removing the disincentives of long careers in social security august 10, 2006 gopi shah goda,...

Removing the Disincentives of Long Careers in Social Security

August 10, 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

3

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

Perc

en

t in

Lab

or

Fo

rce

1965

2003

Early Retirees Retiring 4 Years Younger

3 Years Younger

4

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

5

What are implicit Social Security tax rates?

• The implicit Social Security tax rate is the change in the net Social Security tax as a percentage of earnings

x

gxxx Earnings

NRAxDAVPIAesPayrollTaxecSecTaxRatImplicitSo

),(12

6

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”

7

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

8

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

Male Mortality

11

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

12

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

13

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

14

15

16

17

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

18

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.

19

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

20

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

21

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

22

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

29

30

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

31

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…

32

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%

33

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

34

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