Social Security

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Medicare trust fund to be tapped out by 2017

May 12, 2009 in Medicaid/Medicare, Social Security, Taxes | 1 comment

Bond Markets seem to be concerned over the escalating level of U.S. Government debt.  Yields rose during the latest $14 billion auction of U.S. 30-year Treasury Bonds.  This graph shows an ominous budget deficit trend as well.  There seems to be good reason for this.  

American’s stimulus plan and entitlement programs are putting an increasing burden on American tax payers.  With the recession taking a toll on tax revenues, Social Security and Medicare funding is increasing jeopardy.  CNN reports that the “Social Security trust fund will be exhausted by 2037 — four years earlier than estimated last year… The recession also hit Medicare. The Medicare trust fund is forecast to be tapped out by 2017, or 2 years earlier than the trustees’ estimate last year.”

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No Increase in Social Security Benefits

May 2, 2009 in Social Security | No comments

The N.Y. Times reports that Social Security benefits will not increase this year.  This makes sense on a number of levels.  First, over the last year we have been experiencing deflation.  The CPI decreased -0.4% between March 2008 and March 2009.  Second, wage growth has been negative as well over the past year.  Unemployment has grown and tax receipts have slowed.  Thus, it only makes sense that seniors should share in the economic burden.

Holding Social Security benefits constant will also affect Medicare.  This…”in effect, puts a cap on premiums for Part B of Medicare, which covers doctors’ services.  If there is no cost-of-living adjustment for Social Security, about three-fourths of beneficiaries will not see any change in their basic Part B premiums, federal officials said. But some beneficiaries do not have this protection and could face substantial increases in their Part B premiums.”

Not all is bad news for seniors. Deflation means that the money seniors have saved will be able to purchase more goods.

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Canadian Social Security and Well-Being

March 3, 2009 in Public Policy, Social Security, Taxes | 1 comment

Does Social Security work?  By that, I mean does giving elderly individuals a government pension increase their level of income, the amount of goods the can consume, or even their happiness?

An NBER working paper by Baker, Gruber and Milligan (2009) tries to answer this question in the Canadian setting.

Background

Currently, Canadian income transfer programs to seniors make up 2.3% of GDP, but this figure is expect to rise to 3.2% of GDP by 2030.  Unlike Social Security in the U.S., the pay-as-you-go (PAYGO) component of the Canadian Social Security System if fairly small.  Further, population growth in Canada is higher than in Europe making the old-age income transfer programs more solvent.

The Old Age Security (OAS) program is the oldest elderly income transfer program in Canada.  It was enacted in 1952.  Currently, “the monthly benefit paid to individuals who fully satisfied the residency requirement was $479.83.   This benefit is clawed back from higher income pensioners at a 15 percent rate, starting at incomes of $60,806 (2005).  Benefits are full indexed to the CPI and fully taxable under the Income Tax Act.”

The Guaranteed Income Supplement (GIS) is a means-tested income supplement for elderly individuals with low income.  Benefits are taxed back at a 50% rate.  The current enefit is between $370 and $570.  

The Canadian Pension Plan (CPP) and Quebec Pension Plan (QPP) are finance by contributions from employers and employees.  Individuals pay a 4.95% tax on earnings from $35,00 to $41,100 and benefits are based on a measure of average earnings over the individual’s working life.  Participants can claim benefits at age 60, but the benefit level is increased by 0.5% per month if the benefits are claimed at an older age.

Data

 The authors aim to investigate how changes in the programs described above affect the income, consumption and happiness level of individuals in different birth cohorts. These measures are taken from survey data from Statistics Canada.  Income data comes from the Survey of Consumer Finances (1971-1997) and the Survey of Labor and Income Dynamics (1998-2002).  Consumption data comes from the Family Expenditure Survey (1969-1996) and the Survey of Household Spending (1997-2002).  Happiness is measured by the General Social Survey.

  • For more details on the Canadian Social Security System, see my post from 4 July 2006.

Methodology

If there are time trends in elderly income and consumption, how does one identify the impact of the Canadian Social Security?  The authors use changes in Canadian Social Security legislation to identify this impact.  The regression methodology has 3 specifications:

  1. Regress actual retirement benefits on the dependent variables (income, consumption and happiness).
  2. Partial Simulation. In this approach, the authors hold constant the earnings, capital income, and family status of the individual, but allow the retirement age to vary.  Benefits are based on a fixed earnings histories across all birth cohorts, not actual earnings.
  3. Full Simulation.  In this case, earnings, capital income, family status, and retirement age are held constant and the authors calculate simulated benefits levels based on an average earnings histories and retirement ages across all cohorts.

Results

In general, the authors find that a higher Social Security benefit increases elderly income.  In the full simulation and when simulated benefits are used as an instrument for actual benefits, Social Security income benefits increase elderly income benefits dollar-for-dollar.  Further, elderly income poverty decreased significantly when more generous benefits were enacted; the authors claim that 96% of the reduction in elderly poverty is due to these added benefits.  However, in the partial simulation methodology, the authors find that a $1 increase in benefits leads to only a $0.55 cent increase in elderly income, thus indicating significant crowd-out.  

For consumption, the authors also find that more generous income benefits increase elderly consumption levels, but not dollar for dollar.  A $1 increase in benefits leads to a $0.66-$0.80 increase in consumption, thus indicating some crowd-out.  Unlike for the case of elderly income poverty, more generous Social Security benefits did not affect consumption poverty.  Thus, it may be the case that poor elderly individuals have other sources of consumption (e.g., purchase by family members, unreported income gifts from family members, unreported labor income) that may offset lower government supplied income benefits. 

“For the very happy question, we see no sign of a statistically significant relationship between benefits and being very happy.  On the other hand, there is some evidence of a decrease in reports of being unhappy or very unhappy with higher benefits in the reduced form results, but not in the IV results.”

Healthcare Economist’s Take

This paper indicates that more generous income benefits do increase income and consumption for the elderly.  Social Security benefits create more crowd-out in the case of consumption than income.  It is likely that consumption is a better indicator of well-being, especially since elderly savings is very low (i.e., the elderly are generally spending down their assets than building them up).  While income poverty declined due to these income benefits, consumption poverty did not.  Overall, I would say that these program do help increase elderly well-being, but likely not dollar for dollar.  As the authors note, this paper only looks at the benefits of Social Security without taking into account the costs of raising a significant amount of revenue to pay for these government program.

I will not comment on the happiness measure.  Although many people may think it is the government’s job to make individuals happier, I believe that happiness is determined on an individual level and often based on things the government can’t control (e.g., do you get along with your spouse, has their been a death in the family).  Further, happiness is often measured by comparing your emotional feelings against some status quo.  Thus, a poor family would be very happy to have their income increased to $80,000, but a millionaire would be very disappointed.  

I think this paper makes an important contribution showing that government old age income benefits do increase income and consumption, even if there is some crowd out on the consumption side.  The question for me is less whether or not there should be some government benefit, but more about how generous it should be and whether it should serve only the poor or all elderly.

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Who should be responsible for your retirement?

December 2, 2008 in Public Policy, Social Security | 2 comments

The Economist reports that Argentina has recently passed “a law to nationalise the country’s private pension system.”  Is this a good thing?

With the stock market in the tank, many individuals yearn for the security of a government-funded retirement plans compared to private, individual investments in stocks and bonds.  However, public pensions may not be so safe after all.

An NBER working paper by Novy-Marx and Rauh finds that public pension funds run by the states in the U.S. are significantly underfunded.  

“We conservatively predict a 50% chance of aggregate underfunding greater than $750 billion and a 25% chance of at least $1.75 trillion (in 2005 dollars). Adjusting for risk, the true intergenerational transfer is substantially larger. Insuring both taxpayers against funding deficits and plan participants against benefit reductions would cost almost $2 trillion today, even though governments portray state pensions as almost fully funded.”

As a San Diego resident, I know first hand how the government can mess up public pensions.  San Diego was named “Enron by the Sea” because underfunding the public pension system has created an enormous deficit.  City attorney Mike Aguirre is considering having San Diego declare bankruptcy because of the huge shortfall.

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Age Inflation

September 16, 2008 in Medicaid/Medicare, Public Policy, Social Security | Permalink

Medicare was implemented in 1965 to cover the medical costs of the oldest members in society.  In 1965,  the U.S. life expectancy was only 70 years old.  Now, however, life expectancy at birth is over 78 years.  Medicare is now not just covering the oldest of the old, it also covers the “moderately” old since we are living so much longer.

An NBER working paper by  John B. Shoven, Gopi Shah Goda examines what eligibility ages for programs such as Medicare and Social Security would be today and in 2050 if adjustments for mortality improvement were taken into account.  The authors conclude the following:

“We find that historical adjustment of eligibility ages for age inflation would have increased ages of eligibility by approximately 0.15 years annually. Failure to adjust for mortality improvement implies the percent of the population eligible to receive full Social Security benefits and Medicare will increase substantially relative to the share eligible under a policy of age adjustment.”

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Who values the Social Security Annuity?

March 10, 2008 in Public Policy, Social Security | Permalink

If you were offered an actuarially fair lump-sum payment, would you give up half of your Social Security benefits? This is the question asked by Brown, Casey and Mitchell in their 2008 NBER working paper.

Overall, about 60% of respondents from the HRS data set preferred the lump-sum payment. The authors find the following individuals are more likely to prefer a lump-sum payment over the annuity:

  • those with shorter expected longevity or who are in poor health,
  • those with more education,
  • those with less financial sophistication conditional on education,
  • those who believe Social Security benefits will be cut.

Predictably, individuals who think they live longer will choose the annuity since they will get paid over a longer period of time. We also see that those who believe that there is significant political risk (i.e., Social Security benefits will be cut) are more likely to choose the lump-sum benefits.

Men aged between 63 and 67 have only 5% of their assets in private annuities. People have claimed that this was due to one of the following reasons:

  • Adverse selection leads to high load factors on annuities, making them a poor value.
  • Because they are made up of a fixed payment, Annuities are subject to inflation risk.
  • Social Security may be a substitute for private insurance annuities.

The study finds evidence to contradict all three of these hypotheses. Social security benefits are actuarially fair, and inflation-adjusted. If people really benefited from Social Security annuities, than they should be hesitant to give up this stream of payments. Yet three of five people still would prefer a lump sum payment over the Social Security annuity, a type of annuity that offers significant advantages over those offered in the private market.

Maybe Social Security isn’t as valuable as once thought.

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Ezra Klein vs. Andrew Sullivan

February 19, 2008 in Current Events, Social Security | Permalink

There is an interesting pair of blog posts by Ezra Klein and Andrew Sullivan.  Mr. Klein advocates a more centralized health care system while Mr. Sullivan is opposed to expanding the government’s role in health care.

Who do you agree with?

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Growth in Social Security Disability Rolls

March 6, 2007 in Social Security | Permalink

Over the past two decades, the share of total Social Security spending accounted for by Social Security Disability Insurance (DI) has increased from 10 percent in the 1970s to 17 percent today. In 2005, cash payment to DI beneficiaries topped $85 billion. Authors David Autor and Mark Duggan try to explain this phenomenon in their 2006 working paper.

The researchers main conclusion are:

  • Most of the extra cost of the DI program is due to the liberalization of screening process that occurred due to a 1984 law. This law gives more weight to the applicants pain and discomfort and more credence to medical evidence from the applicant’s physician. In recent years, nearly 40 percent of total DI awards were granted during the appeals process, up from 20 percent in the late 1970s.
  • The value of DI has increased. While the real dollar value of DI has not increased significantly over time, income inequality has increased. Thus, for the individuals on the bottom on the income distribution, DI now appears relatively more attractive since real wages have declined in the lowest income deciles.
  • The aging U.S. population has not had a significant impact on the increase in DI rolls. The authors claim that the demographic shift towards more older individuals in society only accounts for 6% of the increase in DI.

It is always difficult to determine whether an increase in the rolls of a welfare program (such as DI) is ‘good’ or ‘bad’ for society. The population which makes up the increase is likely made up of deserving and undeserving individuals. Further, many individuals are partially disabled. What if a factory worker is injured and can only work 5 hours/week? Are they disabled? What if they can only work 10 hours? 20 hours? It is difficult to know where to draw the line.

In an earlier paper (“Rise in Disability“), the authors use adverse demand shocks between 1984 and 1998 and find that “a growing fraction of discouraged and displaced workers are seeking DI benefits,” suggesting that a higher percentage of ‘undeserving’ individuals may be going on the DI rolls.  The question society must ask itself is how much money will be ‘wasted’ on the inevitable phony DI claims in order to ensure that those truly disabled are able to received adequate DI benefits.
Two suggestions made to reform the system are to make it easier for individuals to obtain health insurance so DI is not serving as the insurer of last resort and, secondly, to introduce graduated DI payments depending on the severity of the injury.

Notional Defined Contribution Model

February 9, 2007 in Social Security | Permalink

Recently I came across a paper by John Williamson describing a Notional Defined Contribution Model as a replacement for state pension system. Countries who have adapted the Notional Defined Contribution (NDC) model include Sweden (1994), Italy (1995), Latvia (1996), the Kyrgyz Republic (1997), Poland (1999), and Mongolia (2000). The model is in essence a pay-as-you-go framework, but benefits are closed linked to contributions. Policymakers hope this will encourage labor force participation.

Individual have an account which details how much money (in taxes) they have paid into the system. This account, however, is entirely virtual in that individuals do not have access to the fund in these accounts. The government chooses a “virtual” rate of return usually based on economic factors such as price inflation (e.g.: in Italy and Latvia) or a mix of wage and price inflation (e.g.: in Poland and Sweden).

Those in favor of this plan claim that since benefits are mostly tied to contributions, this may encourage labor force participation during a person’s working years; on the other hand the NDC model is less redistributive than a guaranteed benefit pension program. There is no financial market risk since the accounts are contemporaneously paid out from the current labor force to current retirees, but there is demographic risk. If a country has few workers and many retirees, the “virtual” rate of return must be lowered to account for this. The NDC plan has lower administrative cost than one in which individuals have access to their accounts because of economies of scale and lower transaction costs, but there is no incentive for individuals to increase their savings.

To me, this plan sounds exactly like the current U.S. Social Security system. Every worker has an account with their Social Security Contributions to date. These funds, however, are not owned by the individual but are paid contemporaneously to retirees. Upon retirement, an individual receives a Social Security pension based on the value in the account. (This is a simplification since Social Security payments are subject to a cap, and the payments also depend on the number of working years).

A more sensible plan is the Chilean system of personal accounts. According to the Cristian Science Monitor, (“In Britain and Chile“):

“The second and main pillar is the obligatory monthly payroll deduction of 12.3 percent. Ten percent goes into the worker’s own account, administered by one of six private pension funds, while 2.3 percent covers administrative fees. Unlike in the US, the payroll tax is funded entirely by the employee. At retirement – age 60 for women, 65 for men – they take out what they put in, plus accumulated gains. Currently 3.6 million Chileans, or 65 percent of the 5.5 million-person workforce, are actively contributing under this system.”

There are a few caveats. The Cato Institute (“Empowering workers“) notes, “This percentage applies only to the first $22,000 of annual income. Therefore, as wages go up with economic growth, the ‘mandatory savings’ content of the pension system goes down.” Also, if an individual works at least twenty years, they are eligible for a state-sponsored minimum pension. Thus, individuals will not be destitute in old-age, even workers with lower wages over their lifetime.

The privatization of a portion of the state pension program was less successful in Britain, however. “Pension sellers, working on commission, frequently coaxed… [workers] into unsuitable products, often overstating the potential for returns.” Still, keeping retirement savings in the hands of individuals will lead to more savings and ensure sufficient funds at retirement for all individuals; especially when paired with a minimum state-provided benefit.

The Excess Burden of Government Indecision

February 1, 2007 in Public Policy, Social Security | Permalink

The future of Social Security is in question. Even Federal Reserve chairman Ben Bernanke warns of the rapidly approaching Social Security “fiscal crisis.”. Individuals at the beginning or middle of their prime working years are unsure of how large (or small) their Social Security benefits will be when they retire.

An NBER working paper by Gomes, Kotlikoff and Viceira (WP #12859) aims to calculate the cost of this uncertainty due to government indecision regarding Social Security benefits. Below I describe the model the authors derive, briefly explain the empirical section of the paper and state their conclusions.

Model

Individuals have constant relative risk aversion (CRRA) utility functions of the form:

  • U=C1-γ(1-γ)-1 (1)

The agents learn at time L whether the social security benefits they will receive in retirement will be large, B, or small, b. AL are the assets accumulated at time L. T represents the last year of one’s life and R represents the year of retirement. Optimal consumption is given by:

  • AL+B(T-R)=CB(T-L), with a large retirement benefit; and (2a)
  • AL+b(T-R)=Cb(T-L), with a small retirement benefit. (2b)
  • AL+=A0-CL (3)

Expected Utility and first order conditions are given by:

  • EU= (1-γ)-1{ C1-γL + (T-L)[pCB1-γ + (1-p)Cb1-γ] } (4)
  • FOC: C-γ= + pCB-γ + (1-p)Cb-γ (5)

One can solve equations (2a) and (2b) for CB and Cb respectively, plug equations (2a), (2b) and (3) into (4), and take the derivative with respect to C to arrive at equation (5). The authors aim to estimate how the agents’ expected utility changes when the date (L) when the government reveals the whether the benefit level is high (B) or low (b) changes. More formally, the authors find that EU/L < 0 when the individual is risk averse (i.e.: γ>1). In words, expected utility decreases when the date the individual is informed of the social security benefits is moved further into the future.
The authors model income as a concave, quadratic function of age which has an error term which is MA(1) with probability π and ln(0.1)»-2.3 with probability (1-π). Thus, income is hump-shaped throughout one’s lifetime with some persistence in the idiosyncratic error term. Also, there is some probability of a negative income shock, which can be thought of as the probability an agent loses their job. The individual invests their savings optimally at each age, dividing their assets between stocks and a risk-free asset.

The authors then calibrate their model using parameter estimates from other sources. The authors conclude that the excess burden of government indecision can be as high as 0.6 percent of the agent’s economic resources. Individuals who are a) more risk averse, b) have more income uncertainty, c) face a larger cut in benefits or d) have higher marginal tax rates are the subpopulations most adversely affected by the government indecision.

While I am usually skeptical of life-cycle model papers which predict the future using calibration and do not feel the author’s estimates are very precise, it is important to realize that increased uncertainty due to delays in social security reform can lead to suboptimal asset allocation and consumption decisions by individuals planning for retirement.

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