest outlays in most non-senior budgets are education, housing, and medical care (these are the 3 items that generally lead to the debt that leads to bankruptcy).

It seems to me that seniors don't have to worry about education inflation.

Most seniors own their own homes, so housing is a non-issue (and rents are FALLING, by the way). In fact, the almost insane home appreciation that they have benefited from over their lifetimes is the biggest reason that seniors as a group have so much mre wealth than they used to. (My grandmother bought her Levitt house for $5000 back in 1950. It is worth maybe $350K to $400K now. Not a bad ROI, huh?)

You forgot about property taxes. That is the one area that can burn seniors and force them out of their homes. Seniors have addressed this problem in the past by moving to Florida, which has very low taxes. My in-laws just moved to Sun City Hilton Head, which doesn't have a local property tax.

There are things seniors can do to minimize their risk of housing inflation, like moving to cheaper areas of the country. This actually might help with medical inflation too.

Eric Krieg writes:

I myself dream of retiring to South Padre Island and working as a bartender at one of the Spring Break bars. I could do that easily if SS would let me retire with diminished benefits at 60, or even better, 55.

I would recieve diminished monetary benefits. But there would be some other... fringe benefits, as those who have gone on Spring Break in Padre are well aware.

Lawrance George Lux writes:

Economists all tend to miss the real problem of Social Security. We spend the Social Security surplus today, as part of general revenues; current contributions are only guarantee of a future Promissary Note. Privatization of Social Security does no better, simply stating the future Economy must endure an alternate form of taxation to pay for care of the elderly.

We face a shrinking active Labor force in the future, alongside increasing numbers of Elderly. The future Economy will have less, not greater, ability to accept the tax of elderly care, no matter in what form the taxation is applied. Attempts at greater extortion will only lead to failures of economic performance. The basic structure of Social Security must change.

It must be altered to a self-help program, where the Elderly do most of the Care-giving. The Youth labor force must be focused on running the Economy. Benefits should be set low, with Minimum Wage payments to training in health care, and in the labor of Care-giving. The full-time staff of current Medical provision should be cut to one-third of current Labor complement, with Self-Help Care-giving substituted. Other medical costs must be reduced through substitution of generic medications etc. lgl

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