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September 2000

How Effective Is Redistribution Under The Social Security Benefit Formula?
by Alan L. Gustman and Thomas L. Steinmeier

Executive Summary

Conventional wisdom holds that the social security benefit formula is highly redistributive by favoring low over high earners. It certainly is true that the structure of the benefit formula is highly progressive as it replaces a much higher share of earnings for individuals with low rather than high earnings. The focus on the individual may be misplaced, however. From a public policy perspective, the proper accounting unit for evaluating redistribution is the household. This Issue in Brief will describe an empirical investigation using data from the University of Michigan Health and Retirement Survey (HRS) linked with social security records for a cohort of individuals nearing retirement. We address only retirement, spouse, and survivor benefits using current social security benefits and formulas.

We provide here a brief overview of the major findings of our investigation. Our aim was to determine the extent of redistribution fostered by the current Social Security System on the basis of each individual’s earnings, and then to see how the extent of redistribution changes when we instead look at redistribution on the basis of total household earnings and finally at redistribution on the basis of potential household earnings, which is what the household could earn if both partners worked full time.

Our analysis contributes to our understanding of just how much redistribution the current system fosters. This information is required to inform policy makers who are involved in system reform. These calculations also provide a benchmark to help understand the effects of various reforms. Any large change in the system will require an accounting of winners and losers, which in turn depends on the extent of redistribution under the current system.

How the Social Security Benefit Formula Works

For each individual, the Social Security Administration calculates a measure of lifetime earnings which is an average of the high 35 years of earnings. The earnings measure is typically expressed as a monthly amount, the Average Indexed Monthly Earnings (AIME). A progressive benefit formula is then applied so that those who have low computed lifetime earnings have higher benefits, relative to earnings, than do those with high earnings. Spouses are entitled to roughly half of their partner’s benefits, and survivors are entitled to an amount roughly equal to what would have been paid to the deceased.

The Data

The Health and Retirement Study (HRS) is a longitudinal, nationally representative study of older Americans. The survey began in 1992 with an initial cohort of 12,652 individuals from 7,607 households, with at least one household member born from 1931 to 1941. Social security earnings histories were linked for 9,472 respondents, or about 75 percent of the respondents to the survey. Of the respondents with linked earnings histories, there were 7,370 who were born between 1931 and 1941, for whom the HRS is representative.

Summary of Major Findings

Work and Earnings Patterns

For the purposes of this report, we distinguish individual lifetime earnings from household lifetime earnings. Household lifetime earnings are the combined lifetime earnings of a husband and wife.

Overall, we find that AIME is a poor indicator of lifetime household earnings. Many individuals in the lowest levels of AIME may not be as poor as their individual AIME suggests.

Many workers falling in the lowest AIME categories, mostly women, are there because they worked few years, rather than because they have low earning potential.

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