Removing the Disincentives in
Social Security for Long Careers
October 20, 2006
Gopi Shah Goda, Stanford University
John Shoven, Ph.D., Stanford University
Sita Slavov, Ph.D., Occidental College
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
2
Labor Force Participation by Age for Men, 1965 and 2003
100.0
90.0
80.0
Early Retirees Retiring 4 Years Younger
Percent in Labor Force
70.0
60.0
3 Years Younger
50.0
40.0
30.0
20.0
1965
2003
10.0
0.0
55
57
59
61
63
65
Age
67
69
71
73
75+
3
Labor Force Participation of Men by Remaining Life Expectancy Average Length of Retirement Up Almost 50% Since 1965!
100.0
90.0
Labor Force Participation
80.0
7.0 Years
70.0
60.0
5.5 Years
50.0
40.0
30.0
1965
20.0
2003
10.0
0.0
8
10
12
14
16
18
20
22
24
Remaining Life Expectancy
4
What are implicit Social Security
tax rates?
• The implicit Social Security tax rate for an
individual age x is defined as the additional
taxes paid at age x, less the present value of
additional Social Security benefits accrued,
divided by earnings at age x
ImplicitSo cSecTaxRatex 
PayrollTax es x  12  PIAx DAVg ( x, NRA)
Earnings x
5
Social Security Benefit Calculation
Pay CPI-Indexed
PIA from Retirement Age until Death
Earnings History
Calculate PIA
(Primary Insurance Amount)
Cap & Wage Index Earnings
2000
1800
Choose Highest
35 Years
1600
slope = 0.15
1400
PIA
1200
Calculate AIME
(Average Indexed
Monthly Earnings)
1000
slope = 0.32
800
600
400
slope = 0.90
200
0
0
500
1000
1500
2000
2500
AIME
3000
3500
4000
4500
6
5000
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
0.1
Implicit Tax Rate
0.05
0
average
10th %ile
90th %ile
full cap
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 8
0.1
Implicit Tax Rate
0.05
0
average
10th %ile
90th %ile
full cap
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 9
0.1
Implicit Tax Rate
0.05
0
average
10th %ile
90th %ile
full cap
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 10
Male Mortality
0.1
Implicit Tax Rate
0.05
0
average
10th %ile
90th %ile
full cap
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 11
Female Mortality
0.1
Implicit Tax Rate
0.05
0
average
10th %ile
90th %ile
full cap
-0.05
-0.1
15
20
25
30
Career Length
35
40
45
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
Current PIA Calculation
1

w
PIA  f  *  NRA earnt  
T
w

t
AIME
(includes zeros)
y 1

w
f  * *  NRA earnt   PIA 
wt
T y

Proposed PIA Calculation
1

w
y
* f  *  NRA earnt 
T
wt

y


career
modified AIME
length
(does not include zeros)
adjustment
18
PIA Under Current and Proposed Law
2000
1800
1600
1400
PIA formula under Current Law
(AIME calculation includes zeros)
PIA
1200
1000
800
PIA formula under Proposed Law for Low, Middle,
and High Income Earner
(AIME calculation does not include zeros)
600
400
Position on ray depends on career length.
200
0
0
500
1000
1500
2000
2500
AIME
3000
3500
4000
4500
5000
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
$1,400
$1,200
2006 Dollars
$1,000
$800
$600
$400
Proposed Law PIA
$200
Current Law PIA
$0
10
15
20
25
30
35
40
45
Career Length (years)
21
average
10th %ile
90th %ile
full cap
0.1
Implicit Tax Rate
0.05
0
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 22
average
10th %ile
90th %ile
full cap
0.1
Implicit Tax Rate
0.05
0
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 23
average
10th %ile
90th %ile
full cap
0.1
Implicit Tax Rate
0.05
0
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 24
average
10th %ile
90th %ile
full cap
0.1
Implicit Tax Rate
0.05
0
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 25
average
10th %ile
90th %ile
full cap
0.1
Implicit Tax Rate
0.05
0
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 26
average
10th %ile
90th %ile
full cap
0.1
Implicit Tax Rate
0.05
0
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 27
average
10th %ile
90th %ile
full cap
0.1
Implicit Tax Rate
0.05
0
-0.05
-0.1
15
20
25
30
Career Length
35
40
45 28
29
30
What impact do these reforms have
on progressivity?
IRRs for Workers with 30-Year Career
Current Law Proposed Law
Low Income Earner
2.64%
2.55%
Average Income Earner
1.34%
1.34%
High Income Earner
0.81%
0.86%
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
Male Benefits
Female Benefits
Total
No Credit
2.44%
0.07%
1.52%
1-Year Credit
2.44%
3.29%
2.77%
2-Year Credit
2.44%
6.42%
4.00%
3-Year Credit
2.44%
9.45%
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
35