The Progressivity of Social Security

Abstract

Abstract How much does the current social security system redistribute from rich to poor? We propose alternative concepts of well-being that can be used to classify individuals from rich to poor, and we show how social security redistributes differently under each concept. We use the PSID to estimate lifetime wage profiles and actual earnings each year for a sample of 1778 individuals, and we use mortality probabilities to calculate expected payroll taxes and social security benefits. For a given set of “facts” about the net flows experienced each year by each individual, measured progressivity depends on many assumptions. This paper attempts to capture and to quantify all of the data and characteristics relevant to determine each individual’s “income” under several definitions. We then use each definition of income to classify individuals from rich to poor and to calculate the progressivity of social security. We proceed in seven steps. First, we classify individuals by annual income and use Gini coefficients to find that social security is highly progressive. Second, we reclassify individuals on the basis of lifetime income and find that social security is less progressive. Third, we remove the cap on measured earnings and find that social security is even less progressive. Fourth, we switch from actual to potential lifetime earnings (the present value of the wage rate times 4000 hours each year). This measure captures the value of leisure and home production, so those out of the labor force are less poor, and net payments to them are less progressive. Fifth, we assign to each married individual half of the couple’s income. The low-wage spouse is then not so poor, and social security becomes even less progressive. Sixth, we incorporate mortality probabilities that differ by potential lifetime income. Since the rich live longer and collect benefits longer, social security is no longer progressive. Finally, we increase the discount rate from 2% to 4%, which puts relatively more weight on the earlier-but-regressive payroll tax and less weight on the later-but-progressive benefit schedule. Depending on the definition of income used to classify people, the overall social security system could be deemed progressive, only mildly progressive, or neutral. With an even-higher discount rate, it could even be deemed regressive.