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Center for Data Analysis Report #98-01 on Social Security

January 15, 1998

Social Security's Rate of Return

By and

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Endnotes

1 This rate of return calculation assumes that both adults were born in 1967.

2 Total taxes paid and benefits received are expressed in 1997 inflation-adjusted dollars. Social Security taxes are defined as Old-Age and Survivors Insurance (OASI) contributions, less (where applicable) an amount which would buy a life insurance policy equivalent to the value of the coverage provided by (pre-retirement) Survivors Insurance. In 1997, the tax rate for OASI is 10.7 percent of all wages and self-employment income less than $65,400, as of year-end 1997. Unless stated otherwise, a discount rate is not applied to these amounts.

3 Assuming that upon retirement this single woman is able to annuitize the lump sum at retirement that she accumulated at a real interest rate of 2.7 percent over 15 years. The current federal income tax rates (with current rate structure, exemptions, tax bands, and deductions adjusted by inflation as mandated in current legislation) are applied against this annuity income.

4 Scott A. Hodge, ed., Balancing America's Budget: Ending the Era of Big Government (Washington, D.C.: The Heritage Foundation, 1997).

5 See Social Security Administration, "Findings and Recommendations," 1997 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, Communication from the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, House Doc. 104-228 (Washington, D.C.: U.S. Government Printing Office, 1997), Table R1, p. 36.

6 See Martin Feldstein, "The Missing Piece in Policy Analysis: Social Security Reform," A.E.A. Papers and Proceedings, May 1996, pp. 1-14.

7 Social Security Administration, 1997 Annual Report of the Board of Trustees, Table II.B1, pp. 34-35. The percentage of wages and salaries taxed to support the Old-Age and Survivors and Disability Insurance programs (Social Security taxes) equals the 50 percent paid directly by the employee plus the 50 percent paid by the employer on the employee's behalf. The employer's half comes from wages the family would have earned had there not been a payroll tax.

8 Taxable threshold levels for 1972 and 1997 adjusted by the index value for the Consumer Price Index--All Urban Series. See Economic Report of the President (Washington, D.C.: U.S. Government Printing Office, 1997), Table B-58, p. 365.

9 Heritage Foundation estimates based on data from the Social Security Administration's 1997 Annual Report of the Board of Trustees, Table II.F14, p. 112.

10 This is complicated by the decreasing number of firms that provide company pensions to their workers. Rising taxes of all kinds, costly regulations, and increasing pressures on the bottom line have led many firms away from the practice of providing pensions for long-time employees.

11 Data on average family consumption expenditures from U.S. Department of Labor, Bureau of Labor Statistics, "Consumer Expenditures in 1995," June 1997, Table A. This report estimates average family income before taxes to be $36,918. Heritage analysts added $2,289 to reflect additional wages the average worker would receive if the employer's share of Social Security was converted to wages.

12 Heritage analysts reduced all rates of return and related calculations presented in this paper by the annual inflation rates for the years between 1997 and 2040, as forecast by the Board of Trustees of the Social Security Old-Age and Survivors Insurance Trust Fund in their 1997 annual report. This adjustment to rates of return, Social Security benefits, and privately managed savings means that the reader is always shown sums and earnings ratios in terms of a dollar's purchasing power today. Thus, the statement "Social Security will pay out an annual amount of $17,000 in the year 2040" means that the program will pay enough to allow a beneficiary to purchase then what $17,000 will purchase now. In order for a beneficiary to have that much "purchasing power" in the year 2040, as he has today, Social Security will actually have to send this person around $100,000 annually. The difference between the two amounts is explained by the effects of inflation on the dollar's value, or by what a dollar will buy in 2040 after years of decreasing value due to inflation.

13 Generally speaking, a low-income earner is defined in Social Security Administration simulations as someone who earns 50 percent of the average wage. In 1996, a person defined as low-income earned approximately $12,862 per annum.

14 Report of the 1994-1996 Advisory Council on Social Security, Vol. I: Findings and Recommendations, p. 35.

15 An average-income family is defined by the Social Security Administration as one in which the earners receive the average wage earned by all of those covered by Social Security. In 1996, earners in such families are estimated to have received $25,723.

16 These amounts reflect the buildup of retirement savings in tax-deferred IRA-type investment portfolios and are prior to the payment of any applicable income taxes.

17 Indeed, life expectancy for this African-American male is likely to be lower than the one used. Life expectancy is closely related to earnings, and while the average African-American male worker in the last quarter of 1996 had earnings of 82.8 percent of the national average, the above worker has only earnings of 50 percent of the average. See footnote 11, supra.

18 The amounts below assume that the worker pays out the amount he has accumulated in an annuity over his lifetime and receives an interest rate of 27 percent. The current federal income tax rates (with current rate structure, exemptions, tax bands, and deductions adjusted by inflation as mandated in current legislation) are applied against this annuity income.

19 The current federal income tax rates (with current rate structure, exemptions, tax bands, and deductions adjusted by inflation as mandated in current legislation) are applied against this annuity income.

20 The current federal income tax rates (with current rate structure, exemptions, tax bands, and deductions adjusted by inflation as mandated in current legislation) are applied against this annuity income.

21 In line with upper-bound estimates of the effects of higher income on life expectancy, the remaining life expectancy of this couple is increased by 10.2 percent for the male and 8.2 percent for the female. See footnote 28, infra.

22 These amounts differ from the amount a lifetime income investment of their savings will generate because they do not include interest on these amounts following retirement or the income taxes paid on them when they are drawn down by the retired couple.

23 In 1996, a little under 14.5 percent of all OASDI tax and interest receipts was added to the OASDI trust funds. See Social Security Trustees Report, Table II, C1.

24 See Michael Tanner, "Public Opinion and Social Security Privatization," Cato Project on Social Security Privatization S.S.P. No. 5, August 6, 1996.

25 Based on an interest rate of 2.7 percent and a lifetime expectancy of 15 years.

26 National Center for Health Statistics, Vital Statistics of the United States, 1992 Life Tables, Vol. II, Section 6, 1997.

27 This estimate has been criticized as too optimistic. Analysts have pointed out that life expectancy data since the late 1980s have shown little evidence of racial convergence. Indeed, some claim that the gap is widening. See Paul E. Zopf, Jr., Mortality Patterns and Trends in the United States (Westport, Conn.: Greenwood Press, 1992).

28 For an analysis of the effects of income on life expectancy, see E. Rogot, P. Sorlie, and N. Johnson, "Life Expectancy by Employment Status, Income, and Education in the National Longitudinal Mortality Study," Public Health Reports 107CH, July-August 1992, pp. 457-461, and J. Duggan, R. Gillingham, and J. Greenless, "The Returns Paid to Early Social Security Cohorts," U.S. Treasury Department, Office of the Assistant Secretary for Economic Policy, 1993.

29 As well as an undermining of the "progressivity" of the current system.

30 Based on the real rate of return for long-term U.S. Treasury bills. The Federal Reserve Board's 10- to 15-year Treasury Bond Index is used from 1950 to 1975; the 20-year Treasury Bond is used in 1976. From 1977 on, the 30-year bond is used.

31 Based on the real rate of return for the Standard and Poors' 500 Equity Index.

32 WEFA, Inc., formerly known as Wharton Econometric Forecasting Associates, is an internationally recognized economics consulting firm. Fortune 500 companies and prominent government agencies use WEFA's forecasts and consulting products.

33 The 1994-1996 Social Security Advisory Committee, for example, found that a long-run real rate of return on equities of 7 percent existed. Report of the 1994-1996 Advisory Council on Social Security, Vol. I: Findings and Recommendations, p. 35.

34 These tax rates are calculated using the intermediate assumptions in the 1997 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Fund.

35 As defined in the 1997 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Fund, p. 208.

36 Ibid., Table II.E.2.

37 Ibid.

38 Based on lowest quotes available for contract from Budgetlife's World Wide Web page, www.budgetlife.com, on September 24, 1997.

39 As defined in the Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Fund, p. 216.

40 All life expectancy data used in this paper show that women have longer life expectancies than men.

41 National Center for Health Statistics, Vital Statistics of the United States, 1992 Life Tables, Vol. II, Section 6, 1997.

42 Ibid.

43 Zopf, Mortality Patterns, op. cit.

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