Social security outcomes by racial and education groups.

• Author: Liu, Liqun

1. Introduction

   Social Security is primarily an intergenerational transfer system providing payments to retired workers and their families financed by payroll taxes on current workers. The Old-Age and Survivors Insurance (OASI) program also provides life insurance through survivors benefits. Because longer lives are positively related to income, the retirement pension favors workers with higher lifetime incomes, other things equal. Conversely, survivors' insurance is more likely to be awarded within groups with higher mortality rates at younger ages, which happens to be those with lower incomes. Further, the benefit formula replaces a higher percentage of the income of workers with lower lifetime earnings, while spousal retirement benefits favor couples in which only one spouse works. As a result, any particular group's outcome depends on their lifetime earnings, their group-specific longevity, the tax rates they face, and the Social Security benefit formula.

   There have been quite a few studies devoted to calculating the internal rate of return and net present value of Social Security. (1) Some consensus has been reached by those studies: early generations do better than later generations, women do better than men, and married couples with a single earner do better than singles or working couples. These results are not surprising given that a pay-as-you-go system usually generates a higher return in its start-up phase than in the mature phase, that women live longer than men, and that nonworking spouses receive benefits without making tax payments.

   However, to date, a consensus has not been reached on some of the more interesting but less obvious issues such as how different income classes or different races fare in the system. This article evaluates how each benefit component affects progressivity by focusing on ex ante well-defined demographic groups classified by education and race and by projecting the returns for current working generations assuming that payroll taxes rise to cover any financing shortfall. The distinguishing features of this article are its accounting of the incidence of survivors' insurance and its use of education- and race-specific mortality tables and earnings profiles for each birth cohort. Ultimately, we calculate the expected net present value and the expected internal rate of return of the OASI package for groups defined by family type, birth cohort, race, and education level. (2)

   We find that, even without accounting for the preretirement survivors' payments that benefit low education groups more, these groups enjoy a higher rate of return. This suggests that the redistributive nature of the benefit formula outweighs the effects of lower life expectancies. In contrast with the outcomes based on education, our estimates indicate that the longevity disadvantage of blacks offsets the redistributional effect of the benefit formula, resulting in a lower rate of return for blacks than for whites. This holds even though blacks, as a group, receive more preretirement survivors' benefits due to a higher probability of early deaths. However, we show that the money's worth ratio is sensitive to the discount rate used. As the discount rate increases within the plausible range, Social Security becomes less regressive and even progressive with respect to the redistribution among racial groups when survivors' benefits are taken into account.

   Adding to previous discussions of Social Security rates of return that focused on earlier generations, this study projects the returns from Social Security for current working generations, taking into account the forecasted financing shortfall. This exercise produces two notable findings. The first is that the dispersion in rates of return by education category grows over time as a consequence of forecasted increasing education premiums. The second finding is that, while the return from Social Security declined over time for earlier generations due to a retirement age that remains constant combined with increasing life spans, rates of return flatten out for current working generations and even increase for less educated members of younger generations despite the increased payroll taxes required to keep the system solvent.

   Earlier studies (Leimer 1978; Hurd and Shoven 1985; Boskin et al. 1987; Duggan, Gillingham, and Greenlees 1993; and Steuerle and Bakija 1994) concluded that the low lifetime earners do better than those with high lifetime earnings. (3) Duggan, Gillingham, and Greenlees (1993) also found that blacks receive a higher rate of return than do whites. These outcomes are consistent with the intent of the benefit formula that replaces a higher percentage of lower income workers' preretirement income.

   Due to the lack of information on income- or race-adjusted mortality risks, the longevity disadvantage of the poor and blacks were not always taken into account in those early studies. By using the mortality rates experienced by people of different incomes or ethnic backgrounds, several more recent studies concluded that the progressivity previous studies found in Social Security may have disappeared or even reversed. For example, Garrett (1995) found that, after adjusting mortality rates according to income, Social Security's rate of return is higher for the middle and lower-middle quintile than that for the lowest quintile. (4) An even more surprising result is found in Beach and Davis (1998), in which race-adjusted mortality makes the rate of return for blacks considerably lower than that of the general population. (5)

   Studies finding that Social Security's progressivity is offset by the lower life expectancy of blacks and individuals with lower lifetime earnings have drawn criticism. (6) Most important, some of these studies fail to account for all the components of Social Security benefits, especially preretirement survivors' benefits and disability benefits. Because groups with shorter life expectancies are likely to benefit more from survivor's insurance and the disability benefits than groups with longer life expectancies, ignoring these components when calculating rates of return may make the system seem less progressive than it really is.

   Our findings also complement a few more recent studies that have focused on the progressivity in the current Social Security and its implications for the transition to a retirement system based on individual accounts. For example, Gustman and Steinmeier (2000) found that, although Social Security significantly redistributes from individuals with high lifetime earnings to those with low lifetime earnings, much of the redistribution is from men to women. They also show that the redistribution is from families in which both spouses spend much of their potential work lives in the labor market to families where a spouse, often with high earnings potential, chooses to spend much of his or her work life outside of the labor force. As a consequence, there is very little redistribution from families with high to low earnings potential when families are arrayed by their earnings capacities. Liebman (2002) found that much of the intragenerational redistribution in the existing Social Security system is not related to in come and that factors like differential life expectancies tend to offset the progressivity of the basic benefit formula.

   Coronado, Fullerton, and Glass (2000a) estimated potential changes to the progressivity of the current system from four Social Security reform proposals by focusing on the retirement portion of the program and the redistribution between rich and poor of a given generation. They found that each of the proposed reforms is a slightly regressive change to the current system. Brown (2000) investigated redistribution in an individual accounts retirement program under various annuity and bequest arrangements with an emphasis on differential mortalities across gender, race, and level of education. He found that, while a basic single-life real annuity significantly redistributes from economically disadvantaged groups toward groups that are better off, these transfers can be substantially reduced through the use of joint life annuities, survivor provisions, and bequest options. Although these studies use different data sets, estimate mortality and lifetime income in somewhat different ways, and even have slightly diffe rent definitions of progressivity, they reveal the degree and sources of progressivity in the current and reformed systems from different perspectives.

   While a detailed description of the methodology used in obtaining our results follows in the next section, two general comments are in order. First, like most previous studies on this topic, this study ignores disability insurance under Social Security. This is possible and appropriate because the disability component is separable on both the tax side and the benefit side and can be analyzed independently. Because we find that blacks' internal rate of return from the OASI program is less than whites', our analysis is open to the criticism that, by omitting disability insurance (DI) (both the DI taxes and benefits), we ignore the possibility that it might restore the redistributive nature of the extended program. With this line of reasoning, including Medicare as part of the total retirement package could also be justified, with its inclusion benefiting groups with higher life expectancy. Of course, all above criticisms are legitimate, and it would be interesting to see how including DI and hospital insurance (HI) components of the elderly entitlement package would affect the system's progressivity, but here we limit our discussion to the OASI program.

   Second, as in other studies, this article identifies the Social Security investment of hypothetical individuals rather than the investment realized by actual individuals as done by Duggan, Gillingham, and Greenlees (1993) and some of the more recent studies. While...