Solutions and Activities
Questions and Problems
1. The government of Westlovakia has just reformed its social security system. This reform changed two aspects of the system: (1) It abolished its actuarial reduction for early retirement, and (2) it reduced the payroll tax by half for workers who continued to work beyond the early retirement age. Would the average retirement age for Weslovakian workers increase or decrease in response to these two changes, or can you tell? Explain your answer.
The first policy change, abolishing the actuarial reduction, would tend to lower the average retirement age. The actuarial reduction is intended to make workers approximately indifferent between retiring early and waiting until standard retirement age. With the reduction, early retirees have a smaller benefit over more years. Abolishing that reduction would make early retirement more attractive: the benefits would be just as high as if workers had waited, and they would be paid over more years. The second policy change would increase the return to working later in life and thus would tend to raise the average retirement age. The overall effect would depend on a number of factors. If people discount the future by enough (that is, have a high enough internal discount rate), they will tend to retire early: the benefit is immediate. People who have a lower discount rate will choose to work longer at the lower tax rate. A second factor that would influence the decision is the potential retiree’s health status or personal (as opposed to statistical) life expectancy. Someone who believes he has a fairly high probability of living long and well late in life will be more likely to opt for later retirement. A third factor that will tend to increase the retirement age is that the early retirement effect is truncated at the age designated for eligibility: even people who choose to retire early will only be able to retire a few years earlier than before in order to benefit. People who choose to retire later may retire many years after the standard retirement age. 2. When you called her last night, your grandmother confided that she is afraid to sell her home because doing so will affect her Social Security benefits. You told her that you’d call her back as soon as you read Chapter 13. Now that you’ve read it, what will you say to her about how her benefits will change when she sells her house?
Social Security benefits do not change with changes in the value of assets held by the beneficiary. The formula used to calculate benefits under Social Security is based on earned income only. Your grandma’s Social Security benefits will not be affected by the sale of her house.
Copyright © Worth Publishers
Jonathan Gruber / Finance and Public Policy
CHAPTER 13 / Social Security
3. Congressman Snicker has proposed a bill that would increase the number of years of earnings counted when computing the Social Security Average Indexed Monthly Earnings amount from 35 to 40. What would be the effects of this policy change on the retirement behavior of workers? Would the Social Security trust fund balance increase or decrease? Why?
Workers may work longer if their best 40 years counted rather than their best 35. Generally, you would expect earned income to increase over a worker’s lifetime; thus, the last several years are likely to yield higher income than the first several years. Being able to count 5 more high-earning years would induce some workers to remain in the workforce to increase their calculated benefits; if they did not work longer, that 40 years might include some very low or zero-earning years (when the worker was in his or her twenties, possibly still in school).
Increasing the number of years of earnings counted would certainly increase the trust fund balance if it caused people to delay their retirement: people would be paying in longer and withdrawing for fewer years....
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