Suppose a pay-as-you-go Social Security system and that there are 500 million wo
ID: 1195109 • Letter: S
Question
Suppose a pay-as-you-go Social Security system and that there are 500 million workers and 400 million retirees. Also suppose that the average annual earnings of a worker is $100,000 and the average annual Social Security benefit is $25,000. What tax rate necessary to finance the benefits? Suppose that 5 years later the number of beneficiaries has increased to 500 million, but the number of workers has stayed the same. Also suppose that the tax rate is the same as in part a). What are the average benefits to retirees? Suppose that Ted is considering his future retirement. He originally planned to save an additional $10,000 for each year of retirement expecting to get $25,000 a year from Social Security ($35,000 total}, but he notices that benefits are going down over time. Do you expect him to save more (privately) now that he expects less from Social Security? Support your answer using the Life Cycle Model.Explanation / Answer
(a) Total number of workers = 500 million
Average annual earnings of a worker = $100,000
Total earnings in the economy = 500 million * $100,000 = $50 trillion
Total number of retirees = 400 million
Average annual social security benefits = $25,000
Total social security payments in economy = $25,000 * 400 million = $10 trillion
Calculate Tax rate required to finance the social security benefits -
Tax rate = Total benefits/Total earnings = $10 trillion/$50 trillion = 0.20 or 20 percent
The tax-rate required to finance the social security benefits is 20 percent.
(b) It has been provided that after 5 years total number of workers in the economy as well as their average annual earnings had remained same.
This implies that total earnings in the economy will remain $50 trillion.
Social security tax rate = 20 percent or 0.20
Social security tax revenue = Total earnings * tax rate = $50 trillion * 0.20 = $10 trillion
Number of retirees has increased to 500 million.
Calculate the average benefit to retirees -
Average benefit = Social security tax revenue/Number of retirees
= $10 trillion/500 million
= $20,000
The average benefit to retirees will now be $20,000.
(c) Life Cycle model states that individuals plan their consumption and savings behavior over their life cycle. This implies that they generally try to maintain stable standard of living over their entire lifetime. In other words, they want to keep their average propensity to consume constant over their life time.
In the given case, Ted was expecting a income of $35,000 in his retirement years based on his calculation of $10,000 as savings of his own and rest coming from Social Security benefits.
However, Ted has noticed that social security benefits are declining over the years.
So, going by Life Cycle model, if Ted wants to maintain same average propensity to consume based on his expected income of $35,000 during his retirement years in face of declining social security benefits, he have to save more (privately) so that inocme level remain at $35,000 post retirement ans he is able to maintain required average propensity to consume.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.