10 The Economics of Social Safety Nets: Here to Catch Us When We Fall?
10 The Economics of Social Safety Nets: Here to Catch Us When We Fall?
Caroline Krafft
Box 10.1. Behavioral economics: Understanding barriers to savings[8]
An important field for understanding savings (as well as health care, discussed last chapter) is behavioral economics. Behavioral economics brings together economics and psychology. The field challenges the assumption of traditional economic theory that individuals have all the information they need and are perfectly rational decision-makers.
Behavioral economics provides insights into why people are bad at savings, and what we can do about it. For example, when employees have to opt-in to their retirement savings (making the default zero) they are less likely to save for retirement than if they had to opt out of savings instead. Although the default should not matter for savers’ decisions, it does, and it matters a lot. In an experiment based on switching workers to automatic enrollment, 86% of employees contributed to a 401(k) plan when enrollment was automatic, but just 49% participated when they actively had to enroll. This insight from behavioral economics has led to more automatic-enrollment plans for savings.
Social Security
Social Security is the United States social insurance program designed to act as a social safety net as people age. The program also helps address the challenges workers face in saving. The United States’ current Social Security program has its roots in the Great Depression.[9] The Social Security Act became law in 1935 as a form of old-age insurance. It provides monthly retirement benefits to individuals 65 and older. It originally covered few workers but expanded substantially over time. Social security is credited with bringing the rate of elderly poverty from 35.2% in 1959 to 10.2% today.[10] The reduction in elderly poverty brought about by social security illustrates some of the arguments for government involvement in saving for old age.
Benefits for social security are based on wages while working.[11] The program was never intended to fully replace other forms of income, as it provides benefits equivalent to 42% of individuals’ previous wages. Dependents (children) and survivors (spouses) of workers who die are eligible for benefits as well. Lower-income earners receive benefits that are a greater share, around 56%, of their earnings, compared to 35% for higher-income earners.[12]
The program uses payroll taxes (taken directly out of workers’ paychecks) to collect workers’ contributions. Workers must contribute 6.2% of their wages. The program has an equal employer share of 6.2%. Wages are taxed up to the first $168,600.[13] Social security taxes are like automatic enrollment in retirement savings – but with no opt-out and a guaranteed benefit.
There are two important economic issues to consider with Social Security. The first is the effect of the program on labor supply. Will people work more or less as a result of having Social Security reduce their presen