Wednesday, May 11, 2011

Subtleties of life expectancy, cont.

Today, Aaron Carroll joins Ryan Grim and Jonathan Chait in highlighting a subtlety in the calculation of the effect of increased longevity on social security costs. Ever-increasing longevity has been used to justify raising the retirement age in the Bowles-Simpson deficit reduction plan (to 69 by 2075 for full retirement).  The catch is this: life expectancy for those who reach age 65 has risen far more modestly than life expectancy from birth:
First, if you made it to 65, even back in 1950, you could expect to be on Social Security for 14 years... life expectancy for someone who lives to 65 and qualifies for these programs, hasn’t gone up as much, or as quickly, as people think.

The reason that Social Security has become more costly is not nearly as much that people are living longer on the program, as it is that many more people were born into the generation approaching 65. They aren’t getting more benefit individually; as a group there’s just more of them. When you argue that you want to raise the age at which they start to 68, instead of 65, you’re basicly giving them as many years on the program as a person who hit 65 in the mid 1970′s. That’s a pretty big change [i.e., we've been getting more years in recent decades?].
There's a further subtlety, though, that's been left out of this discussion. It's true that life expectancy before age 65 does not affect the total size of the benefit that retirees collect.  I presume, however, that it does affect the ratio of active workers to beneficiaries -- though I will note at the outset that that ratio has been remarkably stable since 1975, ranging from 3.2 to 3.4 in every year except 2009, when it dipped to 3.0. And I would guess that that dip occurred mainly because the number of employed workers dropped so precipitously in the Great Recession. 

Still, as Carroll notes, as the baby boomers reach retirement age, that ratio is projected to drop.  And here I would think that longevity before age 65 might play a role, because many more baby boomers will reach age 65 (or 67, or 69) than did their predecessors (of course, an even higher percentage of the younger generations funding the boomers' retirement will presumably also make the eligibility age).  According to the Social Security Administration,  the percentage of adults surviving from age 21 to age 65 has risen quite dramatically since 1940:

Table 1: Life Expectancy for Social Security
Year Cohort Turned 65 Percentage of Population Surviving from Age 21 to Age 65 Average Remaining Life Expectancy for Those Surviving to Age 65

To gauge the effect of these changes would require more data -- and better math skills than mine. On the one hand, the percentage of people who pay into the system without getting anything out of it keeps shrinking. On the other hand, since benefits average just 39% of average lifetime earnings (hat tip - Ezra Klein), a lot of retirees living to a ripe old age presumably put more into the system than they take out. While it's true that higher earners live longer on average, it's also true that they pay proportionately much more into the system than they take out; at present, beneficiaries only get back 15% of average lifetime income exceeding $64k per year (up to the cap on earnings taxed by FICA, currently $106,800).

Again, the key number would seem to be the ratio of workers to retirees. And that, I would think is as affected by the birth rate -- and the immigration rate -- as by longevity.

If life expectancy does need to be taken into account in calculating social security benefits, there are alternatives to raising the retirement age.

UPDATE: in the comment thread on Carroll's post, I have the following exchange going with Austin Frakt (Carroll's fellow blogger on The Incidental Economist).  Further response from Frakt (i.e., "someone with better math skills"...) may pretty much invalidate my working hypothesis in this post.

Doesn’t the increased percentage of people who make it to 65 in the first place also affect the cost of SS – i.e., further swell the baby boom into a geezer boom relative to earlier eras?
They also pay taxes all the way until age 65. That helps those who are older.
Is that a help for all, or most workers? Or only workers above a certain income threshold? If I average, say, $35k per year for 35 years, then live to be 85, will I put in more than I take out? Is there an average earnings break point for those reaching average life expectancy, beyond which they take out more than they put in? To what extent do the wealthy fund the benefits of the majority? Considering that you only get back 15% of average lifetime earnings over $64k/year as benefits, I imagine it may be to a considerable extent.

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