Eco 440_PS5

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Feb 20, 2024

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Eco 440: Public Economics and Ethics Problem Set 5 (Gruber, Ch 13) Instructor: Christopher Cruz, PhD Due date: Mar 2, 2024, 11:59PM Name: 1. The government of Westlovakia has just reformed its social security system. This reform changed two aspects of the system: (1) It abolished its actuarial reduction for early retirement, and (2) it reduced the payroll tax by half for workers who continued to work beyond the early retirement age. Will the average retirement age for Weslovakian workers increase or decrease in response to these two changes, or can’t you tell? Explain your answer. The first policy change, abolishing the actuarial reduction, would tend to lower the aver-age retirement age. The actuarial reduction is intended to make workers approximately indif-ferent between retiring early and waiting until standard retirement age. With the reduction,early retirees have a smaller benefit over more years. Abolishing the reduction would makeearly retirement more attractive: the benefits would be just as high as if workers had waited,and they would be paid over more years. The second policy change would increase the re-turn to working later in life and thus would tend to raise the average retirement age.The overall effect would depend on a number of factors. If people discount the future byenough (that is, have a high enough internal discount rate), they will tend to retire early: the benefit is immediate. People who have a lower discount rate will choose to work longer atthe lower tax rate. 2. Congressman Jones has proposed a bill that would increase the number of years of earnings counted when computing the Social Security Average Indexed Monthly Earnings amount from 35 to 40. What would be the effects of this policy change on the retirement behavior of workers? Would the Social Security trust fund balance increase or decrease? Why? Workers may work longer if their best 40 years counted rather than their best 35. Generally,you would expect earned income to increase over a worker's lifetime; thus, the last several yearsare likely to yield higher income than the first several years. Being able to count 5 more high-earning years would induce some workers to remain in the workforce to increase their calcu-lated benefits; if they did not work longer, the 40 years might include some very low or zero-earning years (when the worker was in his or her twenties, possibly still in school).The primary reason this bill would tend to increase the Social Security trust fund is be-cause it would tend to reduce the Averaged Indexed Monthly Earnings and therefore the sizeof retiree benefits. Simply put, the 5 additional years of earnings history would be the lowest.

3. Suppose the Social Security payroll tax was increased today to 16.4% to solve the 75-year fiscal imbalance in the program. Explain the effect of this change on the value of the Social Security program for people of different ages, earning levels, and sexes. An increase in the payroll tax would reduce the value of Social Security for younger workers relative to older workers. Older workers would benefit from having a more secure plan, and they wouldn't have to pay in at the higher rate for very long. Younger workerswould have to pay the higher rate over many more years, and their benefit calculation wouldnot increase (because the increase in taxes is meant to keep the current system solvent, not toincrease benefits). The very-highest-earning workers would not be harmed as much as lower-earning workers because the payroll tax is not imposed on earnings above $94,200 (cur-rently); however, their payroll tax burden would increase. Women generally benefit morefrom Social Security because they live longer than men. They are also more likely than mento have interrupted their careers to raise their families, so they tend to pay in less. They arealso more likely to receive benefits as a surviving spouse. 4. Consider two households, the Romeros and the Pereiras. The Romeros are a two-earner household: both Audrey and Jaime Romero work and earn the same amount each year. The Pereiras are a one- earner household: Isabela Pereira works while Jonathan Pereira is a homemaker and stay-at-home dad. Use the way spousal benefits are treated in the Social Security system to address the following: a. How do the relative rates of return on Social Security payroll taxes compare for the two families? The relative rates of return on Social Security payroll taxes differ for the Romeros and the Pereiras due to their distinct earning dynamics. In the case of the Romeros, both Audrey and Jaime contribute equally to Social Security through their earnings. When they retire, they are each entitled to their own Social Security benefits based on their individual work records, resulting in a relatively balanced return on their combined payroll taxes. However, the Pereiras present a different scenario. Isabela is the sole earner, while Jonathan does not contribute directly to Social Security through paid work. Therefore, Isabela's contributions alone determine the family's benefits. Jonathan, as a non- earning spouse, may still be eligible for spousal benefits based on Isabela's work record, but the relative rate of return on their combined payroll taxes is skewed towards Isabela's earnings. b. After the kids go off to college, Jonathan considers taking a small part-time job. How might the Social Security system of taxes and benefits affect his decision?

Jonathan's decision to take a small part-time job after the kids go off to college could be influenced by the Social Security system's taxes and benefits. By working part-time, Jonathan would contribute to Social Security through payroll taxes, allowing him to accumulate credits and potentially increase his own Social Security benefit in the future. However, his decision might not directly impact the spousal benefits he receives based on Isabela's work record, though significant part-time earnings could affect their household income. Additionally, if Jonathan starts receiving Social Security benefits before full retirement age and continues to work, his benefits might be subject to the earnings test, potentially leading to withheld benefits if his earnings exceed certain limits. Long-term retirement planning should also consider how Jonathan's part-time income could supplement their retirement savings and impact their overall financial situation and tax liabilities. c. Suppose that both families have retired and have started to receive Social Security benefits. By what fraction will these benefits fall for each of these families if one member of the household dies? What implications does this have for relative consumption smoothing in these two households? If one member of each household dies after retirement, the surviving spouse may be eligible for survivor benefits from Social Security, the fraction of which depends on various factors such as the deceased spouse's earnings history and the age of the surviving spouse. In the Romeros' case, with both spouses being earners and potentially similar benefit amounts, the impact on consumption smoothing might be less severe if one spouse passes away, as the survivor could continue to receive a similar level of benefits. However, in the Pereiras' case, where one spouse is the primary earner, the loss of that spouse's benefits could significantly affect consumption smoothing, potentially leading to financial strain and the need for adjustments in consumption patterns for the surviving spouse. 5. What are the political and economic ramifications of investing a large part of the Social Security trust fund in the stock market, as has been recently proposed? Investing a large portion of the Social Security trust fund in the stock market carries both political and economic ramifications. Politically, such a move could spark controversy, with concerns over government involvement in the market and potential partisan divides regarding the role of government in retirement funding. Economically, there's the risk of market volatility affecting the fund's stability, though proponents argue for potentially higher long-term returns. However, this strategy could also influence market dynamics and raise questions about government interference in free markets. Overall, the decision involves weighing potential benefits against risks and navigating public perception and political feasibility. 6. Dominitz, Manski, and Heinz (2003) present survey evidence suggesting that young Americans are extremely uncertain about the likelihood that they will receive any Social Security benefits at all. How might demographic trends in the United States contribute to this concern?

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Demographic trends in the United States, such as the aging population, declining birth rates, economic challenges, political uncertainty, and increasing longevity, contribute to young Americans' uncertainty about receiving Social Security benefits in the future. With a growing number of retirees drawing benefits and fewer younger workers entering the workforce to support the system, concerns about the program's long-term viability are heightened. Economic difficulties, coupled with doubts about political will for reform, further exacerbate worries among younger generations about their retirement security. These trends underscore the need for policymakers to address Social Security's financial sustainability to provide assurance to younger Americans regarding their future benefits. 7. The Social Security Administration website has a link to a publication entitled Social Security Programs Throughout the World, which is available at https://www.ssa.gov/policy/docs/progdesc/ssptw/ or by searching for “Social Security Programs Throughout the World.” Using the report for the most recent year available, find the summary tables that compare the attributes of retirement systems of all European countries, and in particular, examine the table containing ages for each country at which a person may begin to take a pension from the Social Security program ( Table 3 ). Based on this table, which of countries do you think will have the greatest rate of early retirement, in which individuals exit the workforce prior to becoming eligible for Social Security? Why? I think that European countries will have the highest rate due to Countries with lower pension eligibility ages, generous benefits, and accommodating labor markets may experience higher rates of early retirement. Additionally, societies that prioritize leisure or have cultural norms supportive of early retirement could contribute to elevated rates.

Eco 440_PS5

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