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Special Topic 2
The Economics of Social Security
OUTLINE
I. Introduction to the U.S. Social Security Program
A. Offers protection against the loss of income that usually accompanies old age or the
death of a breadwinner.
B. It is a pay-you-go system. It is not based on saving-and-investment model.
C. Primarily an intergenerational income-transfer program: Most taxes collected from the
present generation of workers are used to finance current benefits.
D. Because of the pay-as-you-go nature of the program, it is influenced by changing
demographics.
II. Why Is Social Security Headed for Problems?
A. Baby boomers moving into the retirement phase of their life will place strong pressure
III. Will the Trust Fund Make It Easier to Deal With the Retirement of the Baby
Boomers?
A. Current revenues exceed expenditures on benefits by about $100 billion per year.
B. This surplus is p
IV. The Real Problem Created by the Current System
A. A crisis faced by the pay-as-you-go system will arise around 2017 when the revenues
from the payroll tax will begin to fall short of the benefits promised to retirees.
B. Four possible ways of dealing with the future shortfall of revenues relative to promised
benefits:
1. reduce benefits;
2. raise taxes and/or cut other government expenditures in order to inject additional
C. The presence of SSTF bonds does not change these alternatives or make it easier to
deal with future Social Security deficits
D. The problem is not depletion of the trust funds, but the burden of soaring Social
Security deficits on the economy beginning in about 13 years
274 Special Topic 2/The Economics of Social Security
V. Does Social Security Help the Poor?
A. Does Social Security Help the Poor?
1. While the Social Security benefit formula favors those with lower lifetime
earnings, low-wage workers have a lower life expectancy, begin work at a younger
VI. Social Security and the Treatment of Blacks and Working Women.
A. Adversely Affects Blacks and Other Groups with Below-Average Life Expectancy
1. Because of their shorter life expectancy, blacks derive a lower rate of return from
Social Security than whites, and a substantially lower return than Hispanics.
B. Discrimination Against Working Women
1. Social Security discriminates against married women in the workforce.
VII. Is Social Security Suitable for the Twenty-First Century?
A. The demographics of the twenty-first century reduce the attractiveness of pay-as-you-
go Social Security.
OBJECTIVES
This special topic examines one of the most widely discussed and debated public policy issues
Social Security. The problem facing Social Security is explained as well as its treatment of various
demographic groups. The special topic concludes with a discussion of possible reforms.
IMPORTANT POINTS AND TEACHING SUGGESTIONS
1. Review Exhibit 1, which shows the workers per Social Security beneficiary. As the
worker/beneficiary ratio falls under a pay-as-you-go system, either taxes must be increased or
benefits reduced (or both).
2. It is important to contrast the pay-as-you-go approach of Social Security with the approach of
private saving for retirement. Comparison to Ponzi schemes is also instructive.
3. Remind students that any pay-as-you-go policy that gives early retirees an unsustainably good
deal faces the same sort of problem as Social Security.
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HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS