Other Free Encyclopedias » Medicine Encyclopedia » Aging Healthy - Part 4 » Social Security and the U.S. Federal Budget - Social Security’s Financing, Social Security’s Treatment Within The Federal Budget, Social Security’s Effect On The National Economy

Social Security and the U.S. Federal Budget - Social Security’s Effect On The National Economy

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In fiscal year 1999, Social Security received payroll taxes and taxes on Social Security benefits equal to roughly 5 percent of the gross domestic product (GDP) and paid out benefits equal to approximately 4 percent of the GDP. Social Security influences economic output through these transactions.

Economic output is commonly measured using the GDP. The GDP is the market value of final goods and services annually produced within a nation over a certain period of time. Labor supply, capital investment, natural resources, and technology all determine economic output. Social Security is thought to primarily influence the first two categories: labor supply and capital investment.

The effect of Social Security on labor supply. Both Social Security taxes and benefits can influence an individual’s decisions on whether to work and how much to work. The effect of the Social Security payroll tax is complex; it may either increase or decrease the incentive to work, depending on how much an individual wants to spend and save and how the individual views the payroll tax. Economic theories indicate Social Security taxes create two opposing effects, known as the income effect and the substitution effect. Social Security benefits, on the other hand, are believed to reduce the incentive to work based on their income effect.

The income effect describes how changes in real wages (the purchasing power of wages) or wealth influence how much a person may consume. Leisure time is something that individuals can consume, like clothing, cars, and other goods. Decreases in real wages or wealth decrease the amount of things, including leisure, that a person may consume. Likewise, increases in wages or wealth increase the amount of goods, including leisure, that a person may consume.

The substitution effect describes how changes in the price of something a person consumes influences the composition of the entire collection of things that person may consume. Changes in real wages influence the opportunity cost of leisure. The opportunity cost of leisure is essentially equal to wages lost by not working during leisure time. When leisure becomes less expensive (i.e., wages decrease), individuals will substitute less work for more leisure and will reduce the amount of labor they supply to the economy.

If workers view the Social Security tax as only a tax, and not as a contribution toward retirement, then the income effect indicates workers would increase the amount they work in response to the perceived reduction in real wages. If workers view the tax as a retirement contribution that provides wealth in the form of earned Social Security benefits, then the income effect indicates workers may decrease the amount of labor they supply. The Social Security tax could also decrease labor supply through the substitution effect, because the reduced real wage reduces the opportunity cost of leisure.

The strength of the effect of Social Security benefits on labor supply depends on both the availability of benefits and the size of benefits. The availability of early retirement Social Security benefits at age sixty-two and regular retirement benefits at age sixty-five may reduce the supply of labor as a result of the income effect. Social Security retirement benefits provide a nonwork source of income, reducing the amount of work needed to achieve a desired level of income.

There is evidence indicating that labor force participation rates of persons around retirement age dropped when retirement benefits became available at age sixty-two in 1956 for women and in 1961 for men. Approximately half of all workers currently apply for Social Security benefits when they attain age sixty-two. Evidence also suggests that availability of benefits at the normal retirement age, which is gradually increasing from age sixty-five to age sixty-seven, induces workers to leave the workforce. Currently, age sixty-five is the second most common age for retirement, after age sixty-two.

Several Social Security program provisions affect the size of an individual’s monthly benefit. The worker’s earnings history is the primary determinant of the size of retirement benefits. However, the program reduces a person’s monthly retirement benefits when he or she retires before the normal retirement age, which is age sixty-five for workers who attained age sixty-two before the year 2000. The program increases a person’s monthly retirement benefits when he or she retires after the normal retirement age. Also, the program reduces a person’s current monthly benefits if he or she retired early and has earnings exceeding a certain threshold ($11,280 in 2002) that is raised annually in line with national wage increases. These adjustments are designed to be neutral over an average lifetime, but some persons may alter their labor supply because of them.

There are two programmatic changes underway that may alter labor force participation among older Americans. First, the normal retirement age is increasing from sixty-five, beginning with people born in 1938, until it reaches sixty-seven for people born after 1959. As a result, persons taking early retirement benefits will receive an even greater decrease in annual benefits, compared to persons who retire at the normal retirement age. This may encourage work among persons between the earliest retirement age and the normal retirement age. Second, the delayed retirement credit is increasing from 6 percent per year of delay (for persons age sixty-two in years 1997–1998) to 8 percent (for persons age sixty-two in years 2005 and later).

Most economists agree that Social Security benefits have decreased the labor supply of older workers. Hurd and Boskin show that increases in real Social Security benefits in the early 1970s explain the majority of reduced labor force participation among married men aged fifty-eight to sixty-seven in 1969 through 1973. Hausman and Wise found a smaller effect—that the increase in Social Security benefits accounted for possibly one-third of the decrease in labor force participation of men age sixty and older between 1969 and 1975. Others have argued that factors unrelated to Social Security, such as health status, receipt of a private pension, availability of health insurance, and the retirement status of a spouse have a greater influence on the labor supply of older workers.

Social Security did not initiate the decline in labor force participation rates for older workers. According to a study by Dora Costa, 70 percent of the decline in the labor force participation rates of U.S. men age sixty-five or older occurred before 1960, when benefits were lower and fewer types of employment were covered under Social Security.

The effect of Social Security on national saving. Social Security taxes and benefits influence capital investment, as well as labor supply. Social Security influences capital investment through its effects on private (includes personal and business) saving and government saving. Together, private and government saving are known as national saving.

The ability of a country to invest in capital is linked to the amount of national saving. National saving is the difference between what the U.S. economy produces and what it consumes and represents funds that are available for capital investment. Capital comprises items like buildings, computers, and machines. To the extent saved funds are invested in capital, they can increase economic output.

Social Security taxes and benefits have a direct effect on government saving. Government saving equals revenues (tax receipts) minus the purchase of goods and services, transfer payments, and interest payments to the public on government debt. To the extent that Social Security receipts equal the sum of benefits paid and administrative costs, it has no net effect on government saving.

However, the Social Security Trust Funds are currently building up reserves. To the extent Social Security tax receipts exceed benefits and administrative costs, they can increase government saving or reduce government dissaving. In times when the non-Social Security portion of the federal budget runs deficits, Social Security surpluses reduce the government’s need to borrow, thereby reducing government dis-saving. In times of unified budget surpluses, the government uses the funds to buy back publicly held debt, making additional funds available for private saving and investment.

As Table 1 shows, Social Security has decreased government dis-saving or increased government saving since the mid-1980s. However, in the mid-1970s and early 1980s, the Social Security Trust Funds paid out more in benefits than they received in income, increasing government dis-saving. It is important to remember that the government does not make spending and taxing decisions regarding Social Security and the rest of the federal budget independently of each other, and these decisions influence each other. For example, if the existence of the Social Security tax kept the government from increasing other taxes, then Social Security’s contribution Table 1 Sector as a percentage of gross domestic product SOURCE: Author’s calculations using data from Table B-8 and B-30 of the Economic Report of the President, February 2000, and the 2000 Trustees Report. to government saving is larger and the rest of the budget’s contribution is smaller than it would be otherwise.

The Social Security Trust Funds are not expected to maintain a surplus indefinitely. By the year 2015, benefits will exceed Social Security payroll tax revenues according to current law actuarial estimates. At that point, Social Security will decrease government saving. This does not mean that the government will be unable to pay Social Security benefits in 2015. However, the Trust Funds will use interest on its investments to help pay benefits. After 2025, actuarial estimates indicate the Trust Funds will begin to redeem their investments. Redeeming the Trust Fund investments will reduce budget surpluses or increase any deficits.

The effect of Social Security on personal saving is less clear. Many factors contribute to a person’s consumption and saving decisions: income levels, the desire to bequeath assets to future generations, concern about unplanned events (disability, unemployment, health crises, etc.), the timing of retirement, and awareness of the amount of savings needed to generate a given level of income at retirement.

Various theoretical arguments support the belief that Social Security decreases personal saving. Social Security could reduce the need for personal saving, since it reduces the amount of spendable wealth needed to produce a specific level of income. Alternatively, Social Security may raise awareness of the need to plan for retirement or encourage workers to retire early, encouraging people to save more than they would otherwise. Finally, some theoretical arguments indicate Social Security has a roughly neutral effect on personal saving. Some persons may increase bequests to their children, knowing that the payroll tax paid by their working children funds their Social Security benefits in retirement. It may also have no effect if workers choose to increase nonpension saving by an amount roughly equal to any reduced saving for retirement.

Economists have not completely modeled all the factors that contribute to decision-making; therefore, they rely on a combination of theory and empirical evidence to try to determine Social Security’s effect on personal saving. Most current research shows Social Security reduces personal saving to some degree. For example, Feldstein and Diamond and Hausman found that Social Security has a negative effect on saving. However, a few studies show Social Security may not decrease overall personal saving. For example, Gullason, Kolluri, and Panik found that Social Security has no significant effect on overall personal wealth, but decreases pension wealth.

We do not know the exact degree to which Social Security influences national saving (combined government, personal, and business saving). If Social Security decreases national saving, then economic output/national income is less than it could be in the absence of Social Security. If the less likely scenario is true—if Social Security increases national saving—then economic output/national income is higher than it would be in the absence of Social Security.

Social Security and the U.S. Federal Budget - Social Security As A Tool In Promoting Economic Growth [next] [back] Social Security and the U.S. Federal Budget - Social Security’s Treatment Within The Federal Budget

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