Saturday, January 8, 2011

Essay on Social Security

Essay on Social Security

Social Security has long been the United States government’s most popular program. Many Americans have little knowledge about how it operates and how its benefits compare with the returns from other retirement investments. Even though millions of Americans are deluded to thinking that Social Security maintains a savings account in each of their names with money in it, in reality, there is no direct connection between the amount of taxes paid and the benefits an individual eventually receives in retirement. In addition, the rate of return on Social Security retirement taxes is extremely low. For example, the average rate of return for a household of two hard-working 30-year-old earners with children is a lowly 1.2 percent. Most people do not realize that since the trust funds consist of trillions of dollars of IOUs, Social Security will be unable to pay full benefits to anyone born after 1974 unless the system is reformed. This where I determine whether the provisions of a re-vamped Social Security bill is indeed formidable.

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The YSSS(Your Social Security Statement) provides official information on the benefits that people are entitled to receive during retirement. However, it discounts important information about Social Security's future. The statements include an accounting of Social Security taxes the individual worker has paid to date, the worker's eligibility for benefits, and an estimate of the various types of benefits the worker and/or family could receive under different circumstances. It neglects to mention that although workers are told that a specific dollar amount from Social Security is due to them, the money may not be there when they retire. One of the provisions of this new bill calls for the elimination of all criteria for determining payments except for Social Security taxes paid. Under this provision, the present value of lifetime Social Security taxes paid would be calculated at the time of retirement, thus alleviating the dilemma of a low average rate of return. For example, if I were working for 30 years and paid Social Security taxes every year, I would be very upset if I realized that by the time I retired, I wasn’t entitled to as much Social Security money that I had anticipated due to the lowly 1.2 percent average rate of return. On the other hand, under the new bill, I would essentially collect on the full amount that I had paid in throughout my career after calculating the present value. This seems like a “fairer” way because workers will reap what they sow. People would then have more faith in Social Security thus increasing their incentives to work longer and harder. Many politicians want workers to have faith that someone else will pay enough taxes to pay off their benefits after retirement instead of letting them invest in their own futures with private “untouchable” accounts. In 2001, Bush ordered a presidential commission to come up with a plan to create individually controlled, voluntary personal retirement accounts to enhance Social Security, which is very similar to this section of the bill.

Several countries including Mexico, Chile, Britain and Australia have successfully made the transition from their failed Social Security systems to healthy systems based on individual retirement accounts. This would help “prop up” the Social Security system because people would be less inclined to depend solely on the government for pay off. Since the elimination of the other criteria would only ensure the reception of Social Security payments as long as the recipient was still living, the deficit incurred by IOUs would slightly decrease.

As of now, a person is required to be 62 years of age to collect on Social Security payments. For two-thirds of Americans aged 65 or older, a Social Security check is their top source of income and one in five of them rely solely on that payment. Although the life expectancy is much higher now than it was 50 years ago, many people aren’t able to “cash in” on their Social Security payments that they worked their entire lives for. Even if people do live to the age of 62 and are able to receive payments, they are too old to really enjoy it. So, this leads to the second provision of this new bill: lowering the minimum age for drawing benefits to 55. With this change, Americans would be able to retire at a significantly young age compared to 62. More importantly, they have a higher probability on collecting the majority, if not all, of their benefits. For example, say I had been working hard for 30 plus years and on my 55th birthday I decided to retire. Now I would be able to receive Social Security payments while I’m still at a relatively “young” retirement age. Therefore I could still be young at heart and travel or spend time with my grand kids (if I have any). However, there are some downsides to lowering the minimum age for receiving Social Security benefits. Social Security was established in 1935 and provides a check to nearly all retirees who worked or were self-employed. This system was not implemented to be an individual savings plan, but as a promise between generations. In other words, today’s workers pay taxes to “cover” the monthly payments received by workers in past generations. The current Social Security system is headed towards serious long-term financing issues derived from accumulated IOUs. Part of the reason for this is because Americans have longer lives and lower birth rates nowadays.

Back in 1955, the country had nearly 9 workers per person receiving Social Security benefits while by 2030, the government projects only 2 workers would be able to support every person receiving Social Security payments. According to deputy commissioner James Lockhart, “Americans really are counting too much on Social Security.” So with the lowering of the minimum age, more and more Americans would be benefiting from Social Security, thus lowering the ratio of workers per beneficiary. This would cause the IOUs to accumulate even more than usual and the government would end up having to raise taxes in the future to cover the financial burden of this provision. Today’s workers should not rely heavily on the overburdened federal retirement system. For the sake of our government not digging itself into a deeper hole than it already has, I don’t believe lowering the age requirement is the best solution.

In the current Social Security system, the payroll tax used to finance Social Security is shared between workers and employers. In other words, both the workers and employers(firms) pay a tax equal to 6.2 percent totaling 12.4 percent. What if the Social Security tax burden was completely absorbed by the firms? According to this provision of the new bill, salary and wage cuts would be a possible consequence. If firms were fully responsible in paying the Social Security taxes, it would mean they would have to pay their workers less. This would anger a lot of workers because a lower pay means a lower income tax return. In addition, since the maximum Social Security tax paid would be raised, a worker would have to make $100,000 a year in order for the maximum to be reached. This just places more of a burden on workers because they would be required to make significantly more money just to be eligible for max benefits in the future.

First, we need to focus on the income distribution issue. The Social Security Program was established to serve more than just as an insurance for retirees. It was also intended to be a “redistribution program” for of reducing income inequality. This is why the income distribution issue is so important among Americans. The Social Security Wealth is best defined as the value of future Social Security payments as a part of family’s total assets. This essentially entails that the Social Security Wealth is implicit in that the younger generations are funding the benefits for the older generations, thus causing an income shift. For example, two individuals who retire in 1980 and 2010 would have a net benefit of Social Security of $39,200 and -$36,300 respectively. After computing the lifetime payroll taxes and gains between the two, it is evident that the income is redistributed towards older generations. In addition, more Social Security benefits are received by women because they generally have a higher life expectancy. If the new bill was passed, then there would be more and more people retiring at a very young age, thus creating a larger pool of retired workers eligible for benefits. This at the same time would cause the labor force to become younger. With the life expectancy gradually increasing, the government is simply projecting that the number of people receiving benefits and the number of people dying before they reach the age of 55 would more or less cancel each other out. Experts project that by the year 2014, the Social Security Trust Fund would be used up. If this happens, then more and more workers would continue to retire at a young age and the remaining source of taxes paid would be spread very thinly to cover all those eligible. This in a sense further exacerbates the problem of the Social Security system because there would be an even larger surplus of retirees without enough funds to cover all of them.

A potential new bill would also constitute several behavioral changes among workers and retirees. There are three types of saving behavior which influence the amount that a retiree might possibly save before he/she retires from the labor force. The wealth substitution effect means that if a Social Security benefit is available, individuals would be inclined to save less and depend on the system to finance their retirement life. This is not the best approach for well being in the future. Another type of savings behavior is the retirement effect. This simply means that the behavior is altered from the norm because as people tend to finance their additional savings as they begin to start receiving benefits for early retirement. The bequest effect illustrates the want of individuals to leave bequests for their children, and therefore they increase savings to offset the implicit fact that income is shifted from their children who pay Social Security taxes onto their parents who receive Social Security benefits. If this new bill were to pass, the number of retirees would increase significantly and people would be more inclined to increasing their savings.

The Social Security System is a very complicated program. It is more than just an insurance program for retired workers. Politicians and Economists are constantly proposing new solutions to “improve” the efficiency of the system. In my opinion, I don’t think the provisions of this new bill will improve the welfare of retirees in the long run. Essentially, this new bill just gives people the liberty of cashing in their chips at a much earlier age than before. This would continue to overburden the federal system with more and more accumulated IOUs. Also, the fact that this “new bill” would only focus on the sole criteria of Social Security taxes paid just doesn’t cut it. Without the build up of substantial surpluses within the Social Security Trust Fund, there’s no safety net to guarantee retirees in the future would be paid off. With our current system, a significant tax increase on current workers could possibly alleviate the problem to pay off the dependency ratio of 2 workers per retiree. This new bill would not necessarily make the Social Security system better off in the long run.

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