removing the disincentives in social security for long careers october 20, 2006 gopi shah goda,...
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Removing the Disincentives in Social Security for Long Careers
October 20, 2006
Gopi Shah Goda, Stanford UniversityJohn Shoven, Ph.D., Stanford UniversitySita Slavov, Ph.D., Occidental College
2
Motivation
• Life expectancy has improved dramatically since the introduction of Social Security– Period life expectancy for 20-year-olds in
1935 was 66 for males, 69 for females– Today, 20-year-old males have life
expectancy of 76, and females have life expectancy of 80
• However, men are retiring much earlier
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Labor Force Participation by Age for Men, 1965 and 2003
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
90.0
100.0
55 57 59 61 63 65 67 69 71 73 75+
Age
Pe
rce
nt
in L
ab
or
Fo
rce
1965
2003
Early Retirees Retiring 4 Years Younger
3 Years Younger
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Labor Force Participation of Men by Remaining Life Expectancy -
Average Length of Retirement Up Almost 50% Since 1965!
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
90.0
100.0
8 10 12 14 16 18 20 22 24
Remaining Life Expectancy
La
bo
r F
orc
e P
art
icip
ati
on
1965
2003
7.0 Years
5.5 Years
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What are implicit Social Security tax rates?
• The implicit Social Security tax rate for an individual age x is defined as the additional taxes paid at age x, less the present value of additional Social Security benefits accrued, divided by earnings at age x
x
gxxx Earnings
NRAxDAVPIAesPayrollTaxecSecTaxRatImplicitSo
),(12
60
200
400
600
800
1000
1200
1400
1600
1800
2000
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
AIME
PIA
Social Security Benefit Calculation
Earnings History
Cap & Wage Index Earnings
Calculate AIME (Average IndexedMonthly Earnings)
Calculate PIA (Primary Insurance Amount)
Choose Highest 35 Years
slope = 0.90
slope = 0.32
slope = 0.15
Pay CPI-Indexed PIA from Retirement Age until Death
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Assumptions
• Single male worker who starts working at age 20, and retires at the NRA
• Assume 2005 benefit rules persist• Earnings by age simulated using a time-series of
average wages for U.S. and an age-wage profile constructed from 2001 and 2002 CPS
• OASI tax rate = 10.6% maximum implicit tax• Real wage growth = 1% • Real discount rate = 2%• Work years are “front-ended”
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15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
9
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
10
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
11
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
Male Mortality
12
Female Mortality
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
13
Why do we see these patterns?
• Once a person works 35 years, additional years of earnings are no longer replacing zeroes – they are replacing lower earnings years
• Each additional year of work does not count the same because of the way the system handles progressivity
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What do implicit tax rates look like for actual earnings histories?
• Benefits and Earnings Public Use File, 2004• 1% sample of SSA beneficiaries in December
2004• Limit attention to beneficiaries receiving retirement
benefits based on their own earnings histories, and who started working 1951 or later
• This leaves 123,552 individuals in the sample– 75,368 men and 48,184 women– Birth years range from 1910 to 1942
• Earnings above the cap are not available• No way to link couples in the data
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Three Possible Reforms
1. Use 40 years rather than 35 in the AIME calculation
2. Disentangle career length and progressivity
zeros) includenot (doesAIME modified
*1
*
adjustmentlengthcareer
*1
*
zeros) (includesAIME
*1
t
t
NRAt
t
NRAt
t
NRA earnw
w
yf
T
yPIAearn
w
w
yT
yfearn
w
w
TfPIA
Current PIA Calculation Proposed PIA Calculation
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PIA Under Current and Proposed Law
0
200
400
600
800
1000
1200
1400
1600
1800
2000
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
AIME
PIA
PIA formula under Current Law(AIME calculation includes zeros)
PIA formula under Proposed Law for Low, Middle, and High Income Earner(AIME calculation does not include zeros)
Position on ray depends on career length.
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Three Possible Reforms
1. Use 40 years rather than 35 in the AIME calculation
2. Disentangle career length and progressivity
3. Establish a “paid-up” category of workers who have worked a full career of 40 years
21
Monthly Primary Insurance Amount Under Current and Proposed Law
Average Income Earner
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
10 15 20 25 30 35 40 45
Career Length (years)
2006
Doll
ars
Proposed Law PIA
Current Law PIA
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15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
23
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
24
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
25
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
26
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
27
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
28
15 20 25 30 35 40 45
-0.1
-0.05
0
0.05
0.1
Career Length
Impl
icit
Tax
Rat
e
average 10th %ile90th %ilefull cap
29
30
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What impact do these reforms have on progressivity?
Current Law Proposed LawLow Income Earner 2.64% 2.55%Average Income Earner 1.34% 1.34%High Income Earner 0.81% 0.86%
IRRs for Workers with 30-Year Career
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What impact do these reforms have on women?
• Since women in the sample are more likely to experience shorter careers, the reforms disproportionately affect women
• Benefit levels are 2.44% higher for males, 0.07% higher for females (vs. 1.52% overall)
• We look at policies to alleviate this redistribution…
33
What impact do these reforms have on women?
Percentage Change in PIA by Gender and Years of Credit Given for Women
No Credit 1-Year Credit 2-Year Credit 3-Year Credit Male Benefits 2.44% 2.44% 2.44% 2.44% Female Benefits 0.07% 3.29% 6.42% 9.45% Total 1.52% 2.77% 4.00% 5.18%
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Summary
• Flat payroll taxes and the current benefit formula together imply that workers face increasing disincentives for working long careers
• This may be contributing to what could be suboptimally long retirement periods
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Summary
• Policies that flatten the pattern of implicit taxes as individuals age would reduce the disincentives of working longer careers
• These policies can be enacted in ways that are either revenue- or benefit-neutral in aggregate
• These policies would involve some redistribution from individuals who work short careers to individuals who work long careers