Book PDF - Employee Benefit Research Institute

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Employee
Benefit
Research
Institute
The Employee Benefit Research Institute (EBRI) is a Washington-based,
nonprofit, nonpartisan
public policy research institution. EBRI's overall
goal is to promote the development
of soundly conceived private and
public employee benefit plans.
Through research,
policy forums, workshops
and educational
publications, EBRI contributes
to the expansion
of knowledge
in the field
and to the formulation
of effective and responsible
health, welfare
and retirement
policies. This work is intended
to complement
the
research
and education
programs
conducted
by academia,
the government
and private institutions.
EBRI's educational
and research materials
aid the public, the media
and public and private sector decision makers in addressing
employee
benefits issues before policy decisions are made. The Institute seeks
a broad base of support
among interested
individuals
and organizations as well as those sponsoring
employee
benefit plans or providing professional
services in the employee benefits field.
DR. SYLVESTER J. SCHIEBER is the Research Director of the Employee
Benefit Research Institute. Dr. Schieber previously served as Deputy Director, Office of Policy Analysis, Social Security Administration and the
Deputy Research Director, Universal Social Security Coverage Study,
Department of Health and Human Services. He has also held other government and academic positions, and has authored numerous publications in
the employee benefit field.
More information
on the Employee Benefit Research Institute can be
obtained by writing: Executive Director, EBRI, 1920 N Street, NW, Suite
520, Washington,
DC 20036 (202) 659-0670.
SOCIALSECURitY..
Perspectives
on
Preserving the System
By
Sylvester J. Schieber
_'._1982 Employee
Benefit Research
Education
and Research
Fund
1920 N Street, NW, Suite 520
Washington,
(202/659-0670
Institute
DC 20036
All rights reserved.
Reproduction
is granted provided proper attribution
is given.
The ideas and opinions expressed
in this publication
are those o[ the author and
do not necessarily
represent
the views of the Employee
Benefit Research
Institute, its trustees,
members
or associates.
Library
Schieber,
Social
o[ Congress
Sylvester
Security,
Cataloging
Data
oll preserving
the system.
J.
perspectives
Includes bibliographical
I. Social
security--United
nance. I. Title.
HD7125.$33
1982
ISBN 0-86643-028-8
Printed
in Publication
in the United
States
references.
States.
2. Social
353.0082'56
of America
security--United
States--Fi82-21046
Table of Contents
List of Illustrations
List of Tables
...................................................
..........................................................
Executive
Summary
Foreword
.............................................................
Introduction
Chapter I
The Evolution
ix
xi
..................................................
xxi
xxxvii
...........................................................
of the Social
Security
Program
1
...................
7
The Early Development
of Retirement
Programs
..............
Environment
in the United States Prior to Enactment
of Social Security
..................................................
Development
of the Social Security Act ........................
The Provisions
of the Social Security Act .......................
Social
Security
Coverage;
Retirement
Age; The Benefit
Structure
Financing
Social Security
.........................................
Growth of the Social Security Program
.........................
Chapter
II
Income Security
for the Elderlv: The Role of Programs
Than Social Security
.................................................
7
10
14
17
33
37
Other
The Role of Pensions ...............................................
Growth in Pension Programs;
Growth in Beneficiaries;
Growth in Benefits
Individual
Savings and Asset Income
...........................
Special
Retirement
Savings
Programs;
Homeownership;
Business Assets; Other Financial
Assets
Employment
Income of the Elderly
.............................
Cash Assistance Programs
.........................................
In-Kind Benefit Programs
.........................................
Continuing
Evolution
of the U.S. Retirement
System
........
45
46
61
70
71
73
74
V
Chapter III
Retirement
Benefit
Levels
Under
Current
Policy
.................
A Framework
for Evaluation
.....................................
Pension and Retirement
Income Simulation
Model;
Assumptions
for the Base Case Simulations
Current Policy Simulation
Results ...............................
Sources and Levels of Income;
Earnings;
Social Security;
Pensions;
Individual
Retirement
Savings; Relationship
of
Pensions
and IRAs; Supplemental
Security
Income;
Projected Income Levels for the Elderly; Retirement
Program
Income
Levels; Replacement
of Earnings
by Retirement
Programs
Implications
of the Results
.......................................
Chapter IV
Social Security
Financing
Problems
...............................
Measurement
of Social Security's
Financing
Status
..........
The Short-Term
Problem;
The Long-Term
Problem
Changing
Perspectives
.............................................
Increases
in Benefits
...............................................
Introducing
Basic Changes ........................................
Recognition
of a Structural
Problem
............................
The Effect of Short-Term
Economics;
The Effect of LongTerm Demographics
Modification
of the System
.......................................
Continuing
Problems
..............................................
Chapter V
The Mathematics
Financing
Problems
and the Short-Term
Policy Options
................................
The Mathematics
of Social Security Financing
................
Short-Term
Imbalances;
Long-Term
Imbalances
Stabilizing
the Financing
of Social Security
...................
General Policy Considerations
Short-Term
Policy Options
.......................................
General Revenue Financing;
Raising Payroll Tax Rates;
Expanding
Coverage; Redefining Taxable Wages; Social Security Benefit Adjustments;
Indexing;
Taxing Benefits
Selecting
Short-Term
Policies ....................................
vi
77
77
83
102
103
103
116
116
! 18
122
128
131
135
136
145
151
158
Chapter VI
Social Security
Beyond
the Short
Term
...........................
Social Security Benefits Under Current Law
The Earlier Debate .................................................
161
...................
161
163
Options for Modifying Social Security's
Benefit Calculation
Procedures
..........................................................
Index Earnings
by Price Increases;
Index Formula Bend
Points by Price Increases;
Options for Limiting
Replacement-Rate
Reductions;
Rapid Bend-Point
Adjustment
for
Limited Period; Slow Bend-Point
Growth Gradually
on a
Limited Basis
167
Options for Changing Work and Retirement
Patterns
........
Increase
Normal
Retirement
Ages; Change Actuarial
Adjustment
Factors;
OASDI Savings with Later Retirement
Ages
Distributional
Implications
of Benefit Formula Adjustments
on Income Levels ...................................................
Implications
of Modifying
the Benefit Formula;
The Response of Pensions and Other Resources;
Distributional
Considerations
171
Implications
of Taxing Benefits
..................................
Implications
of Raising the Retirement
Age ....................
Comparing
the Alternatives
.......................................
Selecting
Options
..................................................
186
187
194
198
Chapter
VII
Universal
Social
Security
Coverage
and the Alternatives
.......
Problems
with the Status Quo ...................................
Inadequate
Protection
for Persons Not Covered; Inequities
Inherent
in Exemption
from Participation
in a Mandatory
Redistributive
Program;
Benefits Afforded Partial
Participants in Social Security
Providing
a Perspective
on the Bonuses .........................
Measuring
the Cost to Social Security of the Bonuses
........
Options for Resolution
of the Problems
.........................
Universal
Social Security
Coverage;
Modification
of the
Benefit Computation;
Offsetting
the Noncovered
Pension
Benefit
The Effect of Eliminating
the Unintended
ients ..................................................................
Benefits
The Cost of Coverage
......................
for Federal
Workers
177
201
202
206
209
212
on Recip224
225
vii
The Cost of Coverage for State and Local Workers ............
Mandatory
Social Security Coverage of Nonprofit
Organizations ..................................................................
Other Issues Associated
with Mandatory
Social Security Coverage .................................................................
Chapter VIII
Other Policy Considerations
.........................................
Redefining
Evaluating
Maintaining
Maintaining
Security
.......................................
Income
Simulation
Model
Appendix
B
Calculating
Social Security Benefits Under the
curity Formula
........................................................
viii
244
249
255
256
261
265
275
the Goals
..............................................
Specific Options
......................................
Incentives
for Private Programs
..................
Flexibility
............................................
Appendix
A
243
249
Horizontal
and Vertical Equity in Social Security
............
The Earnings
Test ..................................................
Trust Fund Accumulations
........................................
General
Revenue Financing
.......................................
Reorienting
the Social Security Program
.......................
The Family Plan; Personal Security Accounts; The Freedom
Plan
Chapter IX
The Future of Social
234
275
278
284
286
.............
1977 Social
289
Se297
List of Illustrations
Figure
1
2
I-1
I-2
Page
Future Average Family Social Security
Age 65 ...................................................
Total Civilian Employment
and Workers
Social Sccuritv
.........................................
Workers
Covered
bv Social
I-4
I-5
II-I
IV-1
V-1
VII-I
A-1
Ratio of Workers
tal Beneficiaries
Social
at
xxxi
Future Average Disposable
Family Income
A_c 65 ...................................................
Over 65 Receiving
I-3
Benefits
at
xxxii
Covered
bv
39
Security
and Persons
Security
..................
Covered bv Social Security
........................................
40
to To41
Year End Average Monthly Social Securitv Benefits
Retired Workers,and
All Beneficiaries
..............
42
Combined
Taxable
43
OASDI Taxes Paid on Average
Earnings
......................................
Reported
Total Number of Tax-Qualified
Plans in Effect
Selected Years ..........................................
for
48
Legislated
OASDI Payroll. Tax Rate and Projected
Cost Rates Under Ahernative
Assumptions
........
113
Replacement
of Preretircment
Earnings
Worker Retiring at Age 65, bv Year
of Retirement
...........................................
149
Flow of Funds Related
ment System, 1980
for Average
to the Civil Service
....................................
Retire228
Data Sources Used to Create the PRISM
Database
................................................
Baseline
A-2
PRISM
Work History
..............
A-3
PRISM
Retirement
Simulation
Benefit
Model
Simulation
290
Model
........
293
296
ix
List of Tables
Table
I-1
Page
Percentage of the Population Over Age 65, 18701940 ......................................................
10
I-2
Labor Force
11
I-3
Five-Year Variations
in Unemployment
Rates for Civilian Labor Force and Nonfarm
Workers, 19001939 ......................................................
12
Replacement
Rates for Workers Retiring at Age 65
Under 1935 Social Security Act and 1939 Amendments ....................................................
23
Replacement
Rates for Single Workers Retiring at
Age 65 Under Various Social Security Amendments ....................................................
26
I-4
I-5
I-6
II-1
II-2
1870-1940
............
Comparison
of Combined OASI Taxes Accumulated
with Interest and Present Value of Retirement
Benefits
I-7
and Employment,
for Persons
Age 65 ...........................
Annual Maximum
Taxable
tion Rates Under Social
Earnings
Security
30
and ContribuAct ...............
38
Wage and Salary Workers in Private Sector Nonagricultural
Establishments
and Pension Participation ......................................................
50
Private Pension Plan Creations,
Terminations,
Net Plan Increases
.....................................
52
II-3
Plan Qualifications
II-4
Working Participants
Per Beneficiary
in Defined
Benefit Pension Plans ..................................
55
Working Participants
Contribution
Plans
57
II-5
and
Participants
and
...................
Per Beneficiary
in Defined
.....................................
53
xi
I1-6
II-7
II-8
II-9
II-10
II-11
Private Pension Plan Participants,
Benefit Recipients, and Average Benefits for Selected Years .....
59
Percentage
of Families with Individuals
Ages 65 to
69 Eligible to Receive Employer
Pension Benefits.
60
Pension Benefits in a Hypothetical
Two-Class
ety: Period I ............................................
Soci60
Pension Benefits in a Hypothetical
Two-Class
ety: Period 2 ............................................
Soci60
Earnings and Age Characteristics
of the U.S. Civilian Work Force and Workers Participating
in a
Pension Plan in May 1979 ............................
63
Percentage
Income
64
of Eligible Persons Who Have IRAs, bv
Class, 1977 ....................................
II-12
IRA Assets by Financial
II-13
Distribution
of Household
Assets and Liabilities
Current Prices for Selected Years, 1950-1979
in
.....
Labor-Force
Participation
Rates for Individuals
65 and Older for Selected Years .....................
Age
II-14
Benefits
...................
71
III-I
Assumed Consumer
Price Index Increases
Used in
Retirement
Simulations
..............................
81
III-2
Assumptions
81
III-3
Assumptions
about
covered Workers
the Annual Probability
of NonAdopting an IRA ...................
82
III-4
Assumptions
IRA Contributions
83
1II-5
Worker's
Reach
about
Savings
1979
67
Federal
about
for the Elderly,
65
II-15
xii
In-Kind
Institutions
Plan Participation
.................
Ages in 1979 and Years When Cohorts
Age 65 ...........................................
.......
.......
74
84
Ill-6
Age in 1979 and Projected Family Earnings
65 ........................................................
Elderly
Families
111-8
Elderly
Employment
III-9
Age in 1979 and Projected Famih' Social Security
Benefits at Age 65 ......................................
88
Past and Future Social Security Benefit
1952-2054
..............................................
89
III-1 l
Rates
in 1979
85
III-7
III-10
with Earnings
at Age
in March
...............
1980
...........
Benefits
90
III-12
Age in 1979 and Projected
III-13
Benefits from IRAs and
Pensions Combined
at Age 65 ........................
II1-14
III-15
Preretirement
Earnings
at Age 65
...
by
97
Estimated
Average Family Benefit Levels from Social Security or Pensions and IRAs ..................
SSI Benefits
aI Age 65
III-17
Annual Familv Income
Lcvels from Selected Sources at Age 65 ............
Estimated
Net Retirement
Program
Replacement
Preretirement
Family Earnings
......................
III-19
Estimated
Replacement
Rates
for Median
IV-1
Actuarial
Status of OASDI on "Closed
and "Open Group, Limited Period"
1980 ...................................................
Earnings.
93
96
IRA or Pension Benefit
...............................
III-16
III-18
86
Levels,
Age in 1979 and Projected Family Pension
at Age 65 ................................................
IRA Benefits
86
98
...
99
100
of
101
102
Group"
Base, 1971104
xiii
IV-2
IV-3
IV-4
IV-5
IV-6
IV-7
IV-8
IV-9
IV-10
IV-I 1
IV-12
IV-13
xiv
Operations
of the OASI Trust Fund During Selected Calendar
Years, 1940-1981
and Estimated Future Operations
..........................
107
Operations
of the DI Trust Fund During Selected
Calendar
Years, 1960-1981
and Estimated
Future Operations
.....................................
109
Operations
of the Hospital
During Calendar
Years,
Trust Fund
...............
110
Economic
Assumptions
Used in the Projections
for OASDI and HI in the 1982 Trustees Report..
112
Insurance
1966-1984
Cost and Tax Rates of the Hospital Insurance
Program,
as a Percentage
of Taxable Payroll
...
115
Payroll Tax Schedule
in Effect in 1971 and
Schedule
Recommended
by 1971 Advisory
Council to Finance OASDI Benefits
..............
119
Payroll Tax Schedule to Finance OASDHI Benefits Established
by Legislation
in 1971 and in
June and October 1972 .............................
121
Projections
of OASDI Reserve Ratios and LongTerm Financing
in Successive
Trustees
Reports
...............................................
122
Primary Insurance
Amount Computation
for Selected Years ...................................
123
Replacement
Rates for Successive
Cohorts
Retiring at Age 65 ..................................
Factors
of Men
124
Comparison
of Five-Year Economic
Assumptions
in the 1972 OASDI Trustees Report with Actual
Experience
...........................................
126
Birthrate,
127
United
States,
1940-1979
................
IV-14
IV- ! 5
IV-16
V-I
Actual and Assumed Total Fertility Rates
lected Years ..........................................
Effects of Changing
OASDI Actuarial
Fertility
Balance
Estimated
Cost Rates
V-3
OASI Average
Beneficiary
V-7
VI-2
VI-3
132
for OASDI
139
Per 100 Workers
Monthly Benefit Levels
...........................................
Number
of Beneficiaries
and Beneficiary
lents ...................................................
..
140
by Class of
142
Equiva143
Projected
OASI Dependency
Ratios, Cost Rates,
and Relationships
Between Average Benefits to
Average Wages for Selected Years ................
144
Social Security
Cost-of-Living
156
Additional
Outlay Savings Under Different
Adjustments
........................
Trust
der Various
VI-1
130
.............................................
OASI and OASDI Beneficiaries
V-6
Assumptions
on
..........................
and Tax Rates
V-2
V-5
129
A Comparison
of Five-Year Economic
Assumptions in the 1977 OASDI Trustees
Report with
Actual Experience
...................................
Programs
V-4
for Se-
Fund
Revenues
Policy Adjustments
for OASDI Un...................
159
OASDI Financing
Surplus and Deficit Under II-B
Assumptions
and Net Savings from Moving to
Price Indexing of Earnings
and Bend Points ....
167
OASDI Financing
Assumptions
and Net Savings from Indexing
PIA Formula Bend Points by 75 Percent of
Wage Growth for Specified Periods
..............
171
National
Commission
on Social Security Proposal
for Phasing in Later Retirement
Ages ............
173
XV
VI-4
VI-5
VI-6
VI-7
VI-8
VI-9
VI-10
VI-I 1
VI-12
xvi
PIA Adjustment
Factors During Transition
to
Normal Retirement
Age of 68 with Early Retirement at Age 62 ..................................
175
OASDI Financing
Surplus and Deficit and Net
Savings as a Percentage
of Covered Payroll Following Raising of the Normal Retirement
Age ....................................................
176
Social Security Benefits in 1982 Dollars at Age 65
Under Current Policy and Three Alternate
Policies for Future Benefit Determinations
..........
179
Average Pension and IRA Benefits in 1982 Dollars
Under Current Social Security Policy and Alternate Policies ......................................
182
Average Family Income in 1982 Dollars at Age 65
Under Current Social Security Policy and
Alternate
Policies
...................................
184
Estimated
Average Family Income from Selected
Sources at Age 65 for Persons Aged 25 to 34
Under Current
Social Security Policy and by 75
Percent Wage Indexation
of PIA Formula Bend
Points for 16 Years ..................................
185
Average Disposable
Income at Age 65 in 1982
Dollars Under Current Policy and Alternate
Formula and Taxing Provisions
...................
188
Average Family Income from Specified Sources
1982 Dollars at Age 68 Under Current Policy
and Alternate
Policy Raising Social Security's
Retirement
Ages by Three Years ..................
in
Average Family Income from Specified Sources in
1982 Dollars at Age 68 Under Current Policy
and Alternate
Policy Raising Social Security's
Normal Retirement
Age by Three Years .........
190
191
VI-13
VI-14
Distribution
of Relative Change in Present Value
of Lifetime Social Security Bcnefits at Age 62
Under Alternative
Policv Scenarios
..............
Distribution
of Relative Change in the Present
Value of Lifetime Social Security Benefits for
Men and Women
Policy Scenarios
VII-1
VII-2
VII-3
VII-4
VII-5
at Age 62 Under Alternate
.....................................
VII-7
VII-8
198
Wage Assumptions
for Three Hypothetical
Workers
..............................................
207
Percentage
of Total Employee
Social Security
Taxes Paid and Primary Benefits Accrued in
Covered Employment
..............................
208
Earnings
Credits, Present Low Benefits, and Estimated Windfalls
for Workers with Identical
Wage Streams
.......................................
211
Estimated
Additional
Benefits Payable Under Alternative
Coverage Options for the Calendar
Years, 1985-1988
....................................
215
Additional
OASDI and HI Tax Collections
Coverage of Federal,
ment, and Nonprofit
VII-6
196
from
State and Local GovernEmployees
..................
217
Estimated
Amount by Which OASDI Taxes Exceed Expenditures,
as a Percentage
of Total
Taxable Payroll, after Extension
of Coverage
...
220
Effect of Economic
Assumptions
on CSRS Cost
Estimates
............................................
227
Federal Agency and General Revenuc Expenditure Projections
for the Current CSRS and
Modified System in Conjunction
with Newly
Hired Workers Under Social Security
...........
231
xvii
VII-9
VII-10
VII-l I
Change in Total Expected
Retirement
Income Under Constant-Benefit
Formula Using Two Inflation Assumptions
....................................
236
Normal Cost of Current Plan Compared
with Normal Cost of Constant Benefit Step-Rate
Plus
Social Security Payroll Taxes .....................
240
Present
Plan Normal
Cost Versus
fit Plan Normal Cost Plus Social
Taxes .................................................
VII-12
VIII-l
VIII-2
VIII-3
IX-l
B-l
B-2
B-3
xviii
Constant-BeneSecurity
Effects of Expanded
Coverage for State
Workers on Social Security Revenues
1985 and 1990 .......................................
241
and Local
Between
243
Monthly Social Security Benefits for Specified Individuals
and Couples Retiring at Age 62 in
Early 1982 ...........................................
253
Estimated
Costs of OASDI System as a Percent_
age of Covered Payroll and as a Percentage
of
GNP ...................................................
261
Fiscal Budget Receipts, Outlays, and Surpluses
Deficits by Fund Group
............................
or
264
Projected Expenditures
of OASDI with Universal
Coverage and with Hypothetical
National Pension Plan .............................................
285
Indexing Average Wage Series, Annual Maximum
Taxable Earnings,
and Wage Indexes Used in
Calculating
Social Security AIME, for 19791982 ...................................................
298
PIAs and Replacement
Using 1979 Benefit
300
of AIME in Selected Cases
Formula
.......................
Social Security Benefit Formula Bend Points
Selected Years .......................................
for
301
B-4
Maximum
Family Benefit Bend Points
lected Years ..........................................
for Se302
xix
Executive
Summary
The public discussion
of the Social Security
financing
problem
throughout
most of 1982 has been broad and serious but not focused
on detail. In its 1983 session, Congress will have to tackle the details
of Social Security
financing.
In November
1982, the largest Social
Security trust fund, the Old-Age and Survivors Insurance
(OASI) program, will be in the unprecedented
position of having to borrow from
the Disability
Insurance
(DI) and Hospital Insurance
(HI) programs.
Without new legislation,
the OASI program
will not be able to make
the benefit payments
on schedule in July 1983.
The legislation
that evolves must do more than merely extend the
inter-trust-fund
borrowing
provisions
that permit
OASI to meet
scheduled
payments
for the next half-year. If the current
borrowing
authority
is extended,
the combined
trust funds will be depleted during 1984 or 1985 at the very latest. Beyond the immediate
short term,
the HI program
faces financing problems during the latter half of the
1980s, and OASI will encounter
new problems
shortlv after the turn
of the century.
This report provides the details for an evaluation
of the status of
the United States retirement
income securitv system in general, and
the Social Security
system in particular.
The analysis particularly
addresses
the scope and mathematics
of the financing imbalances
of
Social Security,
several options for balancing
the system in both the
short and long terms, and implications
of various options for the
income security
of the elderly. The analysis goes beyond Social Security alone, however, because other elements
of the retirement
income security
system
modify
the implications
of various
policy
adjustments
in the Social Security program.
The
Evolution
of Social
Security
The Social Security Act of 1935 has proved to be one of the most
significant
pieces of legislation--if
not the most significant piece-ever passed by the Congress of the United States. The act itself evolved
quite rapidly in the midst of the Great Depression,
but its roots can
be traced to the changing socioeconomic
structure
of thc country
dating back to the Civil War. Chapter I examines
the origins and
evolution of the Social Security system.
xxi
There is a widespread
misconception
that Social Security today is
somehow
radically
different
from the program
that began paying
benefits in 1940. It is true that disability and hospital insurance
benefits have been added, coverage has expanded,
the level of benefits
has grown in real terms, and the tax liabilities
of workers have increased over the years. But the fundamental
elements
of the program--the
financing
basis and the general redistributive
structure
of the benefit formula--have
changed minimally
over the years.
It is the combination
of the maturing
of the program and the growth
of real benefits that has led to the increased
tax burden on workers.
In 1950, only 20 percent of the people over age sixty-five
received
Social Security benefits; today more than 90 percent do so. In 1950,
the average monthly benefit, adjusted
for inflation, was equivalent
to about $125 in 1980 dollars. By the end of 1980, the average benefit
was $300 per month. The combined
employer
and employee payroll
taxes on average earnings
rose from $200 per year in 1950 (in 1980
dollars) to slightly more than $1,000 in 1980. In the face of financing
shortfalls,
the maturity
program
limits the
options for adjusting
the program
to raising revenues or for slowing
benefit growth, or for a combination
of the two.
The
Role
of Income
Sources
Other
Than
Social
Security
In addition
to Social Security benefits, the elderly receive income
from pension programs,
returns from individual
savings and asset
holdings, earnings
and welfare programs.
The changing role of these
additional
sources of income should not be overlooked
in the discussion of Social Security policy; this role is discussed
in chapter II.
When the Social Security Act was passed in 1935, there were about
750 private pension plans in operation.
At the end of 1981, there were
nearly 700,000. As a result of this growth, an increasing
share of the
work force is participating
in at least one pension program other than
Social Security. In 1979, about 70 percent of the civilian wage-earning
and salaried workers outside agriculture
between the ages of twentyfive and sixty-four
who worked at least half time, participated
in a
pension program. And the number of pension plans continues to grow.
New plans that met the Internal
Revenue Service tax qualification
standards
in 1980 and 1981 had 6.3 million participants.
Yet, the
pension system in this country is relatively young. Nearly two-thirds
of all private-sector
tax-qualified
defined-benefit
plans in 1977 were
less than ten years old. Clearly as these plans mature, the proportion
of the population
receiving
a pension will increase markedly.
xxii
Not only have pension plans burgeoned,
but also recent changes to
the federal income tax code encourage
workers to save for their own
retirement.
The Keogh program
for the self-employed
began in 1962;
at that time, the program
allowed tax-deductible
contributions
to a
retirement
program
of 10 percent of income up to $2,500 per year.
By 1983, the self-employed
will be able to contribute
to such programs
15 percent of earnings up to $30,000 per year. In 1974, the Employee
Retirement
Income Security Act (ERISA) allowed workers not covered by a pension plan to establish Individual
Retirement
Accounts
(IRAs). The 1981 Economic
Recovery Tax Act extended
this option to
all workers, who can now take tax deductions
on earnings
of up to
$2,000 per year for contributions
to an IRA. In the case of one-earner
couples, the limit has been raised to $2,250. In addition,
thanks to
modifications
to the tax code in 1978, workers now may establish
cash or deferred arrangements
(CODAs) under qualified
profit-sharing or stock bonus plans. CODAs allow workers to divert part of their
current earnings into a tax-qualified
retirement
program; this portion
of their salary is not taxed until cash distributions
are made to the
worker.
In addition to having access to special retirement
savings programs,
about 70 percent of the elderly own their homes at retirement,
and
nearly 80 percent
of these have no mortgage.
At retirement,
some
people liquidate
their home equity, but the majority continue to reside in their long-term
residence,
enjoying
the benefits
of familiar
surroundings
and lower housing costs than they would have if they
were renting.
Besides retirement
savings and home
significant
amounts of additional
wealth
ticularly
true for the self-employed,
who
that, by retirement,
often make them the
ciety.
equity, many people have
at retirement.
This is paraccumulate
business assets
wealthiest
members of so-
A significant
number of people over age sixty-five continue to work.
Although the labor-force
participation
rates of older people have been
declining
for more than a century, in 1979 nearly half of all families
with a member
sixty-five
years old reported
some earned income
during the year. The rates decline with age, but were still slightly
above 25 percent for persons seventy years old that year.
Finally, for those segments
of the elderly population
who meet the
eligibility
criteria,
there are a variety of means-tested
cash and inkind assistance
programs:
the Supplemental
Security
Income program, food stamps, housing and energy assistance,
and Medicaid.
XXlll
Often, older Americans
are characterized
as being solely or largely
dependent
on Social Security
for retirement
income. While this is
regrettably
the case in too many instances,
the situation
is changing.
In the future, the relative contribution
of various sources of income
will be significantly
different from the situation
today.
Retirement
Benefit
Levels
Under
Current
Policy
In the past, policymakers
have often focused on one component
of
the retirement
system at a time, with little regard for the role of other
programs.
The changes in Social Security that might be considered
in upcoming policy deliberations
can be expected to affect the distribution of total income for the elderly differently from the way they
affect the distribution
of Social Security benefits.
To assess the implications
of current and various policy alternatives, the Employee Benefit Research Institute (EBRI) has developed
an in-depth analysis to evaluate a range of policy options. This analysis is based on a microsimulation
of a sample of the United States
population.
It uses a model developed
by ICF Incorporated
called the
Income Simulation Model (PRISM). PRISM
was enhanced
under contract to EBRI specifically
for this project.
The simulation
procedure
generates representative
work and earnings histories, including periods of retirement program coverage. These
work histories are used to estimate retirement
benefits under various
policy scenarios,
policies.
and to show
the comparative
effects of alternative
Chapter III of this book provides a detailed description of this model,
the base-case assumptions,
and the results of the current policy simulation. The results of the simulations
are generally
consistent
with
the intuitive expectations
based on the evolutionary
analysis in chapters I and II. Average Social Security benefits, in dollar values adjusted for inflation, increase for each successive cohort of retirees, in
line with assumptions
that wages will grow somewhat
more rapidly
than prices in the future. Both the proportion
of the elderly receiving
pensions
and the average
levels of pension
benefits
are projected to increase steadily; by the second decade of the twenty-first
century, three out of four married couples and two out of three single
persons are expected
to be receiving
a pension at age sixty-five.
IRAs are also expected to become progressively
more important
as
a source of retirement
income in the future. The continuing
historical
trend of declining
labor-force
participation
rates among the elderly
will further reduce the significance
of earnings as a source of income
xxiv
for younger groups of today's workers as they reach normal retirement age. On the whole, the simulation
results estimate that average
family incomes in constant dollars will roughly double between now
and 2015.
Social
Security
Financing
Problems
The most sensible way to assess Social Security's
funding status,
given the current structure
of the program,
is to examine the extent
to which currently
legislated
revenue provisions
will be adequate
to
meet the benefits provided
by current law. This evaluation
is complicated
by the fact that the assessment
has to be made on a prospective basis. As was stated at the outset, the OASI trust fund is now
depleted,
so there is no reserve other than short-term
borrowing
capability that expires in December
1982. To give a range of potential
outcomes,
the Social Security
actuaries
base their estimates
of the
program's
future financing
status on a range of assumptions.
Chapter IV considers various sets of assumptions,
but this summary
will consider
the financing situation
under an "intermediate"
set of
assumptions
referred
to in the 1982 Social Security Trustees Report
as the Alternative
II-B assumptions.
Under these assumptions,
which
may prove to be optimistic,
tax collections
for the OASI program will
fall about $99 billion short of benefit payments
between
1982 and
1986. At the end of 1981, the OASI trust fund held $21.5 billion in
assets, an amount
insufficient
to meet the shortfalls
in 1982 alone.
Just to stay even during the 1982-1986
period, the OASI program
would require an increase of 9.0 percent in revenues or a reduction
of 8.3 percent in disbursements.
The long-term
situation
is no better. Even if the short-term
deficits
could be handled,
the OASI program would not accumulate
enough
excess revenues over the next twenty years to pay off the deficits now
occurring.
Beyond the turn of the century, OASI {aces a deteriorating
situation
under current program
provisions.
For the twenty-five-year
period beginning
in 2007, the Social Security actuaries
estimate
that
the legislated
tax rate will fall 21.9 percent short of meeting average
annual
benefit obligations.
In the twenty-five
years following
that,
the actuaries
project that the shortfall will be nearly 50 percent short
of meeting scheduled
benefits.
As was mentioned
at the outset, the OASI trust fund can supplement
its own tax revenues
with enough funds borrowed
from the DI and
HI trust funds to meet the benefit schedule
through June 1983. The
DI program
is solvent and could continue to lend monev to the OASI
XXV
program, or part of the DI tax collections could be reallocated
to the
OASI program. The DI program is much smaller than OASI, however,
and cannot by itself provide sufficient
reserves to resolve the OASI
problem.
Meanwhile,
the HI program
is facing its own financing
shortfalls,
and the HI trust fund is expected
to be depleted
over the
next ten years. Beyond that time, the HI program faces funding shortfalls that are of even greater magnitude
than those projected for OASI.
Although
this report concentrates
on the resolution
of the OASI
financing problem, it is important
to note that resolving this problem
alone will not solve the funding problems
in HI. The 1983 Social
Security Advisory Council is focusing primarily
on those HI funding
problems.
The HI and OASI problems
are somewhat
different,
and
they do not necessarily
have to be resolved simultaneously.
Resolving
the OASI problem first, in fact, may help to define the range of policy
options for addressing
the HI program.
The Mathematics
of Social
Term Policy Options
Security
Financing
and Short-
The cash benefits provided by Social Security are, for all practical
purposes,
financed
on a pay-as-you-go
basis. This means that the
revenues collected from current workers and their employers are paid
out almost immediately
as benefits to retirees. Given the small balances in the trust funds, revenues must closely match benefits during
any particular
time period for the program
to be solvent. The socioeconomic
factors that affect both revenues and benefits become extremely important
in determining
the stability of the system. Through
the use of some simple equations,
chapter
V explores
these factors
and their effects on the system.
Basically, four crucial variables
determine
the tax rate (t) required
to support
Social Security
over time. These are: (1) the number
of
covered workers (Nw); (2) their average covered earnings (W); (3) the
number
of beneficiaries
(Nb); and (4) the average
level of benefits
paid to them (B). For the program
revenues
to equal benefits paid
for a given time period, the tax rate has to equal the ratio of the
number of beneficiaries
to the number of workers (i.e., Nb/Nw) times
the ratio of average benefits to average covered earnings (i.e.i B/W).
Focusing on these crucial ratios can clarify some of the problems
and potential
solutions
for balancing
Social Security. The primary
reason that Social Security has been experier_ciiag financial declines
during the past ten years is that both of these .ratios have been unxxvi
stable. Because of variations
in employment
levels, the beneficiaryto-worker
ratio will always be somewhat
unstable over the economic
cycle. During economic downswings,
unemployment
rises, reducing
the number
of workers contributing
to the program
and increasing
the number
of beneficiaries,
as older workers retire rather than become unemployed.
In recent years, unemployment
has been higher
than anticipated
in the regular cost projections
actuaries.
Underestimating
unemployment
has meant tax collection
shortfalls
and increased
benefit burdens
on the system. In the long
term, the beneficiary-to-worker
ratio will increase significantly
as the
baby-boom
cohort of workers ages and begins to retire after the turn
of the century.
The ratio of average benefits to average covered wages (B/W) also
has been unstable in recent years. A technical error in the 1972 amendments, when automatic
benefit indexing was introduced,
caused benefits to grow faster than wages did. Although this error was largely
resolved
for future retirees
by the 1977 amendments,
retirees
who
benefited
from the earlier error will continue
to receive higher benefits throughout
their retirement.
Even after enactment
of the 1977
amendments,
however, the continued
indexation
of retirement
benefits by the consumer
price index (CPI) has meant further increases
in the B/W ratio, because wages have not grown more rapidly than
prices, as had been expected.
This unforeseen
sustained
growth in
the B/W ratio has meant that the cost of the program
has been higher
than anticipated
in the annual valuations.
In the long term, the benefits-to-earnings
ratio might be expected
to decline as real wages
grow. The projected
recomposition
of the beneficiary
population
in
the future, as a result of the increased
prevalence
of women in the
work force, will stabilize
this crucial
determinant
of the system's
long-term
cost.
Both these ratios for determining
the tax rate required
to finance
Social Security have been moving toward increasing
the cost of the
program. In combination,
their effects are multiplicative
of each other.
In the short term, a number of policy options can help to ameliorate
this situation.
The 1977 amendments
eliminated
much of the problem
of the growing benefits-to-earnings
ratio. The remaining
instability
in this ratio can be eliminated
by linking postretirement
benefit increases to wage growth rather than to price increases.
The linkage
does not have to be direct if productivity
increases are not to be passed
on to retirees. For example, indexing retirement
benefits by the rate
of wage growth minus 1.5 would provide the same benefits
as the
current
price indexing of benefits under the II-B assumptions
for the
xxvii
long term. It would
B/W ratio to occur.
not, however,
allow
the recent
instability
in the
There are basically two ways to decrease the ratio of beneficiaries
to workers. The first would be to quickly raise the eligibility
criteria
for benefits. This course would inflict considerable
hardship on people
who are near retirement,
causing extreme disruptions
in some instances. The second alternative
is to expand coverage to some or all
of the roughly 8 percent of current workers not now participating
in
the program.
This course would garner significant
revenues in the
short term without causing comparable
benefit increases in the future, since 80 to 90 percent of current nonparticipants
will ultimately
get highly subsidized
benefits under the current
system as a result
of taking covered employment
at some time before they reach retirement
age.
The combination
of modified benefit indexation
and expanded
coverage probably
would not provide enough savings or increased
revenues to meet the short-term
deficits, so additional
revenues or benefit
adjustments
would have to be considered.
On the revenue side, there
are basically
two options. The first would be an infusion of general
revenues;
however,
because
federal deficits of $150 to $170 billion
are projected
for each of the next three years, no general revenues
are readily available. Because Social Security is in the unified budget,
general fund infusions would not worsen the deficit in the short term,
but they could prolong or worsen the situation
in the long term. The
second option for raising additional
revenues would be to move forward payroll tax increases already scheduled
in law for 1985, 1986,
and 1990. Moving forward any of the tax increases
would produce
new revenues and help to ameliorate
the overall budget deficit problem to some extent.
On the benefit side, a range of short-term
options can be considered.
The cost-of-living
adjustment
(COLA) for one year could be eliminated. For one or several years, the adjustments
could be provided
only at fifteen-month
intervals,
rather than annually.
They could be
capped in either dollar or percentage
terms. A somewhat
different
approach
would be to treat some part (e.g., 50 percent)
of Social
Security benefits as regular income for income tax purposes and earmark the increased revenues for the trust funds. The reason for considering taxation rather than significant
COLA modifications
is that
the taxation alternative
would affect only upper-income
elderly people who are also receiving income from alternate
sources.
Eliminating
a COLA, on the other hand, would increase
poverty
rates among the elderly. None of these options would be considered
xxviii
in the context of Social Security financing
if the program
were solvent, but the public now widely perceives that the svstem is going
bankrupt.
Elderly retirees
fear for a major portion of their income;
young workers do not believe the system will be there when they
retire. Without solvency, the program
will not have public support;
without public support,
the svstcm cannot be preserved.
The shortterm crisis can be resolved if the burden of balancing
the svstem is
widely shared. The combination
of mandatorv
universal
coverage,
moving forward the 1985 and 1986 tax increases to 1984, and treating
half of benefits as regular income would resolve the short-term
problem. Other options and combinations
can be considered,
but unless
there is a broad public perception
that the problem is being solved
through
an equitable
sharing of the burden,
preserving
the svstem
will be much more difficult.
Social
Security
Beyond
the Short
Term
Chapter
VI of this book presents
a variety of proposed
long-term
modifications
to Social Security that would help to balance the system's financing.
These range from modifications
in the benefit formula to adjustments
to Social Security's
retirement
age. To assess
the implications
of each of the options on the future level and distribution of Social Security benefits and other income sources, several
of these options were simulated
using the Pension and Retirement
Income Simulation
Model. (The options themselves
are spelled out
in the chapter.) The simulation
results from each of the policy options
were compared
with the simulation
results from current policy; then
the results of the various options were compared
with one another.
Because PRISM simulates
the life and work patterns
of individuals,
the effects of each option could be compared
for individuals
with
different characteristics.
Each of these options has been widelv interpreted
as a benefit reduction,
but this interpretation
is only partly correct. What is not
alwavs understood
is that there is inherent
growth built into the
Social Security
benefit structure
that will increase the purchasing
power of average benefits in the future. For example, figure 1 shows
the growth in average benefits under the current
policy simulation
in 1982 dollars as the solid upper line. (Table III-10 in the report
shows a similar pattern
of benefit growth projected
bv the Social
Securitv actuaries.)
The broken lower line in the figure shows future
average
Social Security benefit levels under an option that would
xxix
slow the growth of initial benefit levels through a modification
of the
benefit formula.
The adjustment
to the benefit calculation
procedure
considered
here, for the sake of discussion,
would begin in January
1984 and,
would index the benefit formula "bend points ''_ by 75 percent of wage
growth instead of the full wage indexation
that is now used to adjust
the formula annually.
This procedure
would be continued
for sixteen
years under the II-B assumptions,
although a shorter or longer period
could be used depending
on actual economic
experience.
The net
ultimate
effect of this benefit formula
modification
under the II-B
assumptions
would be to reduce average Social Security benefits by
about 11 percent, when compared
with the current
policy benefit
levels. Yet, over the period, average benefits would continue to grow
steadily.
This option can be perceived
as providing
a real cut in benefits
only if the benefits under the current
policy to potential
retirees decades hence are considered
to be firmly committed--on
the way to
the bank, so to speak. It is tenuous, at best, to assume that the exact
level of Social Security benefits to be paid ten, twenty, or thirty years
from now is broadly
perceived
as that firmly committed.
A more
important
commitment
should be to the assurance
that the benefits
will be there when people need them and that those benefits
will
provide a reasonable
base of support for the elderly's retirement
income security.
It is also important
to remember
that there are other sources of
income that will help to mitigate the effects of modifications
in Social
IRetirees'
Social Security
benefits are based on their lifetime covered earnings.
First,
the earnings
from each year of the workers'
careers are adjusted
to account for historical growth in average earnings throughout
their working
lives. A specified number
of years of the lowest earnings
are dropped;
then the remaining
lifetime earnings
are
added together
and averaged
over the number of months in the years included
on the
workers' benefit calculations.
Benefits are then calculated
on the basis of this earnings
calculation,
referred
to as the average indexed monthly
earnings (AIME) in technical
jargon. The benefit formula established
by the 1977 amendments
has three replacement
rate thresholds
that are then applied to the AIME to calculate
the basic monthly benefit.
If a worker retires prior to age sixty-five, the benefit is adjusted
to account for early
retirement.
In 1981, the Social Security
benefit formula
replaced
90 percent of the first $211 of
AIME plus 32 percent of the next $ 1,063 and 15 percent of any remaining
AIME. These
different
AIME dollar amounts
to which benefit calculation
factors are applied
are
often referred
to as the formula
"bend points."
The amount
of AIME that is subject
to each factor increases each year by the rate of average wage growth in the economy.
For example,
in 1982 the formula replaced
90 percent of the first $230 of AIME, plus
32 percent of the next $1,158, plus 15 percent of any AIME over $1,388.
xxx
FIGURE 1
Future
Average
Family
Social
at Age 65
Security
Benefits
In 1982 Dollars
$10,000,
9,000 .....
Current Policy Benefits
Modified Benefit Formula
•
1985 Average Benefit Level
/
e •
_
8,000.
.
...*'°'...
e.
ee
°e eeeeeeeee
7,000
ee
-
••"°"
eee
"
e*
ee°e
6,000
...........
""
5,000
I
1985
I
1990
I
1995
I
2000
Year
I
2005
I
2010
I
2015
Source: Social Security benefits estimated from the Pension and Retirement Income
Simulation Model.
Security.
By the time any of the long-term
options being seriously
discussed
is fully implemented,
the portion of the elderly population
receiving pension and IRA annuities
will be significantly
higher than
is currently
the case. Figure 2 shows the estimated
average disposable
income for future cohorts
of retirees
from the PRISM simulations
under three different Social Security policy scenarios in 1982 dollars.
The top line in the figure represents
estimated
average disposable
family income under current Social Security policy. The middle line
shows the projected
path of average income under the Social Security
benefit formula modification
that would slow bend-point
growth to
75 percent of wages for a defined period. The bottom line shows the
projected
path if the formula
were modified and half of Social Security benefits began to be treated as regular income. The difference
between
the current
policy and the combined
alternatives
may be
considered
as a 9 percent reduction
in income at age sixty-five by the
year 2015. Another way of expressing
the difference
is to say that
under current
policy, average real disposable
income is projected
to
xxxi
FIGURE
Future
Average Disposable
2
Family
Income
at Age 65
In 1982 Dollars
$22,000,
-• ......
......
20,000
! 8,000
Current Policy
Modified Benefit Formula
Modified Formula and Tax 50%
_
.......
of Benefits
_'_...
• • """ _.-. ....
1985 Average Fam,ly Income /'_,---"_-.--'''-
16,000
.." s S
oe °
14,000
..._ _..*
12,000
Source:
s S
• • _-""
°_
I
I
I
°
1985
1990
1995
I
2000
Year
ss
I
2005
I
I
2010
Disposable family income estimated from the Pension and Retirement
Simulation Model.
2015
Income
rise by 1.9 times between
1985 and 2015, whereas
it might go up only
1.8 times under
the modified
policy•
The combined
effects
of modifying
the formula
plus treating
half
of benefits
as regular
income
would
',:lose at least 90 percent
of the
projected
long-term
deficit
in the Social
Security
cash benefit
programs.
This particular
set of options
has been chosen
not to represent
a preferred
policy option,
but rather
to put the discussion
in a proper
context•
Each of the other options
discussed
in chapter
VI would
have
distributional
results
somewhat
different
from those associated
with
this particular
option,
in the aggregate.
but
most
would
not
be significantly
different
Universal Social Security Coverage and the Alternatives
In 1939, Congress
realized
that there was a long-term
problem
in
the benefit formula
adopted
at that time--a
problem
relating
to people who moved back and forth between
covered
and noncovered
emxxxii
ployment.
amendments
The House
stated:
of Representatives'
report
on the
1939
An average wage formula will also have the effect of raising the level of
benefits payable in the early years of the system, but it will reduce future
costs by eliminating unwarranted bonuses payable under the present formula to workers in insured employment onlv a few years. These bonuses
result from the greater weight now given to the first $3,000 of accumulated
wages. They are justified, if a total wage formula is used, in the case of
older and low-paid workers who retire in the early years of the system and
have not had time in which to build up substantial benefit rights. In the
long run, however, such bonuses are unwise and endanger the solvency of
the system by permitting disproportionately
large benefits to workers who
migrate between uninsured and insured employment and accumulate only
small earnings in insured employment. 2
Today, these "unwarranted
bonuses," as Congress called them, are
costing Social Security at least $2 billion per year. In the long term,
the net savings from mandatory
universal
OASDI coverage would be
0.5 percent of payroll, or slightly more than one-quarter
of the projected long-term
deficit in the Social Securitv cash benefit program.
If Congress had mandated
universal coverage in 1977, the last time
they dealt with the Social Security financing crisis, there would be
no short-term
problem
today. The coverage issue is a political lightning rod, however, and has been successfully
opposed on several occasions
by the groups now exempted.
Only about 8 percent
of all
current
workers are not participating,
but as many as 90 percent of
these people will ultimately
receive benefits
as a result of taking
covered
employment
sometime
in their careers. If the current
exemptions
are extended
and the "unwarranted
bonuses"
are perpetuated, both the short- and long-term adjustments
for full participants
will have to be more severe.
Other
Policy
Considerations
As Congress
takes up the task of preserving
the Social Security
system, it may wish to reconsider
several other controversial
or troublesome Social Security policy issues that have been discussed
over
the years. These include: (1) the equity of Social Security's
treatment
of women; (2) the elimination
or modification
of the earnings
test;
(3) the financing of some portion of the Social Security program through
general
revenues;
(4) the development
of a mechanism
for dealing
2House of Representatives,
76th Congress, First Session,
Act Amendments
of 1939 (June 2, 1939), p. 10.
Report
no. 728, Social
Security
xxxiii
with trust fund accumulations,
should they occur, which could help
to prefund a portion of the benefit liabilities for the baby-boom
generation;
and (5) a fundamental
reorientation
of the whole system of
social insurance
for the contingencies
of old-age, disability,
and survivorship. Chapter VIII deals with each of these issues in some detail.
The
Future
of Social
Security
Historically,
Social Security policy has attempted
to balance the
countervailing
goals of adequacy and equity through
its financing
and benefit structure.
Until recently, this process has been relatively
uncontroversial
because virtually all beneficiaries
have received, or
could expect to receive, benefits that substantially
exceeded the value
of their contributions.
The days are quickly passing when all members
of each retiring group of workers can expect to receive more than the
value of their combined
employer-employee
payroll
tax contributions. The future balance of adequacy and equity has to be considered
in the framework
of a broader set of priorities.
Two equally important
policy goals for Social Security are solvency
and public support.
If these goals are not met, adequacy
and equity
considerations
will become moot. Questions about Social Security's
solvency have substantially
shaken the confidence
of old and young
alike. Without confidence
that the program is solvent, continued
support will wither.
Intergenerational
concerns
about Social Security
link the shortand long-term considerations.
Policymakers
cannot seek solvency with
total disregard
for either adequacy
or equity. There is general agreement across the entire political spectrum
that retirees must not be
ravaged
by program
modifications.
At the same time, the national
commitment
to the income security of the elderly must be perceived
as a burden equitably
shared by all elements of society.
The story that the numbers
throughout
this book tell is that the
future may not be so dismal as a narrow focus on Social Security's
current financing projections
would suggest. While no one can predict
the future with great accuracy, some trends can be observed and their
outcomes
predicted.
For example, American society is aging, and it
will continue
to do so. In addition,
pensions and private retirement
savings are growing in importance
as sources of retirement
income
security, and they will continue to do so in a favorable policy environment.
Although the aging of society is bound to put extra stress
on Social Security,
the growth of pensions can help to relieve some
of that burden.
xxxiv
These two countervailing
trends suggest that Social Security
can
adjust in the future to meet the needs of society. The uncertainty
of
the extent of changes in the economy,
productivity,
birthrates,
life
expectancy,
and a host of other factors suggests that Congress should
adopt a Social Security policy that allows some margin for error. In
essence, this means that any policy changes Congress
makes in the
current environment
should not promise more for the future than we
are sure we can provide.
One has to assume that future Congresses
will be better equipped
in ten or twenty years hence to assess appropriate
benefit and taxing
provisions
in their respective
times. Policymakers
then will be better
able to .judge the relative needs and capabilities
of their society and
economy than anyone in Congress can judge today. It we cannot trust
the future political process in this society, we should be seeking not
to insure ourselves
against that process, but to change it fundamentally.
XXXV
Foreword
Since its creation
in the 1930s, Social Security
has been at the
center of national public policy debates. In 1945 there were twenty
workers
for every retiree and few sources of retirement
income security outside the extended
family.
Today, there are only three active workers to support each retiree,
and extended
families are almost nonexistent.
More than 50 percent
of new retirees receive pension income other than Social Security.
Increasingly,
workers are gaining access to these additional
pension
income sources.
Preserving
Social Security is a national goal that requires thoughtful attention
and bipartisan
action. In this study, Svlvcster J. Schieber
carefully
analvzcs
the development
of Social Security and complementary
retirement
income systems. He thoroughly
reviews both the
short-term
and long-term
financing
issues; and he demonstrates
the
effects of various solutions
to Social Securitv's
financial
problems.
As Dr. Schicbcr
points out, concern over benefit adequacy
and equity dates back to Social Security's
inception.
Debate about the benefit adequacy and equity goals has led to the consideration
of alternative
social insurance
systems. For example, there were proposals
for replacing the current
system with a "double-decker"
system as long
ago as the 1940s. This study discusses
questions
such as the basic
reorganization
of the Social Security system today.
Schieber
stresses
that while the existing structure
of the system
has been the subject of continuing
policy debate, the program
generally has enjoycd widespread
public support. This is in part because
retirees
have traditionally
received more in benefits than they paid
in Social Security
taxes. Many young taxpayers
now perceive
that
they will not receive as great a return on their investment
in Social
Security as their parents received.
The widespread
public confidence
in the system has been shaken
bv recent events. The elderly live in fear that their benefits mav run
out, while young workers who are contributing
to the program
fear
that the program
will not be there when they reach retirement
age.
Public support can no longer be considered
automatic.
To maintain
the integrity of the system, public confidence
must be restored. Policvmakers
should deal with both the short- and long-term
problems
in the system now. This should be done through decisive, fair action
rather than bv asking future generations
to pay higher taxes than we
are willing to pay.
xxxvii
This study developed
out of Dr. Schieber's
work as Research
Director of the Employee
Benefit Research
Institute.
Computer
work
was provided
under contract
by David L. Kennel[, John F. Shiels,
and John Castner
of ICF Incorporated.
Priscilla Taylor edited the
manuscript.
Appreciation
is expressed
to the many people who commented
on
drafts of the study and to those who prepared the manuscript.
Dwight
K. Bartlett,
Robert J. Myers, and A. Haeworth
Robertson,
all former
chief actuaries of the Social Security Administration,
are owed special
thanks for their review and comments.
The views expressed
in the study are those of the author and should
not be attributed
to officers, trustees, members,
associates,
or other
staff members
of the Employee
Benefit Research
Institute,
its Education and Research
Fund, or to any of those who were consulted
with or commented
on the manuscript.
DALLAS
Executive
November
xxxviii
L. SALISBURY
Director
1, 1982
Introduction
A front-page
article in the New York Times on October
18, 1982,
broke the story that within a month, Social Security's
largest program, the Old-Age and Survivors
Insurance
(OASI) program,
would
have to borrow money from the Disabilitv
Insurance
(DI) and Hospital Insurance
(HI) programs
to meet scheduled
benefit payments.
The news spread quickly.
For several years, analysts who have been tracking
the Social Security program have known of the pending financing problems. Moreover, innumerable
accounts
of the situation
have appeared
in the
media, some of them thoughtful
and informative,
others anecdotal
and confusing.
The political
discussion
of the issue has also been
somewhat
uneven. Rather than an attempt
to educate the public and
dispel confusion,
the public discourse
has often been described
bv
the politicians
themselves
as "demagogic."
As a result of the conflicting information,
the public has been generally
skeptical
about the
seriousness
of the problem.
Skepticism
about the existence
of a "crisis"
in Social Security on
the one hand, is a striking counterpoint
to numerous
analyses
that
Social Security is unsalvagcable
on the other. It is not surprising
that
the public is confused bv the wide range of opinions about the Social
Security
program.
For example,
Dr. Henry Aaron, an economist
at
the Brookings Institution,
argues that the situation
can be resolved
with moderate
adjustment,
while Dr. Michael Boskin, an economist
at Stanford University,
argues that the social insurance
system known
as Social Securitv has to be radically
reconfigured.
This book was written to clarify some of the issues that are central
to the Social Security
debate
now beginning
in the public policy
arena. The discussion
presented
here analyzes a wide range of policy
options and their implications
for Social Security financing,
as well
as their potential
effects on the economic security of elderly people.
The analysis
does not conclude
with a definitive
list of policy prescriptions
that need to be implemented
in order to assure Social
Security's
financial
solvency. There are actually
several ways that
the OASI program
can be balanced
in both the short and long terms.
It is not a question of whether it can be done, but rather how it should
be done. This analysis seeks to intorm the public and to help policymakers
who evaluate
the ramifications
of various alternatives.
Background
To some extent, Social Security
can be thought of as a savings
program.
Workers, along with their employers,
pay taxes to the system based on their earnings. This participation
in the program "earns"
workers a benefit they are "entitled"
to receive when they have met
certain
eligibility
criteria
of the program.
In other words, workers
give up part of their current income while working, in return for an
income that will be provided
to them after they retire.
Social Security is different from traditional
savings programs,
however, because the contributions
of each individual
worker are not put
aside into an account
that is specifically
his or hers. For the most
part, the aggregate
tax collections
from all employers
and workers
are put together
each month to pay the benefits as they come due.
In this sense, Social Security is not a savings program, but rather an
intergenerational
transfer program.
This simply means that the program collects revenues from one generation
(i.e., workers) and passes
them on to another (i.e., retirees).
American society consists of a broad range of individuals
and families which can be thought of as economic
units. The activities
of
these basic economic
units tend to follow a pattern over their lifetimes, with some variation
among groups and individuals.
If these
economic units are observed over time, it becomes apparent
that for
the majority,
individual
members
typically spend a portion of their
lifetimes in the work force, earning a living. Prior to work-force
participation
on an intensive
and sustained
basis, the typical person is
born, reared, and educated
through a complementary
set of privately
and publicly financed family and educational
institutions.
During their working years, most people are relatively
self-sustaining. They meet their own consumption
needs and those of their
children,
if they have them. In addition,
many people also save part
of their earned income during their working lives to help meet their
needs during periods when they cannot provide sufficiently
for themselves and to supplement
the income that they can expect from Social
Security.
Prior to the development
of the broad set of programs
that have
come to be known as social insurance
in this country,
the private
accumulation
of savings and dependence
on one's own grown children
or other relatives were the chief mechanisms
for providing economic
sustenance
to people who could no longer make their own way because of old age or disability.
This approach
to economic
security
seemed to meet society's needs during the early years of the nation,
2
but as the economic
structure
ures became noticeable.
became
increasingly
urbanized,
fail-
Retirement
programs
began to develop in the United States in the
latter half of the nineteenth
century when it had become clear that
circumstanccs
could arise which were beyond workers' control and
for which they could not or would not prepare.
People often cannot
anticipate
the occurrence
of disability
or premature
death, and they
need some sort of insurance
protection
against income loss for themselves and their dependents
when either does occur. People must also
provide for themselves
in their old age; they cannot depend solely on
being able to work until they die.
Each of these contingencies
could be provided for through private
insurance
and savings mechanisms.
The evidence of the early 1900s,
before the advent of the Social Securitv Act, however, was that these
mechanisms
were not sufficiently
developed
to meet the challenge.
Today, private insurance
and pensions are more prevalent
and secure
and new tax incentives exist to encourage
private retirement
savings,
but participation
in these programs
is still not universal.
Even if it
were, low-wage
earners would be unable to provide adequate
protection
for themselves,
and some kind of public subsidy would be
necessary
to prevent widespread
economic deprivation.
The fact is that if Social Security did not exist in the United States
today, there would still be many people who would not be protected
by alternative
provisions.
When the contingencies
requiring
income
support
arose, these people would suffer hardship
or require public
support
or both. In a society as diverse as ours, there has to be a
social insurance
mechanism
to support people in the event of earnings
loss.
Scope
of the Current
Analysis
In 1935 when the Social Security Act was passed, its primary
architect, President Franklin D. Roosevelt, did not intend for it to be
the sole source of support for large segments
of the United States
population.
Since that time, significant changes have been made in
Social Security and in other elements of the retirement
income security system. The analysis in this book attempts
to clarify some of
the issues relating
to those changes and their significance
for the
current deliberations.
Chapter
I describes
the historical
development
of the Social Security Act and its evolution, in a structural
sense, into the program
3
that we know today. The time devoted to the historical
perspective
may seem inordinate.
The chapter
is included,
however, because it
seeks to dispel some broadly
held myths that Social Security
is a
radically
different program
from the one originally
conceived.
Chapter II describes the evolution of other organized and individual
retirement,
savings, and income transfer programs
that provide income support
to people during their old age. This chapter may also
seem to dwell on history, but the purpose is to show that these programs evolve over time and that the expectations
from them tomorrow should be quite different
from the level of benefits
they are
providing
today.
Chapter III provides a set of estimates
of what future income levels
would be for retirees
if we were to continue
current
policies and
programs
without change. This chapter serves primarily
as a baseline
for detailed
analysis of a host of alternative
policies later in chapter
VI.
Chapter
not focus
the short
problem
changing
IV discusses the Social Security financing problem. It does
solely on where we are today and what we can expect in
or long terms but explains how the Social Security financing
crept up through a process of program
modifications
and
socioeconomic
circumstances.
Chapter V focuses on the intrinsic elements of the Social Security
program that gave rise to the financing problem and describes a series
of options that might stabilize the program
in the short term. While
chapter
IV focuses on the magnitude
of the problem
and its recognition, chapter V explains why there is a problem. For anyone wanting
to understand
the nature of the financing problem, chapter V is one
of the most important
sources of information
in the book.
Chapter VI describes
several proposals
that have been widely considered as ways to deal with the long-term
Social Security financing
deficits. The first part of the chapter
describes
these proposals
and
their long-term
effects on the program's
financing.
The second part
of the chapter looks at what the implications
of each of the proposals
considered
would be for future beneficiaries.
The last part of the
chapter
compares
the distributional
implications
of the various options.
Chapter VII discusses the issue of mandatory
universal
Social Security coverage and the various alternatives
that have been proposed.
The noncoverage
of about 8 percent of the work force gives rise to
serious equity questions
that Congress should consider. This chapter
describes
and analyzes these equity questions.
The chapter also explains how extending coverage to remaining noncovered workers would
have significant,
beneficial
financing
effects on Social Security
in
both the short and long terms.
Chapter
VIII discusses
a range of other issues that are mentioned
elsewhere
in the book but deserve further consideration.
Five issues
are discussed
at length: (1)the equity of the current
treatment
of
women under Social Security spouse and survivor benefit provisions;
(2) the problems
with maintaining
the earnings
test in Social Security; (3) the potential of financing some portion of the program through
general revenues; (4) the problem of OASDI trust fund accumulations
to unmanageable
levels under certain
policy options; and (5)three
proposals
that would change the Social Security system more fundamentally
than any of the other incremental
changes considered
throughout
the analysis.
The last chapter summarizes
the prospects
for the future of Social
Security and for the retirement
income security of elderly people.
I. The Evolution
Program
The Social Security Act, signed into law on August 14, 1935, was
undoubtedly
one of the most significant
pieces of legislation
ever
passed bv the United States Congress. The original
act and subsequent amendments
established
a number
of programs
that arc beyond the scope of this discussion.
This chapter
will focus on those
programs that are financed primarily
by Social Security payroll taxes,
including
the Old-Age (OA), Survivors (S), Disability (D), and Hospital
(H) Insurance
(I) programs
(OASDHI) which constitute
what the public usually thinks of as Social Security. I
When thc initial act was passed in 1935, it included only Old-Age
Insurance
and was limited to private-sector
workers in commerce
and industry.
Traditionally,
the program
has been financed bv the
payroll tax, first levied in 1937. The first old-age benefit check was
issued in January
1940 to Ida M. Fuller of Ludlow, Vermont.2 Benefits
for dependents
and survivors
were added in 1939, disability
benefits
in 1956, and health insurance
in 1965. Before we examine
this evolution in detail, it is important
to review the context in which the
Social Security Act was developed and passed in 1935. Then the actual
development
of the initial Social Security Act is described
in some
detail. This includes a description
of the developmental
process, the
substance
of the original act, and the subsequent
modifications.
This
chapter seeks to provide a broad historical and conceptual
framework
that defines the Social Security structure
as we know it today.
The
Early
Development
of Retirement
Programs
The earliest retirement
program in this country can be traced back
to 1636 when the settlers at Plymouth Colony decreed "that any man
sent forth as a soldier and returned
maimed should be maintained
by the colony during his life." The colonies made similar provisions
for men who were disabled and for survivors of men who were killed
in military expeditions
against the Indians. The first national pension
IThis discussion
will not generally
focus on the Supplementary
Medical Insurance
(SMI) program,
"Part B" of Medicare,
which is tinanced by' premiums
paid by people
who elect to be covered and subsidized
through
general revenues.
2W. Andrew Achenbaum,
Old Age iu the New Land (Baltimore,
Md.: Johns Hopkins
University
Press, 1978), p. 126.
7
law, which dates back to 1776, provided half pay for life, or during
disability,
for soldiers disabled
during the Revolutionary
War. Military provisions based on service date back to 1780. Gradually,
service
pensions came to be provided separately
for veterans of each war. In
1861, the first major nondisability
program
provided
for voluntary
retirement
of military officers after forty years of duty. In 1885, nondisability
retirement
was extended
to Marine and Army enlistees,
providing
voluntary
retirement
after thirty years of service. 3
Civilian retirement
programs
in this country date back to the end
of the eighteenth
century. In 1794 Albert Gallatin established
the first
recorded
profit-sharing
plan in his glassworks
in Pennsylvania.
New
York City established
a pension system for its policemen
in 1857. A
smattering
of additional
local public pensions
were started during
the remainder
of the nineteenth
century.
In 1911 Massachusetts
established
the first state retirement
program
for public employees.
About a dozen private
pension plans existed in 1900; the number
grew to about 60 by 1910, 270 by 1920, and 420 by 1930. 4 The federal
Civil Service Retirement
System began in 1920.
Early on, pensions were established
for many of the same reasons
they still are being established
today, including
employers'
desires
to encourage retirement
of older workers, so younger ones could move
up the organizational
ladder, and employers'
desires to entice superior workers and discourage
excessive
turnover
by providing
an
attractive
compensation
package.
Most of the early pension plans provided no benefits prior to age
sixty-five, and they often required twenty or more years of continuous
service prior to retirement.
Some of the early plans included restrictions prohibiting
the hiring of workers over forty-five
to fifty-five
years of age. Many of the early pension plans were "final-pay"
plans,
which provided
annual benefits equal to 1.0 to 1.5 percent of final
average pay for each year of service.
The growth of organized
retirement
programs
was not an isolated
American
phenomenon.
In Europe, interest in providing
security for
old age dates back to the nineteenth
century. In fact, European
mining
communities
had established
miners' funds as far back as the Middle
Ages. These funds provided
income replacement
for men who could
_Office of the Actuary,
Del_ense Manpower
Data Center, Valuation o[ the Military Retirement System: Fiscal Year 1980 (Washington,
D.C.: U .S. Government
Printing Office,
1981), p. 2.
4M. W. Latimer,
Industrial Pensio_t Systems in the United States and Canada (New York:
Industrial
Relations
Counselors,
Inc., 1933).
no longer work in the mines because of age or disability. 5 Horlick,
an American authority,
notes that as early as 1832 German employers
were beginning
to establish old-age retirement
programs; he suggests
that these employer
programs
were the precursors
of Germany's
social security
program
adopted
in 1889. 6
Two types of public programs
for the aged evolved in Europe: noncontributory
old-age assistance
programs
aimed at deserving elderly
poor, and contributory
types to cover the working population.
The
first of the noncontributory
plans was established
in Denmark
in
1891. During the first decade of the twentieth
century, France and
Great Britain established
similar programs. By the beginning of World
War I, New Zealand, Austria, Newfoundland,
and Iceland had oldage assistance
programs
in operation.
After the war, the trend continued around the world with several more national programs
being
established
.7
Two objections
arose in connection
with these programs:
(1)the
"means-tested"
basis of the programs
conflicted
with the general
desire to make benefits available
as a right upon attaining
old age,
and (2) as the number of needy recipients
increased,
the old-age assistance programs
put an increasing
fiscal strain on the sponsoring
governments
.8
These concerns
encouraged
the rapid growth of the contributory
type of old-age income support
program
that actually
preceded
the
establishment
of the early assistance
programs.
The contributory
program established
by Bismarck
in Germany in 1889 covered all wage
and salary workers and provided
disability
(then called invalidity)
and old-age benefits. In 1911 the German program
was amended
to
provide survivor
benefits. Prior to World War I, Luxembourg,
Rumania, Sweden, and the Netherlands
had enacted contributory
programs. Between the end of World War I and 1927, an additional
fifteen
countries,
mostly European,
enacted contributory
old-age programs.
These included France and Great Britain, which had established
oldage assistance
tems.9
programs
prior
to setting
up their
contributory
5Committee
on Economic
Security,
Social Security in America (Washington,
Government
Printing
Office, 1937), p. 181.
6Max Horlick, Private Pensions in West Germany and France (Washington,
Security
Administration,
1980), p. 3.
7Comrnittee
on Economic
Security,
Social Security in America, p. 181.
Slbid.
91bid., pp. 181-182 and 470.
sys-
D.C.: U.S.
D.C.: Social
9
Environment
in the United
Social Security t°
States
Prior
to Enactment
of
More than forty-five years passed between the time that the first
contributory
programs were established
in European countries and
the Social Security Act was passed in the United States. There are
many reasons to explain this significant time lag. At the end of the
Civil War the elderly constituted
about 3 percent of the U.S. population, as shown in table I-1. Declining birthrates
in the late nineteenth and early twentieth
centuries,
increasingly
restrictive
immigration
policy, and gradual improvement
of life expectancy
all
contributed
to an aging population. The elderly as a percentage
of
the United States population doubled during the lifetimes of persons
who reached age sixty-five by 1935. Furthermore,
actuarial projections at that time estimated
they would again roughly double, to
make up 11.3 percent of the population by 1980.11
TABLE I-I
Percentage
Year
1870
1880
1890
1900
1910
1920
1930
1940
of the Population
Over Age 65, 1870-1940
Percentage of Population
Over Age 65
3.0
3.4
3.9
4.1
4.3
4.7
5.4
6.3
Source: U.S. Bureau of the Census, Historical Statistics of the United States (Washington, D.C.: U.S. Government Printing Office, 1975),p. 14,Series 91-104.
Not only was the country's
population
aging, but the nation's economic fabric was changing
as well. During the 1880s, the economy
was still predominantly
agrarian
with more than half the labor force
engaged in agricultural
employment
(see table 1-2). By 1910 agricultural employment
had declined to 31.4 percent of the labor force. In
the decades since 1910, agricultural
employment
has declined in ab_°For a detailed discussion of changing retirement policy in the United States, see
Achenbaum, OM Age in the New Land.
lICommittee on Economic Security, Social Security in America, p. 141. It is worth
noting that forty-five years later this estimate has proved to be correct.
10
solute terms as well as relative size. This shift from an agricultural
economy to an industrial
one was accomplished
largely bv the movement of younger workers to urban .jobs. According to the 1910 census,
29 percent
of farm operators
were under age thirty-five,
while not
quite 24 percent were over age fifty-five. The 1930 census showed
that farm operators
under age thirty-five
had declined to 23 percent
while those over age fifty-five had risen to 29 percent of the total. 12
TABLE I-2
Labor
Year
Force
and
Employment
Labor Force
(Thousands)
in Agriculture,
1870-1940
Employment in Agriculture
Number
Percentage of Total
(Thousands)
Labor Force
1870
12,930
6,790
52.5
1880
17,390
8,920
51.3
1890
23,320
9,960
42.7
1900
29,070
11,680
40.2
1910
37,480
11,770
31.4
1920
41,610
10,790
25.9
1930
48,930
10,560
21.6
1940
56,290
9,575
17.0
Source: U.S. Bureau of the Census, Historical Statistics o[ the United States (Washington, D.C.: U.S. Government Printing Office, 1975),p. 139, Series D 182-232.
Historically,
agricultural
employment
has been far less sensitive
to recessions
and depressions
than nonfarm
employment
has been.
The decline in agriculture
was important
because it increased
the
sensitivity
of employment
to the general level of economic
activity.
A comparison
of the rates of nonfarm unemployment
and unemployment in the total labor force shows this relationship.
Between
1900
and 1940, the unemployment
rate showed greater variation
for nonfarm workers than for the total labor force (see table I-3). More significant is the consistent
decline in the ratio of the nonfarm
to total
unemployment
rates. During the early 1900s, nonfarm
unemployment was consistently
double that for the total labor force; swings
in unemployment
also were twice as high in the nonfarm
sector as
in the total labor force. During the dust bowl period in the late 1920s
and early 1930s, when natural disaster
wrought havoc in the Plains
states and dislocated
many farmers, agricultural
unemployment
levels
_2u.s. Bureau of the Census, Historical Statistics o[the UnitedStates (Washington, D.C.:
U,S. Government Printing Office, 1975). p. 465, Series K 82-108.
11
rose. As growth in the nonfarm sector of the economy grew, the effects
of cyclical swings in the economy were exacerbated.
At the turn of
the century, the nonfarm unemployment
rate was consistently
at least
twice that of total labor-force
unemployment.
When nonfarm
unemployment
reached all-time high levels in the Great Depression
of
the 1930s, it was only 50 percent higher than unemployment
in the
total labor force.
TABLE 1-3
Five-Year
Period
1900-1904
1905-1909
1910-1914
1915-1919
1920-1924
1925-1929
1930-1934
1935-1939
Variations
in Unemployment
Rates for the
Civilian Labor Force
and Nonfarm Workers, 1900-1939
Civilian Labor
Unemployment Rate
High
Low
Difference
(Percent) (Percent) (Percent)
5.4
8.0
7.9
8.5
11.7
4.2
25.2
20.3
3.7
1.7
4.3
1.4
2.4
1.8
8.9
14.3
1.7
6.3
3.6
7.1
9.3
2.4
16.3
6.0
Nonfarm Worker
Unemployment Rate
High
Low
Difference
(Percent) (Percent) (Percent)
12.6
16.4
14.7
15.6
19.5
6.9
37.6
30.2
8.6
3.9
8.2
2.4
4.1
2.9
14.2
21.3
4.0
12.5
6.5
13.2
15.4
2.0
23.4
8.9
Source: U.S. Bureau of the Census, Historical Statistics o[the United States (Washington, D.C.: U.S. Government Printing Office, 1975),p. 126, Series D 1-10.
Industrialization
of the United States changed the status of older
workers. In an agrarian
society, elderly people could choose to continue to work at their own enterprises
or to pass the reins on to
subsequent
generations.
Retirement
was often a gradual process, with
the older farmer first taking on less strenuous
activities
in the production process as the sons undertook
the heavier tasks. Opportunities for gradual
retirement
were more limited in the industrial
workplace.
The increased mechanization
of production
processes required vigorous, competitive
workers.
"In such competition
the position of older persons tends to become more and more unfavorable."13
Hence large employers
had begun establishing
pension programs
to
provide retirement
income for superannuated
workers in public as
t_Committee on Economic Security, Social Security in America, p. 143.
12
well as private employment.
At the end of the nineteenth
century,
nearly 70 percent of the men over sixty-five continued
to work; by
1920 tewer than 56 percent did so. 14
The various
factors affecting
the elderlv's
ability to provide
for
themselves
converged
during the early 1930s. The transition
from an
agrarian
society was far enough along that significant
numbers
of
older workers were being retired. Demographic
factors were increasing the size of the elderly population
to more noticeable
levels. Finally, the Depression,
which raised unemployment
levels among
nonfarm
workers above 35 percent, had a particularly
devastating
effect on the elderly. Not only did the Depression
eliminate
many
employment
opportunities
for older workers, but also the stock market crash of 1929 and the rash of bank failures during the early years
of the Depression
wiped out the limited resources
that many older
workers had accumulated.
Furthermore,
many of those who had pension protection
lost it when businesses collapsed. Achenbaum
reports:
"Forty-five
plans, covering one hundred
thousand
employees,
were
discontinued
between
1929 and 1932; other plans, lacking an adequate fiscal base, curtailed
benefits. ''_s In this environment,
a host
of proposals
for supporting
the aged were put forth.
Arizona enacted the first publicly supported
old-age assistance
bill
in the United States in 1915, but that bill was later declared unconstitutional.
By the end of 1928, six states had established
old-age
assistance
programs
that counties within the states could adopt if
they so chose. These programs provided benefits to slightly more than
1,000 people over sixty-five years of age in 1928. By the end of 1934,
twenty-eight
states had established
old-age assistance programs.
Many
of the programs
became mandatory
for all counties within the states
that established
programs
after 1929. Bv the end of 1934, nearly
250,000 people were benefiting
from these old-age assistance
programs. 16
High unemployment
levels, particularly
among the elderly', led to
a couple of revolutionary
policy prescriptions.
Francis E. Townsend,
a retired
California
doctor, proposed
that every citizen over sixty
years of age who was not employed
be entitled
to receive $200 per
month on the condition
that the recipient
spend the benefit within
thirty days of its receipt. This proposal was aimed at simuhaneouslv
_4U.S. Bureau of the Census, Historical Statistics o['the U_zited States (Washington,
U.S. Government
Printing Office, 1975), p. 132, Serics D 29-41.
ISAchenbaum,
O/d Age i_z the New La_ld, p. 129.
16Committee
on Economic
Security,
Social Security m America, pp. 159-163.
D.C.:
13
providing
for the elderly and stimulating
the general economic
demand for goods and services. The program
was to be financed by a
2 percent sales tax on all transactions,
which most policy analysts at
the time estimated
to be grossly inadequate.
Also early in the Depression,
Senator Huey Long of Louisiana
was
beginning
a run for the presidency
with a campaign
based on the
policies he outlined in his book, Eve_. Man a King, published in 1933.
Among other things, he proposed free college educations
for everyone,
a homestead
worth $5,000 for every family, veterans'
bonuses, and
old-age pensions for the elderly with less than $10,000 in cash.
During Franklin D. Roosevelt's
first year in office, more than onequarter of the U.S. work force and more than one-third of the nonfarm
workers were jobless. The Townsend
plan was gathering
widespread
support and the Democratic
party was concerned
that Senator Long's
campaign
could garner enough votes to result in the election of a
Republican
president
in 1936. In this context FDR proposed a program to assure the economic
security
of the United States and its
population.
On June 8, 1934, the president sent a message to Congress indicating
his desire to establish
a long-range,
contributory
social insurance
program. He opposed financing this system through general revenues
on two grounds: (1) he believed a contributory
system would be more
fiscally secure, and possibly more important;
(2) he felt that personal
contributions
to the system would build in a political safeguard,
because the benefits would be perceived as an earned right, t7
Development
of the Social
On June 29, 1934, President
Security
Act
Roosevelt
issued
Executive
Order
6757
which established
a Committee
on Economic
Security to study the
problems
related to the economic security of individuals
and to develop recommendations
to promote greater economic
security. The
Committee
consisted
of the Secretary of Labor as chairman,
the Secretary of Treasury,
the Attorney General, the Secretary of Agriculture,
and the Federal Emergency
Relief Administrator.
The committee
was
to report its recommendations
to the president
by December
1, 1934.
In addition
to establishing
the committee,
President
Roosevelt's
executive order also created an Advisory Council on Economic Security,
a Technical
Board on Economic
Security,
and a staff to assist the
17Arthur J. Altmeyer,
The Formative
Wisconsin
Press, 1968), pp. 10-11.
14
Years ofSocial
Security
(Madison:
University
of
Committee
on Economic
Security.
Edwin E. Witte was selected as
executive
director of the staff on July 24, 1934. The staff was to work
under the immediate
direction
of the executive
director
but at the
general direction of the technical
board, which was composed
of people then in government
service designated
by the committee.
Arthur
J. Altmeyer was appointed
chairman
of the technical
board. The advisory council, which was made up of people outside the federal bureaucracy,
was initially
to include fifteen representatives:
five each
from business, the labor movement,
and the general population.
Because of various
special interest
additions,
the council ultimatelv
included
twentv-three
members.
The Committee
on Economic
Security concentrated
on major policy issues, resolving questions
in accordance
with the president's
policy positions. I_ The technical
board was to help the staff develop a
concrete program
while apprising
committee
members
of the issues
important
to their policy deliberations.
The advisory council was not
to make a formal report but rather to advise the committee
of the
views of interested
outside groups and individuals.
The advisory council did submit a final report that included several
recommendations
somewhat
different
from the final recommendations of the committee
itself. Dr. Witte's diary of the proceedings
of
these various
groups suggests that the advisory
council had little
influence
on the deliberations
by the committee
or on the development of the ultimate
proposal. 19 The major players then were the
president,
his Cabinet-level
committee,
their designees
as technical
advisers, and the staff that Dr. Witte organized.
On Januarv
17, 1935, the president
transmitted
a message to both
the House of Representatives
and the Senate recommending
legislation on economic
security. 2° At the same time he transmitted
the
report of the Committee
on Economic
Security
that provided
the
analytical
basis for the various titles in the act. On Januarv
21 and
22, the House Ways and Means Committee
and the Senate Finance
Committee
began hearings
on the proposed
legislation.
According
to Witte, both committees
focused on the o/d-age assistance (title I) provisions in the act. In the Ways and Means Committee,
the old-age insurance
(title II) provisions
provided
the most contro-
_The intended
functions
of the various bodies have been described
in ibid., p. 8.
I_Edwin E. Wittc, The Developme_zt of the Social Security Act (Madison:
University
of
Wisconsin
Press, 1963), p. 63.
2°Ibid. The discussion
of the legislative
consideration
of the act is based on Witte's
diarvaccount,
pp. 75 108.
15
versy, and were nearly stricken at one point. Ultimately,
the House
committee
completely
redrafted
the legislation,
making several substantive changes in the provisions.
The committee
also changed the
title of the legislation
from the "Economic
Security Act" to the "Social Security Act." The committee
favorably
reported out the bill on
April 5, and the House began debate on April 11. Roughly fifty amendments were offered to the bill but none passed. On April 19, 1935, the
House passed the Social Security Act by a vote of 371 to 33.
The legislation's
opponents concentrated
their strongest opposition
on the Senate Finance Committee.
Witte suggests that it was the
adroit management
of the committee
chairman,
Senator Pat Harrison
of Mississippi,
that salvaged title II, the old-age insurance
provision,
in the bill. The real fight in the Senate Finance Committee
was over
the Clark amendment,
which would have exempted
employers
with
pension programs
from participation
in the old-age insurance
program. In committee,
this amendment
was defeated on a tie vote. On
May 20, the Senate Finance Committee
filed a report in favor of the
legislation.
Debate on the bill in the Senate began on June 14. When the Clark
amendment
was reintroduced
on the Senate floor, it became the subject of extended
acrimonious
debate. On June 19 the amendment
was
finally adopted
by a vote of 51 to 32, and the Senate then approved
the legislation
77 to 6.
The Conference
Committee
did not begin deliberations
until the
end of June. All differences
in the two legislative
versions, with the
exception
of the Clark amendment,
were reconciled
by July 16. The
conferees
reported
back to their respective
bodies recommending
adoption of agreed-upon
facets of the bill and seeking further instruction on the Clark amendment.
On July 17, both the Senate and House
accepted
this conference
report but the chambers
instructed
their
respective
conferees
to hold firm to their different positions on the
Clark amendment.
The Conference
Committee
set about having the amendment
redrafted. After several weeks, the legislative
drafters
indicated
to the
committee
that their work would extend beyond the end of the legislative session. The conferees
then recommended
that the Social
Security Act be adopted without the Clark amendment,
with the understanding
that a joint committee
be formed to develop such legislation for the next session of Congress. The conference
report was
accepted
by the House on August 8 and by the Senate on August 9.
The Social Security Act became law on August 14, 1935, when President Roosevelt signed it.
16
The
Provisions
of the Social
Security
Act
The Social Security Act passed in 1935 was basically a retirement
annuity program.
Coverage was mandated
for private-sector
wageearning and salaried workers under age sixty-five engaged in commerce or industry, with the exception of railroad employees.
In 1937
this group of covered workers included roughly 58 percent of all paid
employment
in the United States. The program was to be financed
by a payroll tax, shared equally by employers and employees, initially
set at 1 percent on the first $3,000 of covered annual earnings. Tax
collections
began in 1937; the first benefits were scheduled
for January 1942. Benefits were to be paid to retired workers on the basis
of cumulative
earnings credits, and were to be weighted to favor lowincome earners. Contributors
who died before receiving a benefit were
to have their contributions
plus an allowance
for interest returned
to their estates.
The Social Security Act was substantially
modified before the first
retirement
benefit was paid. In 1939 the first amendments
to the act:
(1) expanded
Social Security's
retirement
provisions to include benefits for dependents
of retirees and survivors
of active workers and
retirees; (2) eliminated
the provision for contribution
rebates and the
age restriction
for participation;
(3) significantly
altered the benefit
computation
formula; and (4)provided
for the first benefits to be
payable in January 1940. The 1939 amendments
were the precursors
of many additional changes to Social Security. The institutional
role
that the Social Security Administration
has played and the political
process involved in the development
of Social Security policy have
been discussed at length in a Brookings study by Martha Derthick. 21
Another study, bv Robert J. Myers, provides
a comprehensive
description of the actual changes to the program over the years. 22 While
it is unnecessary
to repeat those analyses here, it is important
to
understand
the effects of the changes on the program and its participants over time. The following sections discuss the evolution of Social Security coverage, retirement
age provisions,
benefit structure,
and financing provisions of the program.
Social Security
tee on Economic
Coverage--The
proposal developed by the CommitSecurity limited the scope of coverage for various
21Martha Derthick, Polic_vmaki_lg [or Social Security (Washington,
D.C.: The Brookings
Institution,
1979).
22Robert J. Myers, Social Security, 2nd ed. (Homewood,
Ill.: Richard D. Irwin, Inc.,
1981).
17
practical
reasons. Self-employed
people were excluded because they
were assumed
to earn no wage or salary and because including them
would have complicated
administration
of the program.
State and
local workers were excluded because of constitutional
limitations
on
federal taxing power. Federal employees and railroad workers 23 were
already largely covered under other federal retirement
programs
and
thus were also excluded. Farm laborers, domestic servants, and other
widely dispersed
workers were not included
for administrative
reasons. Finally, the tax exemption
provided to religious and charitable
organizations
was deeply imbedded
in tradition;
therefore,
Social
Security coverage
was not extended
to employers
in the nonprofit
sector primarily
because of constitutional
considerations.
Once the Social Security Act had been enacted, there was consistent
pressure to expand coverage under the program. Social Security coverage was first expanded
in 1939 when workers above the age of sixtyfive were covered. In 1950, the program
was expanded
to include
regularly employed and domestic workers; federal civilian employees
not covered by the federal retirement
program;
Americans employed
outside
the United States; and nonfarm,
nonprofessional,
self-employed people. In 1954, self-employed
farmers and professionals,
except lawyers, dentists, and medical professionals,
were included.
In
1956 the military
and the remaining
self-employed
people, except
physicians,
were included. In 1960, Americans
employed
by foreign
governments
or international
organizations
and parents working for
their children were included. In 1965 interns and self-employed
physicians were included and tip income for the employee tax only was
covered. Finally, in 1967 ministers
and members
of religious orders
not under the vow of poverty, who had been able to elect coverage
on a voluntary
basis beginning
in 1956, were included
unless they
claimed a conscientious
exemption.
In addition
to mandating
expansion
of coverage to the group just
described,
the government
has offered several groups the option of
becoming
covered voluntarily
over the years. In 1950, employees
in
nonprofit
organizations
and state and local employees
not covered
by a retirement
system were extended
coverage on an optional basis
at the election of the employer.
In 1954, state and local employees,
except policemen
and firefighters,
could be covered by Social Security
even if they were already covered by a pension plan; such coverage
was available
if both employers
and employees
elected it. In 1956,
23Actually railroad workers were included for a short period until the Railroad Retirement Act was enacted on August 29, 1935.
18
optional
coverage was extended
to all police and firefighters
under
a retirement
plan in selected states; in 1967 optional coverage was
extended
to all firefighters.
There were various other optional
provisions for individuals
in religious
professions
and orders in 1954,
1965, 1967, 1972, and 1977.
Today, slightly more than 90 percent of the nation's workers have
Social Security coverage. Of those now covered, roughly 2.5 million
are federal civilian workers, about 3 million are state and local government
workers, and about 500,000 to 1 million are employed
bv
nonprofit organizations.
Most public employees
not covered bv Social
Security participate
in retirement
programs
sponsored
by their employers, but nonprofit workers not covered by Social Security are less
likely to be covered by private programs.
Other people without Social
Security coverage include quasi-workers
such as casual laborers who
do not earn enough in a year to meet the coverage criteria. Also some
conscientious
objectors,
such as the Amish, are not covered on the
basis of self-employment.
Retirement
A_e--Thc
recommendation
of the Committee
on Economic Security
and the 1935 Social Security Act provided
benefits
for workers retiring at age sixty-five. The committee
never articulated
its reasons for selecting
this age, although
it was a common
retirement age in private pension plans and foreign social security
programs.
For example,
Germany',
Great
Britain,
and Italy
had
contributory
programs
then in effect that paid benefits to people aged
sixty-five or over. The staff analvsts for the Committee
on Economic
Security who developed
the Social Security Act in 1935 argued that,
as workers grow older, they became less and less able to maintain
sufficient
earnings
to sustain themselves.
Thev showed that unemployment
stemming
from the Great Depression
was higher among
workers over age forty-five
and increased
with age. Their analysis,
however, does not provide any svstematic
rationale
for selecting age
sixty-five. In fact, at the time of the passage of the Social Security
Act the federal civil service retirement
age for most classes of employees was seventy, 24 although
civil servants
with thirty years of
service could retire at age sixty-eight.
There were also special classes
of workers who could retire at age sixty-five or sixty-two.
While there appears to be no gerontological,
physiological,
or other
basis for settling upon age sixty-five, all of the initial published
actuarial cost estimates
for the proposed system assumed that the pro24Committee
on Economic
Security,
Social
Security
i_t America,
p. 179.
19
gram would provide retirement
benefits at that age. Over the years,
the retirement
age in many public retirement
programs
has been
reduced;
this process dates back to 1916 when Germany
reduced its
retirement
age from seventy
to sixty-five.
In 1956 the U.S. Social
Security
retirement
age for women was reduced
to age sixty-two,
primarily
on the basis that wives were, on average, three years younger than their husbands.
The extension of this early retirement
"privilege" to men in 1961 was justified on the basis of unemployment
in
the short term.
Early retirements
under Social Security are coupled with benefit
reductions
at a rate of five-ninths of 1 percent for each month or 6.67
percent for each year short of attaining
age sixty-five. During 1981,
to discourage
early retirement
and save money when it occurred, the
Reagan administration
proposed reducing
early retirement
benefits
at age sixty-two from 80 to 55 percent of the full benefit payable at
age sixty-five. The proposed
reduction
in early retirement
benefits
which was to have taken effect in 1982 was widely criticized
because
it allowed too little time for workers to adjust their retirement
planning. Congress never seriously considered
the proposal.
The Benefit Structure--One
of the most complicated
elements of the
Social Security program over the years has been its benefit structure.
From the outset, policymakers
have attempted
to balance countervailing goals. In its statement
of basic principles
on the design of
Social Security,
the Committee
on Economic
Security held that benefits should bear a "definite relationship
to the previous earnings
of
the beneficiary. ''25 They attempted
to find a set of factors that would
determine
the proper and feasible relationship
of benefits and earnings.
The first factor related
to the start-up
problem.
The committee
believed that although it was socially desirable for benefits eventually
to approximate
50 percent of previous earnings,
it was fiscally impossible to meet that goal during the early years of the system. The
committee
recommended
that benefits should rise gradually
over a
generation
to correspond
with the duration of covered employment.
As a counterweight
to their basic principle that benefits be related
to earnings,
the committee
stated that benefits must be of sufficient
magnitude
to "prove a considerable
item of income to the recipient
and to warrant
the administrative
costs of distribution.
''26 Hence the
2Slbid., p. 202.
2¢'lbid.
20
committee
concluded
that no benefits should be paid for five years;
it would take longer than this for "earned"
benefits to meet the goal,
so the committee
recommended
that initial individual
benefits should
be not less than 15 percent of the beneficiary's
average wages.
The committee
also believed that benefits should be graduated
so
that low-wage earners and people who entered the system late in life
would receive proportionately
higher benefits. The committee
believed
that the goal of preventing
dependency
dictated
that benefits be adjusted to meet "the relative needs of various classes of beneficiaries
even though need is not a determinant
in the individual
case. ''27 To
enhance the redistributive
nature of the program,
the committee
recommended
that a maximum
wage-base
standard
should be established as the basis for benefits and contributions.
A fourth factor the committee
considered
in designing the benefit
structure
was the treatment
of persons who continued
to work beyond
the age at which they became eligible to retire. The committee
believed that benefit payments
to persons who continued
to work would
be a wage subsidy that would put younger workers at a disadvantage.
The committee
therefore recommended
that benefits to regularly employed individuals
be suspended
on the basis "that the social advantages of encouraging
retirement
at age 65 far outweighed
the objective
that individual
equities would be reduced when benefits were thus
suspended."28
Finally, because the original legislative
proposal included only retirement benefits, the committee
proposed lump-sum refunds for covered persons who died if their contributions
plus an interest allowance
exceeded
benefits. The refunds were to be paid to the estate of the
deceased.
If the person had received no benefit prior to death, total
contributions
plus the interest allowance
were to be refunded.
If the
person had received benefits, the refund was to be reduced by that
amount received.
The benefit provisions in the original Social Security Act paralleled
the recommendations
of the Committee
on Economic
Security,
but
there were some significant
differences.
The original bill provided
that benefits would be paid to persons with five years of coverage
under the act. Since tax collections
began in 1937, benefits would not
have been payable until 1942. The benefit formula enacted in 1935
applied to cumulative
creditable
wages; it provided proportionately
higher benefits to low-wage workers but would have increased
ben27Ibid.,
28Ibid.
p. 203.
21
efits, on average, for each successive cohort of retirees as the duration
of coverage increased.
The Committee
on Economic
Security
designed an annuity program aimed primarily
at lower-income
workers. The committee
recommended
that workers other than manual workers earning
more
than $250 per month be exempted
from paying taxes and excluded
from credit for benefits
for such years. The committee's
proposal
would not have provided
benefits "unless 200 weekly tax payments
had been made in his behalf within a 5-year period prior to his attaining age 65." To deal with low start-up
benefits, a minimum
benefit of 15 percent
of the worker's
average wage was proposed
for
workers entering
the system during its first five years. Subsequently,
the committee
recommended
paying relatively larger benefits for the
first $15 of a worker's average wages per month. 29
The proposed
weighting
of benefits toward people earning lower
wages would have made the program
income redistributional,
but
the proposed
exclusion
of white-collar
workers earning more than
$3,000 per year would have excluded
higher-salaried
workers from
participating
in the redistributional
aspects of the program. The Social Security legislation enacted in 1935 included all workers in covered employment
with the provision
that only the first $3,000 in
annual earnings
would be used in computing
benefits and determining tax liabilities.
This change made the program considerably
more
redistributive
than the original proposal would have because higherincome workers were included. Although this change was significant,
Witte indicates
it was made with relative ease:
The new benefit rates were still geared to average contributions of S per cent during an industrial lifetime, but a
new principle was introduced to give relatively larger benefits to workers receiving low wages. This idea had been
discussed favorably by the staff on old age security, but
never had been worked out. This revision of the benefit rates
was never seriously questioned by any member of either
congressional committee. 3°
Myers has described
the characteristics
of the benefit structure
established
in 1935 by showing the earnings
replacement
capacity of
the program. Table I-4 shows the replacement-rate
estimates
for various workers under that act, where the replacement
rate is the per-
2_Ibid., pp. 211-214.
3°Witte, Tile Development o[ ttle Social Security Act, p. 152.
22
centage
rep[aced
of annual
earnings
in the year
by the Social
Security
benefit.
argued
to the contrary,
from high- to low-wage
act.
prior
to retirement
that
Although
it is sometimes
the redistributive
workers
was firmly
is
nature
of Social
Security
established
in the original
The modifications
incorporated
in the 1939 amendments
significantly
altered
the redistributional
characteristics
of the program.
These amendments
maintained
the principle
that benefits
should
increase
on the basis of the number
of years
of coverage,
but the relationship
became
much
less pronounced
than it was in the original
act. First,
benefits
became
payable
in 1940 with only three
years of
coverage.
Second,
short-term
beneficiaries
received
higher
replacement of their earnings
than originally,
while long-term
replacement
rates
for single
workers
were reduced.
These changes
were accomplished
by moving
from a formula
that based
benefits
on lifetime,
cumulative,
covered
earnings
to one based on average
monthly
covered earnings.
TABLE
I-4
Replacement
Rates for Workers Retiring at Age 65 Under
the 1935 Social Security Act and 1939 Amendments
Earnings Level a
Low
(Percent)
Average
(Percent)
Maximum
(Percent)
1935 Social Security Act
Minimum
(5 years of coverage)
Maximum
30.0
73.0
20.0
58.0
10.0
34.0
1939 Ame_tdments
SingLe Worker
Minimum
(3 xears of coverage)
Maximum
41.2
57.2
28.9
40.0
16.5
22.9
1939 Amendme_zts
Worker with Dependent
Spouse
Minimum
(3 vears of coverage)
61.8
43.2
24.8
Maximum
85.8
60.0
34.4
Source: Robert J. Myers, "History of Replacement Rates for Various Amendments to
the Social Security Act,;' Memorandum no. 2 (Washington, D.C.: National
Commission on Social Security Reform, 1982), p. 3.
_The annual average earnings level is assumed to be $1,000 under the 193S act and
1939 amendments.
The actuarial projections at that time assumed wages would
remain stable. The low earnings level is approximately S0 percent of the average
level, and the maximum level is based on maximum taxab[e wages.
23
The redesign of the program
in 1939 further redistributed
benefits
through the provisions covering spouses. Under the modified program
a sixty-five-year-old
wife was entitled to 50 percent of her husband's
basic benefit; this change more than doubled the replacement
rates
for early retirees with spouses provided for in the original act. At the
same time the 1939 amendments
increased
the potential
long-term
benefits for those workers, as well. The 1939 amendments
also established
a new category of beneficiaries,
survivors. Finally, the lumpsum distributions
provided in the 1935 act were eliminated,
although
a small, residual
lump-sum
benefit justified
as a funeral
expense
allowance
was maintained.
The net effect of these provisions, as with
dependent
benefits, was to redistribute
benefits toward nonworkers.
The 1939 amendments
profoundly
changed
the goals of the program. Instead of being heavily weighted
toward equity (i.e., benefits
based on cumulative
wages) albeit income redistributive,
the program after 1939 included much broader protection
against hardship.
Over the years, debate has continued
over the relative weight that
the "equity"
and "adequacy"
goals of the program
should receive.
Early critics of the Social Security system argued that the adequacy
and equity components
should be separated.
This argument
led to
various proposals
to substitute
for Social Security a "double-decker"
system, under which a universal
"demogrant"
for all elderly persons
(i.e., the first deck) would have been supplemented
by a benefit proportional
to average covered earnings.
For people with no covered
earnings, the demogrant
would be the total benefit. Some proponents
of a modified
system argued that only the bottom deck should be
provided through government
transfer mechanisms;
employers could
provide the top tier of benefits through pension programs.
There were several arguments
in favor of the double-decker
system.
First, it was clear that early beneficiaries
under Social Security
received benefits on a highly gratuitous
basis. By 1950 only about 20
percent of all persons over age sixty-five were receiving benefits, and
critics argued that such selective subsidization
under a publicly supported program
was highly inequitable.
Furthermore,
critics said,
those receiving
the greatest
subsidy were the least needy to begin
with. Representative
(later Senator)
Carl T. Curtis of Nebraska
articulated
this criticism
in a dissent to legislative
amendments
to the
Social Security Act being considered
in 1949. He argued that benefit
differentials
between high- and low-wage workers could not be justified on the ground of individual
equity:
Primary insurance benefits which would be awarded in 1950
under the bill proposed here by the majority, for a worker
24
who has been steadily employed at an average of $250 a
month, are $16 a mont_a greater than the benefits for a worker
steadily employed at $100 a month. Yet, less than $2.47
differential in primary benefit amounts can be justified actuariallv bv the higher contributions of the $250-a-month
man. In other words, the higher-paid man has paid for $2.47
more in benefits but receives $16 more in benefits. 31
Proponents
of the double-decker
system argued that inclusion
of
all the elderly could be accomplished
quickly. Furthermore,
such
coverage would immediately
present the svstem and taxpayers
with
the cost of supporting
a full cohort of retirees and thus relieve some
of the pressures
to increase benefits under the partially
mature Social
Security system. Finally, unwarranted
redistribution
toward higherincome individuals
could be eliminated.
The Social Security
Board acknowledged
that Old-Age and Survivors Insurance
benefits would greatly exceed the value of contributions for early beneficiaries.
But, according
to Altmeyer, the board
feared that the uniform benefit under the double-decker
system would
be raised over time, and this would erode and eventually
destroy "the
rationality
of a contributory
social insurance
system under which
benefits, contributions,
and wage loss were interrelated.
''32
The pressure
for a double-decker
system was so intense that the
Social Security Board did develop a double-decker
proposal and President Roosevelt
himself, in a speech to the Teamsters
Union during
1940, seemed to support such a measure. 33 Although the debate over
this proposed
alternative
to Social Security
continued
throughout
the 1940s and beyond, it has never received sufficient support to have
been seriously
considered
in Congress. It did result in special "age
seventy-two"
benefits
that were payable
to men reaching
that age
before 1972, and to women reaching that age prior to 1970 who could
not otherwise
qualify for benefits.
Nonetheless,
the double-decker
option still receives serious consideration
and was advocated
by several members
of the 1979 Social Securitv Advisory Council. 34
The 1939 benefit formula increased benefits significantly
for workers with short periods of coverage by using average monthly
wages
as the computational
basis. Benefits also were to increase bv ! percent
for each year of coverage, thus maintaining
the linkage of benefits to
_Carl T. Curtis, "Additional Minority Views," Social Secm'ity Act Ame_Mme_ltso/1949
(Washington, D.C.: U.S. House ot-Representatives Report no. 1300, 1949), p. 176.
32Altmeyer,The Formati_,eYears ofSocial Secl_rit)',pp. 125-126.
3_Ibid., p. 126.
34Report of the 1979 Advisory Council on Social Security, Social SeczlriO"Fi_zanci_lg
a_ldBene/_ts (Washington, D.C., 1979), pp. 68-71.
25
duration
of coverage.
The 1950 amendments
further
benefits
to short-term
covered workers by eliminating
increments
related
to length of covered service and
exclusion of earnings before 1951 in computing average
The 1950 amendments
further raised benefits in the
the program
while simultaneously
reducing
benefits
the system fully matured
(see table I-5).
TABLE
redistributed
the benefit
permitted
the
monthly wage.
early years of
payable when
I-5
Replacement
Rates for Single Workers Retiring at
Age 65 Under Various Social Security Amendments
Earnings
1939
Amendment
Level a
Low
(Percent)
Average
(Percent)
Maximum
(Percent)
b
Minimum
Coverage
(3 years)
41.2
28.8
16.5
Maximum
Coverage
(43 years)
57.2
40.0
22.9
Subsequent
1950
Amendments
44.7
30.0
26.8
! 952
45.2
30.3
28.3
1954
47.5
34.0
31.0
i 958
46.7
34.2
3 ! .8
1965
44.2
33.5
30.5
1967
46.9
36.3
33.5
1969
51.7
40.3
38.6
! 971
1972
53.5
62.7
43.0
51.2
39.4
42.7
70.2
55.9
42.6
52.5
41.2
27.6
1975
1977
Source:
(present
law)"
Robert J. Myers, "History
of Replacement
Rates t0r Various Amendments
to
the Social Security
Act," Memorandum
no. 2 (Washington,
D.C.: National
Commission
on Social Security
Relorm,
1982), p. 3.
aThe average annual earnings level is assumed to be $1,000 [or the computations
under
the 1939 amendments
(because
wages were relatively
stable in the late 1930s), and
equal to average
earnings
in the economy
for subsequent
computations.
The low
earnings
level is approximately
50 percent of the average level, and the maximum
is
equal to the applicable
maximum
taxable
wage base.
bThe minimum
coverage
was 3 years ["or the 1939 amendment:
the length of coverage
for steady workers generally
has no effect on benefits under subsequent
amendments.
The maximum
coverage
was taken as forty-three
years (from age twenty-two
to age
sixty-five)
for the 1939 amendment
(actually,
forty-three
years was the maximum
creditable
under the maximum-earnings
case under the 1935 act).
"Ultimate
replacement
rates shown. Alternative
II-B assumptions
used in the 1981
OASDI Trustees
Report.
26
Subsequent
amendments,
particularly
those during the late 1960s
and the early 1970s, gradually
increased
benefits across the board.
By the mid-1970s,
Social Security
began to face serious financing
problems.
The 1977 amendments
substantially
reduced
benefits for
future beneficiaries,
but the effects of the 1977 act were delayed) s
Because of the way Social Security
was started, virtually
all beneficiaries
with normal life expectancy
at retirement
could expect to
get back more from the program
than they had paid in. Because of
benefit enhancements
over the years, this situation has persisted until
now, although
it is diminishing.
One way of showing this phenomenon is to compare
the value of contributions
at retirement
to the
value of expected
benefits. The value of contributions
is estimated
by accumulating
the value of contributions
workers make over their
lifetimes
plus interest they would have received if they had invested
the monies in their own behalf instead of paying
taxes to Social
Security.
The value of expected
benefits at retirement
can be similarly derived by determining
how long people can expect to live and receive
benefits, on the basis of detailed
studies of death rates among individuals at various ages. To estimate
the amount of lifetime benefits,
the annual benefit that will be paid during each year of the expected
lifetime must be calculated.
Benefits payable in future years have to
be discounted
because a dollar paid in the future will be worth less
than a dollar in hand. For example, investing ninety-one
cents today
at l0 percent interest will be worth one dollar a year from now. Stated
alternatively,
if interest rates are l0 percent, one dollar a year from
now is worth only ninety-one
cents today. Using life expectancy,
estimated annual benefits, and a discount factor, it is possible to estimate the present value of Social Security benefits at retirement.
Myers has described the technical considerations
in estimating
the
value of contributions
and benefits under Social Security. 36 He has
developed estimates
that show the value of contributions
and benefits
strictly related to the OASI program
for workers retiring at various
times. His calculations
assume that workers retire at age sixty-five.
He also assumes,
for the cases considered,
that the workers were
steadily
employed
between
1937 or their twenty-first
birthday,
whichever
is later, and age sixty-five without any periods of unem-
3SThe Social Security
financing
problem
is discussed
in chapter
llI.
X6Robert J. Myers, "Money's
Worth Comparison
for Social Security
Benefits,"
Memorandum
no. 45 (Washington,
D.C.: National
Commission
on Social Security
Reform,
August 12, 1982).
27
ployment.
Myers' analysis considers workers at two levels of earnings.
The first worker is assumed to have had "average"
covered earnings
during each year of employment.
For years prior to 1980, this average
earnings
level is based on empirical
data maintained
by the Social
Security
Administration.
For 1980 and beyond, earnings
were estimated
using Alternative
II-B assumptions
contained
in the 1982
Trustees
Report. The second worker is assumed
to have had maximum taxable earnings
in each year. For years prior to 1980, savings
are based on the historical
maximum
levels; for 1980 and beyond,
the calculations
arc based on the Alternative
II-B assumptions.
Myers makes separate calculations
for male and female single workers and for married
couples with one earner. His work indicates that
in the long term, two-earner
couples are better represented
in the
calculations
by combining
single-worker
cases than by using the oneearner married-couple
example.
His analysis assumes that there are
no children
who receive benefits in any of the examples.
Myers' analysis for future retirees is based on current law tax rates
and benefit computation
methods. His assumptions
for future growth
in wages and the Consumer
Price Index (CPI) are consistent
with the
Alternative
II-B assumptions
in the 1982 Trustees
Report. For purposes of calculating
the value of benefits at retirement,
Myers uses a
2 percent real (i.e., 2 percent in excess of inflation)
discount rate. To
value contributions,
he uses the average yearly interest rate on new
special-issue
investments
of the trust funds for 1951 to 1981. For 1937
to 1950 he uses an assumed interest rate of 2.25 percent; beyond 1981,
he uses the Alternative
II-B assumptions
from the 1982 Trustees Report.
Table I-6 shows the results of Myers' analysis
and compares
the
cumulative
value of combined
employer and employee contributions
for earnings
throughout
the careers of workers to the present value
of benefits for persons retiring
in selected years. The top section of
the table shows the results for workers earning
the average wage,
while the lower section shows the results for workers earning
the
maximum
covered earnings.
The table shows that the ratio of benefits to total taxes paid for
full-career
workers has been declining
for workers at both earnings
levels--and
that ratio will continue to decline because of the nature
of the program.
The workers retiring
at age sixty-five in 1960 were
forty-two years old in 1937 when tax collections started. These people
paid no taxes for twenty years of their careers, and they paid very
low taxes throughout
most of the remaining
years.
28
The table also indicates
that workers
with different
characteristics
have fared and will continue
to fare quite differently
on a benefit-tocontribution
basis. Virtually all analyses of this kind show that workers with normal life expectancy
who have retired under Social Security up to now could expect benefits exceeding
the value of their
contributions.
Myers notes in his analysis, however,
that the present
value of benefits as a percentage
of contributions
shown in table I-6
is probably
too high for future retirees under OASI. Cost projections
for the OASI indicate that if Social Security's
current cost-financing
basis is to be maintained,
future tax rates will have to be raised or
benefits lowered, or both. Either change will lower the value of benefits in relation
to contributions.
The maturing
of Social Securitv
has raised questions
about the
redistributive
nature of the program
and the competing
adequacy
and equity goals. Because even high-wage workers up until the present could expect to receive more in Social Security benefits than the
value of the total taxes paid on their earnings, there has been a peaceful coexistence
of the countervailing
goals of adequacy
and equity.
Balancing
these goals in the future may be more difficult because
many current
workers will receive less than their "money's
worth"
from Social Sccuritv
if the combined
employer-employee
taxes are
considered.
It is argued that in order for Social Security to be a "good
buy" (i.e., equitable)
for workers, they should expect benefits roughly
equal to their contributions.
If "their contributions"
are interpreted
to include their employers'
contribution,
this is virtually impossible
to accomplish
in a program
that strives to accomplish
income redistribution
(i.e., adequacy).
The nature of this problem is reflected most clearly in the part of
table I-6 that relates to maximum-wage
earners. For the high-income,
single male worker, OASI, as now structured,
will provide less than
a full return as of the end of this century.
For the single female, this
situation
will occur somewhat
later because women, on average, live
longer than men and thus have higher expected
lifetime
benefits.
Changes to the program
could cause this less-than-full-return
phenomenon
to occur sooner and to filter further down the income spectrum.
This characteristic
of Social Security has given rise to various criticisms of the benefit structure,
and several modifications
to the system have been proposed. Some critics of the system support the concept
that the program should give low-income workers more in proportion
to their earnings
than it gives high-wage workers, but they are critical
of what Professor
Laurence
Kotlikoff of Yale University
calls the
29
_-_
_
_
-
_
"_
3O
°_
_
31
"capricious
redistribution
of economic resources among individuals
in the same income class. ''37 Kotlikoff points out that "under
the
current system two families making the same contributions
to Social
Security
may expect to receive dramatically
different benefits, and
two families that expect to receive the same benefits may make radically different contributions.
''3_
To a certain extent this phenomenon
can be demonstrated
by comparing the single average-wage
earner in the top section of table I-6
with the one-earner,
high-wage
married couple in the lower section
of the table. Consistently
the one-earner,
high-wage
couple has received and can expect to receive a better return from Social Security
than is the case for the unmarried
single worker with only average
earnings.
The question
that some Social Security
analysts
raise is
whether this type of redistribution
is socially desirable.
Some critics
even question the desirability
of any income redistribution
at all in
a work-related
retirement
program.
These latter critics argue that
such redistributions
could be carried out more equitably
and efficiently through
a means-tested
transfer program
supported
by the
general income tax system.
These criticisms
could change the public's perspective
and undermine the overall popularity
of Social Security. Thus far the program
has been tremendously
popular in America because people have perceived that they are getting a fair return on their contributions.
In
fact, retirees until now have received a much better return on their
payroll tax contributions
than they could have gotten from almost
any alternative
investment.
To argue that current beneficiaries
have
"paid for" their benefits is correct in a statutory
sense but not in
economic
terms.
The economics
of Social Security is changing, however, because of
the interaction
of the benefit structure
and its maturity
relative to
its financing
provisions.
The evolution of the financing provisions
is
discussed in the following section. The discussion will follow the time
path presented
in this section on the description
of the benefit structure; that is, it begins with the financing
structure
developed
at the
conception
of the program
and describes its subsequent
evolution.
_TLaurence J. Kotlikoff, "Personal Security Accounts: A Program ot Social Security
Ret0rm" (Cambridge, Mass.: National Bureau of Economic Research, 1982),p. 2.
_SIbid.
32
Financing
Social
Security
The Committee
on Economic
Security
also developed
the basic
financing structure
of Social Security, considering
various potential
sources of revenue. The committee
decided that even with sharply
higher tax rates, personal income taxes would be insufficient to meet
the program's
funding requirements.
Corporate
income taxes and
inheritance
taxes were dismissed
for the same reasons. Sales-tax financing was not proposed because the committee feared the potential
fiscal and economic effects and worried about the incidence of such
taxes.
President
Roosevelt
himself had very strong ideas about the financing of Social Security. He wanted the system to be contributory,
partly because he thought that design was economically
sound, but
also because it provided
political insurance
for the program:
I guess you are right on the economics, but those taxes were
never a problem of economics. They are politics all the way
through. We put those payroll contributions there so as to
give the contributors a legal, moral, and political right to
collect their pensions .... With those taxes in there, no damn
politician can ever scrap my Social Security program. 39
The Committee
on Economic
Security
responded
with a financing
proposal that called for taxes on a percentage
of employees'
earnings,
taxes on a percentage
of employers'
payrolls, and "subsidies
from the
Federal Government
financed through taxes not borne by workers. ''4°
The rationale
for the employee
tax was that benefits
would be
provided
as a "matter
of right without a test of means."
To obtain
this "virtual
equity,"
the committee
believed
that workers had to
share the burden of making it possible. To avoid disproportionate
hardship
on workers earning lower wages, a proportionate
formula
was selected in lieu of a fiat tax. Since the benefit design was redistributive,
the committee
did not feel a progressive
tax structure
was
called for.
The committee
also reasoned that "Just as industry,
generally, has
become accustomed
to meeting charges for the depreciation
and replacement
of its material equipment,
many employers
have developed programs
for the payment
of retirement
allowances
for their
39Arthur M. Schlesinger,
Jr., The Age ofRoosevelt,
vol. 2, The Coming of the New Deal
(Boston, Mass.: Houghton
Mifflin Co., 1959), pp. 309-310.
_°Committee
on Economic
Security,
Social Security m America, p. 204.
33
superannuated
workers. TM They believed that such costs were related
to production,
and that employers
should contribute
to the social
insurance
program
designed
to protect
their workers.
To assure a
direct relationship
between the labor services provided
to the employer and the cost of Social Security,
the committee
recommended
a tax on earnings covered by the system, to be computed
on the same
basis and at the same rate as employee
contributions.
To minimize
the initial shock, the committee
recommended
that
the initial tax rate be set at 1 percent (0.5 percent each on employee
and employer)
and that the joint contribution
rate should be raised
by one percentage
point at five-year intervals until a maximum
combined rate of 5 percent was reached. The .joint 5 percent payroll tax
would meet the system's
cost for twenty-five
years; the committee
proposed
that the financing
deficits that would arise beyond that
time should be subsidized
by "the Government."
The committee
reasoned that as Social Security
matured,
the federal budgetary
costs
of old-age assistance
would decline. They believed that the savings
in federal costs that resulted from an expanding
Social Security program should not be realized at the expense of Social Security participants,
but that the old-age
retirement
program
should
be
subsidized. 42 This subsidy was projected
to reach 67 percent of combined employer
and employee contributions
by the time the program
fully matured
in 1980.
When President
Roosevelt discovered
that after 1965 a large deficit
would develop in the proposed
program
because benefits would exceed employer
and employee taxes, he insisted that the proposal developed by the committee
be changed.
But the committee's
report
had already been distributed
to Congress and the press by the time
FDR made his discovery.
Rather than reworking
the financing
proposal that was in the original bill, the committee
modified its report
to indicate
that general revenue financing
was merely one means of
dealing with the deficits that would result as the program matured. 43
During the legislative
development
of the act, the financing schedule was amended
to include an initial payroll tax of 1 percent each
on employers
and employees,
with scheduled
increases of 0.5 percent
on each (1 percent combined)
every three years. The tax rate was
scheduled
to increase
to a combined
rate of 6 percent
in 1949 and
411bid.,p. 205.
421bid.,pp. 206-207.
4_Witte, I'he Development o[ the Social Security Act, p. 74.
34
remain level thereafter.
This revised schedule
of tax collections,
it
was thought,
would make the program
completely
self-supporting
until at least 1980. It was also understood
that this financing mechanism, which was included
in the Social Security Act, would result
in establishment
of a large trust fund during the early years of the
program, and with positive balances in the trust fund persisting through
1980 and beyond.
The Committee
on Economic
Security had proposed
the development of a trust fund to assure the availability
of resources
to meet
benefit payments.
The committee
believed
that such a fund could
help to meet gradual changes that would affect the program
such as
declining
retirement
ages, increasing
wages, and variations
in mortality rates. The committee
also thought that in the event of a depression, a trust fund might mitigate
the effects of accelerating
benefit
claims. Under the committee's
original financing
proposal the trust
fund was expected
to accumulate
to roughly $15 billion by 1960. 44
Under the modifications
made in the Social Security Act, it was expected to grow to three times this magnitude.
During
the early days of the program,
many policymakers
expressed various concerns about the projected
magnitude
of the trust
fund. One concern was that the accumulation
of such a large trust
fund would rcsuh in politically motivated benefit increases that would
sharply incrcasc
the program's
cost in the long run. A second set of
concerns focused on the central government's
control of such a large
pool of assets. Senator
Arthur Vandenberg
argued, "It is scarcely
conceivable
that rational men should propose such an unmanageable
accumulation
of funds in one place in a democracy. ''45 The third set
of concerns related to the fiscal implications
of a government
program
in which tax collections
would exceed benefit disbursements
for such
a sustained
period.
Arthur Altmeyer believed that the trust funds should be allowed to
accumulate
to help defray the long-term
cost of the program.
He
argued that "if there were no reserve to earn interest and no government subsidy in lieu of interest,
the schedule
of contribution
rates
would have to be raised, so that the eventual
combined
employeremployee
contribution
rate in 1980 would have to be 10 percent instead of 6 percent. ''46 He also thought that the accumulation
of the
trust fund would provide a better perspective
on the long-term
cost
44Committee
4SAltmeyer,
_01bid.
on Economic
The Formative
Security,
Social Security i_zAmerica,
Years ofSocial
Security, p. 89.
p. 212.
35
of the system
and benefits.
and an appreciation
of the relationship
between
costs
In the short term, the 1939 amendments
resolved the concerns over
trust fund growth. As was discussed
previously,
benefit payments
were moved up two years, to begin in 1940, and heavily weighted
to
the advantage
of early retirees. At the same time, the increase in the
payroll tax scheduled
for January
1, 1940, was delayed; the tax had
been scheduled
to rise at that time to 1.5 percent in the first of four
increments.
The 1939 amendments
did retain the 1943, 1946, and
1949 scheduled
increases
to 2.0, 2.5, and 3.0 percent, respectively.
Throughout
the 1940s Congress continued
to defer tax increases
under Social Security, and the method of financing
continued
to be
debated.
While FDR had come down strongly in favor of a system
that paid for itself, the 1937-1939 Advisory Council had argued for
partial financing
from general revenues. During the 1940s the Social
Security Board also advocated
federal subsidies for the program
and
the 1947-1948 Advisory Council again forwarded
the recommendation. The benefit
increases
incorporated
finally brought the financing issue to a head. As Derthick notes, Congress came down firmly on the side of a self-supporting
program
in
which benefits were clearly tied to payroll collections:
This link made taxes easier to raise because the public could
see that it would get something for its money. The link also
disciplined the demand for benefits, because congressmen
in general and their constituents could be admonished that
they must pay the costs, and this in turn relieved the committees of the need either to raise general revenues for the
program, a relatively unpopular course, or to accept responsibility for increases in the national debt. Perceiving
these advantages at an early stage of the program's development, the committee committed themselves unequivocally to the payroll tax. 47
The 1950 amendments
modified the future payroll tax schedule on
both employers
and workers and increased
the level of maximum
taxable
earnings
from $3,000 to $3,600 per year. When the 1950
amendments
were passed, the tax rate was scheduled
to rise to 2.0
percent
in 1954, 2.5 percent
in 1960, 3.0 percent in 1965, and 3.25
percent
in 1970. Since the passage of the 1950 amendments,
there
47Derthick, Policymaking [br Social Security, p. 239.
36
has been no fundamental
change to the financing for Social Security.
The actual increases
in tax rates and those currently
scheduled
for
the future are shown in table I-7. These data show a consistent
increase in Social Security costs as the program
has matured.
Part of
that increase is attributable
to the addition of disabilitv
and hospital
benefits. The actual OASI contribution
rates of 4.5 percent in 1980
w;ere not far off the rates predicted
bv the Social Security actuaries
in 1935 when the first projections
were made. 4s
Growth
of the
Social
Security
Program
Although
the basic benefit and financing structure
of Social Security was established
during the early years of the program,
the
system has not been static. Moreover, although the program has bad
its critics over the years, it has also been one of the most popular
public endeavors
ever undertaken
in this country. Since 1940 Social
Security has expanded to touch nearly every element of society.
Figure I-l traces the growth of civilian employment
in this country
and the corresponding
covered employment
under Social Security.
Initially the program covered slightly less than 60 percent of all workers. The gap between
total and covered employment
narrowed
considerablv
following enactment
of the 1950 and 1954 amendments.
Since the late 1950s there have been no major changes
in Social
Security's
coverage provisions,
and covered employment
has continued to closely parallel total civilian employment.
Figure I-2 shows the percentage
of workers covered by Social Security and the percentage
of the U.S. population
over age sixty-five
receiving
benefits. This picture of Social Security's
development
is
important
in several respects.
First, it clarifies the criticism
of the
early program
that heavily subsidized
benefits were being provided
to only a small segment of the elderly. In 1950, less than 20 percent
of people over age sixtv-five were receiving
Social Securitv.
As the
program
has matured,
nearly all old people are receiving
benefits.
Although the program's
inherent redistributive
features are still criticized, the redistribution
takes place on an economic rather than class
basis.
4_Robert J. Myers, "Actual Costs of the Social Security
System Over the Years Compared with 1935 Estimates,"
Social Security Bulleti_t,'vo(.
45, no. 3 (March 1982), pp.
13-15.
37
TABLE
I-7
Annual Maximum Taxable Earnings and Contribution
Rates Under the Social Security Act and Amendments
Employer
Year
Beginning
Annual Maximum
Taxable Earnings
1937
1950
1951
1954
1955
1957
1959
1960
1962
1963
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983_1984 J
1985 _
1986-1989 _
1990 and beyond _
$ 3,000
3,000
3,600
3,600
4,200
4,200
4,800
4,800
4,800
4,800
6,600
6,600
7,800
7,800
7,800
7,800
9,000
10,800
13,200
14,100
15,300
16,500
17,700
22,900
25,900
29,700
32,400
_b_
Ib_
_b)
lh_
Total
OASI
1.000
1.500
1.500
2.000
2.000
2.250
2.500
3.000
3.125
3.625
4.200
4.400
4.400
4.800
4.800
5.200
5.200
5.850
5.850
5.850
5.850
5.850
6.050
6.130
6.130
6.650
6.700
6.700
7.050
7.150
7.650
1.000
1.500
1.500
2.000
2.000
2.000
2.250
2.750
2.875
3.375
3.500
3.550
3.325
3.725
3.650
4.050
4.050
4.300
4.375
4.375
4.375
4.375
4.275
4.330
4.520
4.700
4.575
4.575
4.750
4.750
5.100
and Employee
(Each)
DI
0.250
0.250
0.250
0.250
0.250
0.350
0.350
0.475
0.475
0.550
0.550
0.550
0.550
0.575
0.575
0.575
0.575
0.775
0.750
0.560
0.650
0.825
0.825
0.950
0.950
1.100
Tax Rates
HI
0.35
0.50
0.60
0.60
0.60
0.60
0.60
1.O0
0.90
0.90
0.90
0.90
1.00
1.05
1.05
1.30
1.30
1.30
1.35
1.45
1.45
Source: Social Security Btdletbz: Ammal Statistical Supplement, 1980 (Washington,
Social Security Administration,
1982), p. 35.
_'Currently scheduled tax rates in existing law.
bSubject to automatic increase with growth in average wages.
38
D.C.:
FIGURE
I-1
Total Civilian Employment and
Workers Covered by Social Security
Millions
100
/
Civilian
Workers
Covered
Workers
/
80............
60-
_...
...._
SF
/
._..°._.-
40
/
/
•
,,
.-'-.•
!
/
2O
1940
Source:
I
1945
I
1950
I
1955
I
I
I
I
1960
1965
1970
1975
1980
Year
Data for 1940-1970 period, from U .S. Bureau of the Census, HistoricalStatistics
o[the United States (Washington, D.C., 1975), p. 348; for 1971-72, from U.S.
Bureau of the Census, Statistical Abstract o[ the United States 1079 (Washington, D.C., 1980), p. 331; for 1973-79, fi'om U.S. Bureau of the Census, Statistical
Abstract o[ the United States 1981 (Washington, D.C., 1982), p. 326.
A second
and more important
point illustrated
in figure
I-2 is the
relationship
between
the percentage
of workers
covered
and the percentage
of beneficiaries
over time. The Old-Age
Insurance
system
is
a work-related
retirement
program.
Because
benefits
are tied to earnings and contributions,
albeit
not directly,
it takes time for succeeding
waves
of covered
retirees
to make up a dominant
share of all elderly.
Coverage
can be expanded
very quickly
in a retirement
system,
but
it is only the gradual
aging of covered
workers
that can raise the rates
of receipt
of benefits.
Another
way to show
the maturing
of Social
Security
is through
the direct
relationship
between
workers
and beneficiaries,
in other
39
FIGURE
I-2
Workers
Covered
by Social Security
and
Persons
Over 65 Receiving
Social Security
Percent
100
60.
80
_
s j'S"
. o.. _..y,f
....
"-
s#
40
/"
sS
8S
iI
so °
20,
/
ooo
o"
940
Source:
............
I
I
I
1945
1950
1955
I
Percent
Percent
I
of Workers Covered
Over 65 Benefiting
I
I
1960
1905
1970
1975
Year
Coverage data for 1940-1970, from U.S. Bureau of the Census, Historical Statistics o[ the U_tited States (Washington, D.C., 1975), p. 348; for 1971-1979,
from U.S. Bureau of the Census, Statistical Abstract ol the U_tited States 1979
(Washington, D.C., 1980), p. 331; for 1973-1979, from U.S. Bureau of the Census, Statistical Abstract o[ the United States 1981 (Washington, D.C., 1982), p.
326. Beneficiary data t0r 1940-1969, [rum U.S. Bureau of the Census, Historical
Statistics o[the United States (Washington, D.C., 1975), p. 357; for 1970, from
Social Security Bulletin (March 1981 ), p. 73; [or 1971-74, from Social Security
Btdleti_l (December 1978), p. 75; for 1975-79, from Social Security Bulletiil
(March 1982), p. 66.
words,
the number
of workers
in covered
employment
for each person
receiving
a benefit,
which is often referred
to as the dependency
ratio.
Figure
I-3 shows
how the Old-Age,
Survivors,
and Disability
Insurance dependency
ratios
sharply
declined
and then leveled
off in the
1960s. This leveling
off at a very low ratio has important
implications
for the financing
of Social
Security
especially
as it relates
to benefit
increases.
Since Social
Security
is financed
on a pay-as-you-go
basis,
each dollar
in benefits
paid has to be spread
across
contributors.
For
40
FIGURE
I-3
Ratio of Workers Covered by
Social Security to Total Beneficiaries
Workers Per
Beneficiary
120
100
8O
60
40
2O
1940
Source:
1945
1950
1955
1960
Year
1965
1970
1975
1980
Coverage data t0r 1940-1970, _rom U.S. Bureau of the Census, Historical Statistics oi the Umted States (Washington, D.C., 1975), p. 348; for 1971-1979,
from U.S. Bureau of the Census, Statistical Abstract olthe United States 1979
(Washington, D.C., 1980), p. 331; for 1973-1979, from U.S. Bureau of the Census, Statistical Abstract o[ the U_zitedStales 1981 (Washington, D.C., 1982), p.
326. Beneficiary data f0r 1940-1969, from U.S. Bureau of the Census, Historical
Statistics o/ the United States (Washington, D.C., 1975), p. 357; for 1970, from
Social Security Bulleti_t (March 1981), p. 73; for 1971-74, from Social Security
Bulletin (December 1978), p. 75; lbr 1975-79, from Social Security Bulletin
(March 1982), p. 66.
example,
in the early
1940s there
were a hundred
or more workers
for each beneficiary.
In this period,
significant
benefit
increases
could
be provided
with relatively
small
effects on the taxpayers
supporting
the program.
In the early
1950s there were still ten workers
per beneficiary.
A onc-dollar
increase
in average
benefits
would
still have
cost workers
earning
the average
wage and their employers
together
an additional
dime in tax. Bv thc 1970s a much closer linkage
between
41
benefit increases and their financing
impacts was being felt. By the
end of the 1970s there were only 3.5 workers per beneficiary,
meaning
that an added dollar in benefits would cost average workers and their
cmployers
an additional
thirty cents in tax.
The growth in Social Security benefits over the years has improved
the economic
status of the program
beneficiaries.
Figure I-4 plots
average monthly benefits in 1980 dollars. The upper line shows the
average benefits paid to retired workers; the lower line reflects average benefits paid to all Social Security beneficiaries.
The declining
benefits during the 1940s show the effect that inflation had on stable
nominal benefits during that decade. While the 1940s could be characterized
as a decade of declining
benefits, the 1950s showed substantial
growth, with the most significant
increases
resulting
from
FIGURE I-4
Year
End Average
Monthly
Social
Security
Retired
Workers,
and All Beneficiaries
Benefits,
In 1980 Dollars
J
$300-
i
Retired Workers
............
All Beneficiaries
_"_'__,
/_-"'""
250.
I
200•.........
I"" .... '£"/
150
100
..o_a
1940
I
I
|
t
I
I
1945
1950
1955
1960
Year
1965
1970
i
1975
1980
Source: 1980 dollar adjustments calculated by the author based on data for 194070, from Social Security Bulletin Annual Statistical Supplement 1970, p. 89;
for 1971-1980, from Social Security Bulletin (June 1978),p. 43; and Social
Security Bulletin (February 1982),p. 50.
42
enactment
of the 1950 amendments.
In the 1950s average benefits
increased
by more than one-third
in real terms. Throughout
most of
the 1960s, the purchasing
power of average benefits remained
relatively constant.
At the end of 1960, retired workers' average benefits
(measured
in 1980 dollars) were just under $215 per month; at the
end of 1969 they were just under $226 per month. During the next
three years, ad hoc benefit increases of 15, 10, and 20 percent raised
average benefits for retired workers to nearly $320 per month by the
end of 1972. Benefits continued
to grow in real terms throughout
the
remainder
of the 1970s, although
not at the precipitous
rates of the
1970-1972 period.
Between
1950 and 1980, the proportion
of people over age sixtyfive who were receiving
benefits jumped
from less than 20 percent
to more than 90 percent.
During this period, benefits also became
Combined
Average
In 1980 Dollars
FIGURE I-5
OASDI
Taxes
Reported
Taxable
Paid
on
Earnings
$1,000
80(>
600
400,
2O0_
1940
I
1945
I
1950
I
1955
I
1960
I
1965
I
1970
!
1975
Year
Source: Calculated from data provided in Social Security Bulletin Annual Statistical
Supplement 1980, p. 35 and p. 88.
43
payable to persons retiring
at age sixty-two,
and disability
benefits
were added as well. At the same time the real value of average monthly
benefits for retirees rose more than 125 percent, and the real value
for all beneficiaries
more than 140 percent.
The declining dependency
ratio in combination
with increased benefit levels meant that both the tax base and tax rate had to expand
to meet the pay-as-you-go
cost. In constant dollars, the taxes paid by
workers earning the average wage covered under the system increased
by more than 500 percent. The annual combined
employer
and employee OASDI taxes paid by average workers are shown in figure I5. Workers'
tax liabilities
under Social Securitv will probably
continue to increase. Under existing law, payroll tax rates are to continue
to rise until after 1990. Growth in average wages also will raise the
base against which these rates are applied. Furthermore,
the Social
Security system now faces a serious financing
shortfall
in both the
short and long terms.
If Social Security is to remain a pay-as-you-go
system, bencfi ts will
have to be cut, additional
revenues will have to be raised, or some
combination
of the two will have to be implemented.
These are not
pleasant
choices for anyone, especially
politicians,
but there are no
alternatives.
One factor that policymakers
should keep in mind is
that Social Security does not exist in a vacuum; there are other elements o[ retirement
income security that are maturing.
These other
programs
could help relieve the financial
burden and allow some
restructuring
of the Social Security system.
44
II. Income Security for the Elderly:
The Role of Programs Other Than
Social Security
Although Social Security retirement
benefits have had a dramatic
effect on the economic well-being
of the elderly over the past four
decades,
rnanv other facets of federal law have also enhanced
the
elderly's
income security. Today the elderly receive income from an
amalgam
of publicly and privately organized
programs
that aim to
provide them with adequate income, as well as from their own private
provisions.
All the major components
of this loosely configured
system have developed
in the past forty-five years, but they have not
evolved at the same rate. It is important
to understand
this point,
because the various income sources will play different roles for future
groups of elderly people.
In 1930, 54 percent
of the men in the country over age sixty-five
continued
to work; by 1940, the employment
rate of men over age
sixty-five
had fallen below 42 percent. 1 Much of the decline related
directly
to the escalated
unemployment
rates during
the Great
Depression.
Although
it was widely understood
that the U.S. economy's collapse
had diminished
the extent and value of individually
held assets, there was little precise statistical
evidence to support the
premise.
When Social Security
(OASI) and the Old-Age Assistance
(OAA)
programs
were established
in 1935, there were approximately
750
private pension plans in operation.
Nonetheless,
for many years after
the two government
programs
began paying benefits, they were the
only source of income support
for many elderly persons. As Social
Security
matured,
it became the predominant
source of retirement
income support.
Today, the reliance
of elderly people on public income support
programs
is diminishing
in relative terms, and in the
future it will probably
decline even further.
The elderly now have four major sources of income in addition
to
Social Security:
pension programs,
individual
savings and asset income, employment
earnings, and welfare programs.
Because the current debate on Social Security
financing
and future benefit levels
should be conducted
in this broader
context, this chapter
discusses
the history of these four sources of retirement
income.
_u.s. Bureau of the Census, Historical Statistics o/the U_litedStates (Washington, D.C.:
U.S. Government Printing Office, 1976),p. 132, Series D 29-41.
45
The Role
of Pensions
The expansion
in the role of pensions can be traced through
growth in pension programs,
beneficiaries,
and benefits.
the
Growth in Pension Programs--Pension
programs
have been publicly
regulated,
in one way or another, almost since their very beginnings.
Dan McGill, who has written extensively
on pension programs
and
policy, notes that even prior to the enactment
of regulatory
legislation, reasonable
employer
pension payments
to retirees
or contributions to trust tunds were tax-deductible
expenses. 2 However, the
funding of prior service credits and amortization
of unfunded
liabilities were not tax deductible.
Furthermore,
income accruing to either
the employer
or employee
in an established
trust fund was taxable.
The 1921 Revenue Act eliminated
current taxation of income for stock
bonus
"some
and profit-sharing
plans
or all" of their workers.
established
by employers
to benefit
Through
an administrative
ruling, pension trusts also were accorded preferential
tax treatment,
and the 1926 Revenue Act established this treatment
of pension trusts as law. The 1928 Revenue Act
permitted
reasonable
deductions
in excess of currently
accruing
liabilities,
in effect allowing funding of past service credits. The 1928
Revenue Act allowed the continued
provision
of pensions for "some
or all" of the employees
of a sponsoring
employer,
which allowed
owners and officers to establish
plans under which they received
preferential
tax treatment
while excluding
rank-and-file
workers.
Also at that time pension trusts were revocable.
That is, a sponsor
could establish
a plan in a high-income
year, make tax-free contributions to the plan, and revoke it in an unprofitable
year. The 1938
Revenue Act modified the revocability
provisions
and required
that
a retirement
trust be for the exclusive benefit of the employees
covered until all liabilities
were met under the plan.
In 1940 a sharp increase
in corporate
income tax rates greatly
expanded
the incentives
to establish pension programs,
particularly
because the 1938 Revenue Act had not changed the provisions allowing selective coverage of the sponsor's
work force. The 1942 Revenue
Act and amendments
to it in the 1954 Internal Revenue Code modified
the tax qualification
standards
and changed the tax code to preclude
plan sponsors from discriminating
in favor of a sponsor's owners and
officers.
2This paragraph
Private Pensions,
46
and the next four rely heavily on Dan M. McGil[, Fundamentals
4th ed. (Homewood,
Ill.: Richard
D. Irwin, Inc., 1979), pp. 23-28.
o[
Organized
labor also played a major role in the evolution
of pensions in the United States. When Inland Steel Company
initiated
mandatory
retirement
at age sixtv-five
in 1946, the union filed a
grievance
with the National
Labor Relations Board (NLRB) arguing
that the company's
unilateral
decision on this issue violated a provision in its negotiated
contract dealing with separation
from service.
The employer
argued that the mandatory
retirement
provision
was
an essential part of the company's
pension program and that pensions
were outside the realm of collective bargaining.
The 1948 NLRB ruling, based on the 1947 Labor Relations
Management
Act, held that
pensions were negotiable.
The NLRB based its ruling on two principles: ( 1) that pensions fell under the term "wages" as defined in the
law, and (2) that pensions could be considered
"other conditions
of
employment,"
which were negotiable.
When the company
appealed
the ruling, tile Seventh Circuit Court of Appeals found that the employer had reasonably
argued that pensions were not wages but that
premiums
were clearly included in the "other conditions
of employment" clause.
Inland Steel's original disagreement
with the union over the negotiabilitv
of pensions
linked to its mandatory
retirement
age provision indicates
that employers
do use their pension programs
for
manpower
management.
Over the years the unions themselves
have
negotiated
vigorously
['or pensions
that help provide
new jobs for
younger workers as older ones retire. The Social Security Act's provision of a bottom tier of retirement
income has further increased
awareness
that economic
security
for the elderly is of paramount
importance.
The policy focus on income adequacy
since the 1960s
has especially
highlighted
the needs of the elderlv.
Thus, pensions have grown as a result of a combination
of preferential tax treatment,
employer
and union interest,
and social consciousness.
Figure II-I depicts the dramatic
increase in tax-qualified
plans which rose from 659 at the end of 1939 to 696,000 at the end
of 1981. Growth has been steady over most of
the mid-1970s,
when the Employee
Retirement
(ERISA) was implemented.
ALthough enactment
in a shift toward defined-contribution
plans, 3
fined benefit plans have been established
in just
the period except for
Income Security Act
of ERISA did result
more than 46,000 dethe past three vears. 4
_Svlvestcr
J. Schicbcr
and Patricia M. George, Retirellze_zl h_co.te Opportz.Hties
i_*aH
.4_i_zg America: ('o_wraRe a_M Be_wl)'t E_tlith'me_tt {Washington,
D.C.: EBRI, 1981 ), p. 66.
4S_,]_,csIcF J. Schicber,
Tremls m PeplsioH £'overa,_e a_ul Be_wlit Receipt (Washington,
D.C.: EBRI, 19821, p. 5.
47
FIGURE
Total
Number
II-I
of Tax-Qualified
Plans
for Selected
Years
in Effect
Thousands
of Plans
600-
500-
400 -
300-
200 -
100-
0
I
1940
Sources:
I
1945
I
1950
I
1955
i
I
I
I
1960
1965
1970
1975
1980
Year
Charles D. Spencer & Associates, Inc.. EBPR Research Reports (Chicago,
I11., 1980), section 101.1; and periodic IRS press releases.
As a result
of this growth,
an increasing
share of the work force is
participating
in at least one pension
program
other
than Social
Security.
The May 1979 Current
Population
Survey
(CPS) provides
the
most recent
available
statistics
on recent
pension
participation
levels. 5 This survey,
based
on a sample
of households
representing
the
U.S. civilian
work force, estimated
that outside
agriculture,
68.3 percent of all civilian
wage or salary workers
between
the ages of twentyfive and sixty-four,
working
at least half time, who had been with
_For a description of the Current Population Survey, see the U.S. Department of Commerce, Bureau of the Census, "The Current Population Survey--A Report ot Methodology," Technical Paper no. 7 (Washington, D.C., 1963); U.S. Department of Commerce,
Bureau of the Census, "The Current Population Survey--A Report of Methodology,"
Technical Paper no. 40 (Washington, D.C., 1979); and Marvin M. Thompson and Gary
Shapiro, "The Current Population Survey: An Overview," Amtals o/Ectmomic
a_td
Social Management (Washington, D.C.: U.S. Department ot Commerce, Bureau of the
Census, 1973).
48
their
plan.
employer
for a year
or more,
were participating
in a pension
Because private employment
constitutes
85 percent of all U.S. employment
and because
lower coverage
rates prevail in the private
sector, pension policy is often focused on this segment of the economy.
[n fact, most noncovered
workers are in private sector employment.
The federal government
provides pension coverage to virtually all its
civilian employees
in permanent
positions; the approximately
10 percent of federal civilian workers who are in temporary
positions
receive only Social Security coverage. At the state and local levels, 85
to 90 percent of full-time employees
are covered by a pension plan. 6
The growing prevalence of private pension plans has led to a marked
increase in pension participation,
as table II-1 shows. The growth of
private pension participation
is indicated
bv the steady growth in
the number of participants.
In addition, and perhaps more important,
over the years participation
has grown more rapidly
than privatesector employment
has. Private-sector
employment
grew 15.4 percent
from 1950 to 1959, 27.0 percent from 1960 to 1969, and 26.8 percent
from 1970 to 1979. Over the same three periods, pension participation
increased
by 85.7, 39.0, and 36.8 percent.
Some analysts
have suggested that the stabilization
of the participation
rate during the 1970s
indicates
that the private pension system has stagnated.
According
to previous research by the Employee Benefit Research Institute (EBRI),
more reasonable
explanations
of stable pension participation
rates
during the 1970s are the rapid growth in employment
as the postWorld War II babv-boom
generation
entered the work force, the rapid
rise in female labor force participation
rates during the 1970s, and
the implementation
of ERISA. 7
Private-sector
employment
grew as much between
1975 and 1979
as it had in the previous eleven years. Most of the new workers were
young people who were just embarking
on a career. Nearly 58 percent
of the spurt in private-sector
employment
during the late 1970s occurred in firms with fewer than 100 employees, and almost 55 percent
of the growth occurred
in trade and service firms. Pension coverage
is known to be lowest in smaller firms and in the trade and service
industries, s
_House Pension Task Force, Pension Task Force Report on Public Employee Retireme_zt
Systems (Washington,
D.C.: U.S. Government
Printing Office, 1978), p. 59.
7See Schieber
and George, Retirement
l_wome Opporttotities
i_zat_ Agitzg America, chapter 3.
qbid.,
p, 49.
49
TABLE
II-I
Wage and Salary Workers
in Private
Sector,
Nonagricultural
Establishments
and Pension
Participation,
1950-1979
Year
P_vate-Sector
Wage and Salary
Worke_
(Thousands)
Workers
Participating in
P_vate Pensions
(Thousands)
Participation
Rate
(Percent)"
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
39,171
41,430
42,185
43,557
42,239
43,727
45,091
45,237
43,485
45,185
45,836
45,405
46,659
47,427
48,687
50,691
53,117
54,412
56,058
58,189
58,326
58,333
60,342
63,059
64,095
62,260
64,511
67,345
71,025
73,966
9,800
10,800
11,300
12,600
13,400
14,200
IS,S00
16,700
17,200
18,200
18,700
19,200
19,700
20,300
20,900
21,800
22,700
24,300
24,800
26,000
26,100
26,400
27,500
29,200
29,800
30,300
30,700
32,000
33,700
35,200
25.0
26.1
26.8
28.9
31.7
32.5
34.4
36.9
39.6
40.3
40.8
42.3
42.2
42.8
42.9
43.0
42.7
44.7
44.2
44.7
44.7
45.3
45.6
46.3
46.5
48.7
47.6
47.5
47.5
47.6
Sources:
50
Employment data are from the U.S. Department ofLabor, Bureau of Labor
Statistics, presented in the 1981 Eco_to,tic Report o/ the President, table B35, p. 273; pension participation data are h'om Alh'ed M. Skolnik, "Private
Pension Plans, 1950-1974," Social Sec,ritv Bttl_titt, June 1976, vol. 39, no.
6; and Martha Remv Yohalem, "Employee Benefit Plans, 1975/' Social Security Bul_tin, November 1977, vol. 40, no. 11. Estimates Ior 1979 were
derived from the May 1979 Current Population Survey. Estimates tot 19761978 were derived by interpolation between 1975 and 1979.
The stabilizing
pension participation
rate was the result of the
simple mathematical
calculation
of participation
rates bv which the
numerator
(pension participation)
did not keep up with the denominator (workers) during a period in which the latter was growing at
unprecedented
rates. During the 1980s, private-sector
employment
is expected to grow at only one-half to one-third
the rate during the
latter half of the 1970s. The slowdown
in the expansion
of the work
force means that continued
pension expansion
should result in higher
rates during this decade. Also, because of the
decline in birthrates
toward the end of the 1950s, a smaller proportion
of the work force will be under age twentv-five
and excluded
from
on the basis of ERISA's standards.
Another important
factor that can contribute
to further growth in
pension
participation
rates is the continued
establishment
of new
pension programs.
Table II-2 shows net growth of 51,607 tax-qualified
plans during the three years 1975 to 1977. The average annual growth
in plans was less than one-third
the rate ['or the years immediately
prior to the passage of ERISA. This slowdown
in plans created in the
mid-1970s obviously slowed participation
growth as well. However,
the number
of tax-qualified
programs
increased
by 220,592 plans
between January
1978 and December
1981.
The number
of participants
affected bv new pension programs
is
less well documented
than plan growth. Table II-3 includes the number of new plan qualifications
bv plan type for 1976 through
1981,
and the number of participants
in newly qualified plans for each year.
There are two problems
in interpreting
these data, however:
First,
the Internal Revenue Service (IRS) does not publish participant
levels
in terminating
plans, so it is impossible
to estimate
net participant
growth. Second, many of the new plans being created either replace
coverage for persons previously covered bv terminating
plans, or represent supplemental
coverage for workers who are already pension
participants.
The data in table II-3 appear to suggest that 1977 and 1978 were
far more expansionary
(8.8 million participants
in newly qualified
plans) than the subsequent
two years (only 5.8 million participants
in newly established
plans). The problem is that the 1977-1978 period
_The participation
rates are tot all private-sector
workers
regardless
of age, tenure
with employer,
or hour's worked per year. If only workers who met ERISA participation standards
were considered,
the participation
rates would be much higher. For
example,
if the work torce were narrowed
to include only those people between
the
ages of twenty-five
and sixty-four,
working at least half time, and having one or more
years of tenure with their current
employer,
the 1979 participation
rate would rise
to 65 percent.
51
52
TABLE
Plan
Qualifications
Defined Contribution
Year
Plans
1976
Number
Percentage
1977
Number
Percentage
1978
Numbcr
Percent age
1979
Number
Percentage
1980
Number
Percentage
1981
Number
Percentage
Source:
II-3
and Participants,
Participants
1976-1981
Defined Benefit
Plans
Participants
Total
Plans
Participants
18,891
87.9
780,708
85.3
2,595
12.1
134,462
t4.7
21,486
100.0
915,170
100.0
28,463
80.4
3,315,205
66.9
6,953
19.6
1,639,719
33.1
35,416
100.0
4,954,924
100.0
55,956
85.2
2,754,635
71.0
9,728
14.8
1,125,498
29.0
65,684
100.0
3,880,133
100.0
41,122
72.3
1,050,595
51.9
15,755
27.7
972,062
48.1
56,877
100.0
2,022,657
100.0
50,493
72.8
1,997,285
52.8
18,849
27.2
1,784,280
47.2
69,342
100.0
3,781,565
100.0
57,748
70.8
1,302,089
37.3
23,789
29.2
2,185,551
62.7
81,537
100.0
3,487,640
100.0
EBRI tabulations
o[ periodic IRS press releases.
is misleading.
The Pension
Benefit
Guaranty
Corporation
found
that about
40 percent
of the participants
in plans
during
the early days of ERISA were recovered
bv newly
(PBGC) has
terminated
established
defined-contribution
plans. 9 It is important
to note that
18,857
defined benefit
plans
were terminated
between
1975 and
1977, compared
with
15,514 such
terminations
during
the previous
nineteen
years.
The surge in defined-contribution
plan participants
in 19771978, therefore,
probably
did not represent
a comparable
increase
in
total participation
levels.
These caveats
aside,
the combined
information
in tables
II-2 and
II-3 indicates
that pension
participation
has grown
significantly
in
recent years. The rate of plan qualifications
has consistently
exceeded
terminations
indicating
real
growth
in plan
availability.
Furthermore, the average
number
of participants
in newly established
plans
indicates
manv
of these
plans
are being
established
in small
and
9Pension Benefit Guarantv Corporation, Analysis o[ Single Employer Delined Benefit
Plan Terminatio_t, 1976, 1977, 1978, 3 vols. (Washington, D.C.: PBGC, 1977, 1978, 1979).
53
intermediate
size firms. For example,
the newly qualified
definedbenefit plans in 1981 had an average of eighty-five participants,
while
plans averaged
twenty-three
participants.
This
fact is particularly
significant
when one considers
that more than
two-thirds
of nonagricultural
workers between
the ages of twentyfive and sixty-four,
working at least half time who were not covered
by a pension plan in 1979 were in firms with fewer than 100 workers. I°
Growth
in Benefi'ciarie3"--Increased
pension
participation
ultimately means higher rates of benefit recipiency,
but these rates do
not rise instantly.
It is misleading
to judge the effectiveness of pension
programs
on the basis of the number
of current
retirees receiving
benefits. A newly established
pension plan does not provide benefits
to workers who have already left the sponsoring
firm. Depending
on
the nature of the program established
and the characteristics
of the
employer's
work force, it could take several years before retirements
under the program
occur.
Table II-4, based on tabulations
o[' information
that plan sponsors
filed with the [RS (form 5500) in compliance
with ERISA [or the 1977
plan year, indicates a clear relationship
between plan age and beneficiaries
in defined-benefit
plans. Among other things, torm 5500
requires reporting
the "effective plan date" or date the plan was set
up, the number of active participants
in the plan, and the number of
beneficiaries.
The age o[ the plan can be calculated
from the eflcctive
plan date. As expected,
most of the young plans have more workers
per participant
than older plans do. Less than 10 percent of the plans
that had been created in the previous five years reported
fewer than
five workers per retired beneficiarv.
For plans operating
twenty-five
years or longer, nearly 49 percent had fewer than five active participants per beneficiary.
The changes in this relationship
with increasing plan age are too consistent
to be coincidental.
At the other end
of the participant/beneficiary
range, the pattern
is comparably
consistent. More than 55 percent of plans less than live years old had
twenty or more active workers per beneficiary,
while less than 11
percent of the oldest plans reporting
had as many as twenty participants per beneficiary.
Undoubtedly
many of the older plans with high participant/beneficiary ratios are in firms that are expanding.
High participant/beneficiary ratios will continue as some plan sponsors continue to expand
in the future, but such sponsors will still have increasing
numbers of
I°Schieber
54
and George,
Retirement
Income
Opportmlitie._
m an Aging America,
p. 49.
N
•,.
I _
r-_
-
_
_
_r--:_
.......
-
._
_ dmd°
55
beneficiaries
over the vcars. This relationship
of plan age and beneficiary rates becomes particularly
significant
in comparison
with the
defined-benefit
plan creation data shown earlier in table II-2. If we
use 1977 as the reference year, because it corresponds
with the ERISA
data, we find that the universe
of private defined-benefit
programs
grew by 218,487 plans in the previous twenty years; 32.0 percent of
this growth occurred
between
1973 and 1977 and 72.7 percent
between 1968 and 1977. If all 28,169 tax-qualified
plans in existence at
the end of 1955 were assumed
to be defined-benefit
plans, which is
certainly
not the case, 62.7 percent of all defined-benefit
plans would
have been less than ten years old at the end of 1977. The definedbenefit pension system in this country
today is still quite young. As
the system matures,
the ratio of workers to beneficiaries
will markedly decline, much as the ratio of workers to beneficiaries
in the Social
Security program declined during the 1950s and 1960s. The ratio will
decline not because of fewer covered workers, but because of more
beneficiaries.
The data on defined-contribution
plans are more difficult to interpret but equally revealing.
Table II-5 shows the participant/beneficiary ratio for defined-contribution
plans with more than 100 active
participants
in 1977 based on ERISA filings. With the exception
of
plans more than twenty-five
years old, less than 20 percent of the
plans in any other age category reported
a ratio of working participants to beneficiaries
below twenty to one. This may seem particularly peculiar in comparison
with the defined-benefit
plan statistics,
because defined-contribution
plans often have more lenient vesting
requirements
than their counterparts.
The most significant
category
in the table is the "unknown"
category, which indicates that benefits
were paid during the year but that there were zero beneficiaries.
Most
plans are not themselves
annuity programs;
at
withdrawal
or retirement,
vested participants
are generally
given a
lump-sum
distribution.
In many instances the employer will arrange
for conversion
of the distribution
into an annuity
program,
but the
plan itself seldom pays pension benefits in the traditional
sense. Some
plans also report the number of cash distributions in this reporting
period as the number of beneficiaries--hence,
the consistent
percentage
of plans reporting
worker-to-recipient
ratios above twenty to one. It is unlikely that many employers
would
experience
turnover
of vested employees
in excess of 5 to 10 percent
of their total work force each vear.
This lump-sum
distribution
phenomenon
also results
in undercounting
of the number
of pension
beneficiaries
on population
56
_1 _
__
57
surveys.
For example,
the Census Bureau's
annual March Income
Supplement
to their Current Population
Survey gathers information
on the prevalence
of the receipt of pension and the annual levels of
benefits.
Interviewers'
instructions
and training
specifically
direct
that only regular income is to be recorded in the interview;
one-time
income is to be ignored. Unless defined-contribution
plan lump-sum
distributions
are converted
to an annuity, they never show up on the
survey as retirement
program
benefits.
Historical
data on the growth of private pension beneliciaries
over
the years are scarce. Table II-6 includes the data that are available.
The phenomenon
of declining
numbers of active participants
relative
to beneficiaries
noted in the age analysis of the defined-benefit
plan
also prevails
for all plans as the pension system ages. This phenomenon will continue
to some extent as the younger plans now in the
system continue to mature. Ultimately,
it is reasonable
to expect that
this ratio will approximate
the Social Security dependency
ratio and
vary directly with the demographic
swings of the population.
The aging of the pension system has also increased
the receipt of
benefits among the elderly. Table II-7 shows the percentages
of families with persons between the ages of sixty-five and sixty-nine eligible
to receive employer
pension benefits in 1967 and in 1979. Over that
period, the recipiency
rates for couples increased
more than 80 percent, while for single persons the rates more than doubled.
Again,
the further maturing
of the pension system should result in additional
increases
in pension recipiency.
Growth in Bene[its--The
data in table II-6 indicate
that average
benefits paid by private plans have steadily increased.
EBRI's previous research has shown this to be true among public plans as well. a_
Some analysts have argued that the relative stability of average benefits in constant
dollars indicates
that the income-replacement
capacity of the private pension system is not growing. It is important,
however,
to distinguish
between average benefits per recipient
and
average
benefits for all the elderly. The following example
demonstrates this point.
Assume there are two groups of elderly people consisting
of fifty
persons each in a two-class society. Assume that forty people in group
1 each receive a pension of $1,000 per month and ten people in group
2 each receive $100 per month. Table II-8 shows the outcome of this
example.
_JEmployee
Benefit Research
Institute,
Retirement
America: Income Levels arid Adequacy (Washington,
58
hwome
Opportunities
D.C.: EBRI, 1982).
in an Aging
q_
_°
_
5
59
TABLE
Percentage of Families
Eligible to Receive
II-7
with Individuals
Ages 65 to 69
Employer Pension Benefits
1967
1979
29
15
22
53
33
42
Married Couples
Single Persons
All Families
Source:
Note:
1967 values from U.S. Social Security Administration, Demographic and Eco_umtic Characteristics of the Aged (Washington, D.C.: Office of Research and
Statistics, 1975), p. 184. March 1980 and May' 1979 Current Population Survey
data fur 1979 values.
Values for 1979 arc higher than the percentage ot elderly persons currently
receiving benefits because some persons ages sixty-five to sixty-nine have a
vested right to employer pension benefits but have not vet received them.
TABLE
Pension
Benefits
Then
Calculated
assume
in a Hypothetical
Period 1
Total
People
Number
Receiving
a Pension
50
50
100
40
IO
50
Group 1
Group 2
Total
Source:
II-8
Two-Class
Society:
Monthly
Benefit
Total
Benefits
$1,000
100
$40,000
1,000
$41,000
by the author.
that
some
time
later,
this
society
still consists
of two
groups
of elderly
persons,
but conditions
have improved
for both.
Assume
that lorry-five
persons
of group
1 each
receive
a monthly
benefit of $1,200, while thirty-five
people in group 2 each receive $200
per month.
Table II-9 shows
the outcome.
TABLE
Pension
Benefits
Group 1
Group 2
Total
Source:
60
Calculated
II-9
in a Hypothetical
Period 2
Total
People
Number
Receiving
a Pension
50
50
100
45
35
80
by the author.
Two-Class
Society:
Monthly
Benefit
Total
Benefit
$ 1,200
200
$54,000
7,000
$61,000
The example suggests that things have generally
improved for both
groups in the interval between the periods depicted. The total level
of benefits and recipiency
rates improved
for both groups, and average benefits for all elderlv increased from $410 to $610; the average
benefit per recipient,
however, declined from $820 to less than $763.
Basically this same phenomenon
has been occurring
among private
pensions.
Many early pension plans provided
benefits only to longcareer workers who stayed with the sponsoring
firm until retirement.
Also pension plans were most prevalent
in firms and industries
with
higher-than-average
salary and wage structures.
The combination
of
these factors meant that average
benefits were often large. During
the 1950s and 1960s, sponsors began to establish
vesting standards
allowing
workers to acquire
pension entitlements
based on shorter
periods of service. When ERISA mandated
vesting standards
in 1974,
it reduced the average service required
to earn a benefit. At the same
time that service requirements
were being reduced,
pensions
were
being extended
to an increasing
segment of the work force, including
workers
in the lower- and middle-earnings
range. These improvements in the pension system are responsible
for the extension
in the
number of people receiving
benefits. Enhancing
the general welfare
of the elderly has meant stable average benefits per recipient,
howcver.
The growth in pension plans will mean expanding
exposure
of
American workers to these programs
in the future. The maturing
of
the baby-boom
generation
also should contribute
to increased
participation in these programs.
The standardized
vesting requirements
established
bv ERISA in combination
with the aging of the pension
plans themselves
will assure higher rates of benefit recipiency
as
today's workers
reach retirement.
Thus, the pension system is expanding its role in the retirement
income security system.
Individual
Savings
and Asset
Income
Several recent studies have analyzed personal
savings behavior,
basing the analysis on a life-cycle consumption
model which assumes
that consumption
in any given time period is not based solely on
current earnings. I_ The model takes account of financial
markets
_Albert
Ando and Franco
Modigliani,
"The Lite Cycle ot Hypothesis
of Savings,"
America_z Ec'ommtic
Review, vc_l. 51, no. 1 (March 1963), pp. 55 84: and Franco
Modigliani
and Richard
Brumberg,
"Utility Anah'sis and the Consumption
Function:
An
Interpretation
of Cross Section
Data," Po.sl k'evl_esiau Ec'ouomics
(New Brunswick:
Rutgers University
Press, 1954).
61
which permit
wealth and debt accumulation
that can be used to
adjust consumption
patterns
over time. People are assumed to make
consumption
and savings decisions by comparing
current and future
resources
with current
and future needs. The theory suggests that
people would save or accumulate
wealth during their working years
and liquidate
those resources to meet retirement
consumption
needs.
In this context, savings become a crucial element in the retirement
income security system.
Special Retirement Savings Programs--The
U.S. tax code specifically
recognizes
the desirability
of private retirement
savings. People who
are self-employed
or in unincorporated
businesses
can establish
a
retirement
program
for themselves
called a Keogh plan. Keoghs were
initially
authorized
by the Self-Employed
Individuals
Tax Retirement Act of 1962, often referred to as H.R. 10. Initially, contributions
were limited to the lesser of 10 percent of earnings or $2,500 annually.
Today, Keoghs permit deductions
from taxable income for retirement
contributions
up to $15,000 or 15 percent of earnings annually, whichever amount is smaller. The Tax Equity and Fiscal Responsibility
Act
of 1982 increased the Keogh deduction
limits to $30,000 for plan years
beginning
after 1983. In the future these limits will increase in step
with contribution
limits in incorporated
business plans.
The last year for which comprehensive
information
is available
on
the utilization
of Keoghs is 1977. At that time there were 649,456
plans in operation
with 907,403 participants.
At the end of the year,
according
to filings with the IRS, these plans held $6.5 billion in
assets.
Individuals
can also establish tax-deferred
retirement
savings programs for themselves.
When ERISA was enacted, the tax code was
modified to allow persons not covered bv a pension plan to establish
individual
retirement
accounts (IRAs). The 1981 Economic
Recovery
Tax Act (ERTA) made IRAs available
to all workers beginning in 1982,
regardless
of their pension coverage status. ERTA allows individual
IRA contributions
annually up to $2,000 to be deducted
from taxable
earnings.
If an individual
worker has a spouse who does not work,
the limit is $2,250.
Based on individual
tax return data for 1980, the IRS estimates
that $3.4 billion was contributed
to 2.6 million IRA accounts
that
year. It is too early to estimate
the actual response
to the new IRA
provisions
included
in ERTA, but there is some concern that IRAs
may not be a particularly
effective element of the retirement
income
security
system. During 1977, roughly 50 million workers were eli62
gible to establish
an IRA, but less than
contributed
to them. I_ There were several
11 percent
of those eligible
reasons
for low utilization
rates
under
previous
law, however.
The major
reason
was that the
people
most likely to take advantage
of the IRA provisions
were excluded
prior
to 1982. The expansion
of IRA availability
to workers
covered
bv a pension
plan
completely
changes
the economic
and
demographic
characteristics
of the eligible
population.
Table
II-10
shows
the earnings
and age distribution
of workers
in May 1979 and
their pension
participation
status.
Anyone who was a plan participant
at that time was excluded
from contributing
to an IRA during
1979.
Some additional
workers
also were excluded
because
they had changed
.jobs and thereby
had become
plan participants
at some time during
1979. The table shows
that more than three-fourths
of workers
with
TABLE
II-10
Earnings and Age Characteristics
of the U.S. Civilian
Work Force and Workers Participating
in a Pension
Plan in May 1979
Estimated Earnings
in 1979
Total
Work Force
(Millions)
Workers Participating in
a Pension Plan
(Millions)
(Percent)
$
I -$ 4,999
$ 5,000-$
9,999
$10,000-$14,999
$15,000-$19,999
$20,000-$24,999
$25,000 or more
11.97
23.42
19.66
12.49
5.95
5.70
1.20
8.62
12.10
9.45
4.74
4.63
10.0
36.8
61.5
75.6
79.7
81.2
Unestimated
16.18
2.81
17.4
21.18
25.41
18.56
16.04
7.00
4.33
2.85
95.37
4.65
12.84
10.05
9.23
4.08
2.20
.49
43.54
21.9
50.6
54.7
57.6
58.2
51.0
17.2
45.7
Age
Less than 25
25 34
35 44
45 54
55-59
60-64
65 or older
Total
Source:
EBRI tabulations
of Mav 1979 Current Population
Survey data.
I_Dallas L. Salisbury and Susan E. Click, "IRAs: An Expanding Opportunity
Retirement Provisions" (Washington, D.C.: EBRI, 1981 ).
for Private
63
annual earnings over $15,000 were excluded. Also, most members of
the prime age groups between twenty-five
or thirty-five
and sixtyfive in which retirement
savings are most likely to occur were largely
excluded.
Seventy percent
of prime-age,
regularly
employed
wage
and salary workers were covered by pension plans. If the work force
were narrowed
to include only workers employed
at least half time,
IRA participation
rates would probably
be higher.
The population
eligible for IRAs roughly doubled in 1982. Table |I11 indicates
that the use of IRAs has expanded
with income of workers. Because the expansion
in eligibility
occurred
primarily
among
higher-income
workers, the use of these savings vehicles should increase more than proportionately.
While the long-term effects of IRAs
on the income security of future retirees has not yet been adequately
analyzed,
this analysis is important
if IRAs are to be a vital part of
the retirement
system.
Information
on the early response to expanded
IRA availability
is
sketchy but encouraging.
The increase in IRA assets invested in selected financial
institutions,
shown in table II-12, suggests that total
IRA assets could easily double and possibly triple this year alone. A
recent survey by the Life Insurance
Marketing
and Research
Association found that one-third of all eligible households
intend to open
an IRA this year. Furthermore,
the survey found that about 60 percent
of those opening an account intend to fund them, at least in part,
from current
income.14
TABLE II- 11
Percentage of People Who Are Eligible
and Who Have IRAs, by Income Class, 1977
Family
Adjusted Gross Income
Percentage of
Eligible People
Who Have IRAs
$
0-$ 5,000
.2
$ 5,000-$10,000
1.3
$10,000-$15,000
3.3
$15,000-$20,000
5.5
$20,000-$50,000
21.7
Over $50,000
52.4
Source: President's Commission on Pension Policy, Co_ni_lgo/Age: Towarda National
Retiremettt Income Policy (Washington, D.C., 1981),p. 35.
14WallStreet Journal, July 1, 1982,p. 2.
64
TABLE
11-12
Assets in IRAs by Selected
Financial
Institutions
Percentage
Increase
12/31/81
(Millions)
Commercial
Banks
Mutual Savings
Banks
Savings and Loan
Associations
Credit Unions
Mutual Funds
$7,000 _
3,400
9,200 _
205
2,600
3/31/82
(Millions)
$11,660
6/30/82
(Millions)
12/31/81
to 6/30/82
$14,905 b
112.9
4,200
5,764
69.5
15,493
447
3,800
NA
NA
4,285
68.4 _E
118.0 d
64.8
Source:
EBRI calculations from data provided by the Federal Reserve Board, National
Association of Mutual Savings Banks, National Credit Union Administration,
U.S. League of Savings Associations, Investment Company Institute.
_IRA and Keogh deposits.
bEstimated.
_Preliminarv.
dTo March .31, 1982.
In addition
to Keoghs and IRAs, changes
in the tax code in 1978
allow
employers
to establish
tax-deferred
"salary
reduction"
programs.
Section
401(k) of the Internal
Revenue
Code sanctions
"cash
or deferred
arrangements"
(CODAs) under qualified
profit-sharing
or
stock-bonus
plans.
Although
the enabling
legislation
was part of the
1978 Revenue
Act and was effective
for the plan year beginning
on
or after
Januarv
1, 1980, IRS did not publish
proposed
regulations
until November
10, 1981. Under these rules, qualified
plans may offer
participants
the choice
of immediate
or deferred
compensation
taxable in the year actually
received.
Participants
can choose
to receive
as cash the part of the employer
compensation
that would
otherwise
be contributed
to the plan,
or
the participants
can choose
to defer receipt
of the part of their compensation
that would
normally
be received
in cash.
The employer
pays the deferred
amount,
or salary reduction,
into the qualified
plan.
As with all qualified
plans,
nondiscrimination
requirements
must be
met. In addition,
any employer
contributions
deferred
at an employee's individual
election
under
a CODA must vest immediately.
The nondiscrimination
ing provision
will assure
pants.
This test separates
test in conjunction
with the immediate
vestbenefit
distributions
for all CODA particithe eligible
employees
into those in the top
65
third of the salary scale and those in the bottom two-thirds,
and
calculates
an average deferral percentage
for each group. To be qualified as nondiscriminatory,
a plan has to meet either of two tests.
Under the first test, the average deferral percentage
in the top salary
tier cannot exceed that in the lower by more than 1.5 times. Under
the second test, the higher tier may contribute
at a rate of 2.5 times
the lower group but the higher group's average deferral rate may not
exceed the lower group's rate by more than three percentage
points.
Little information
is available yet on the ultimate potential
of these
programs.
Early marketing
surveys indicated
that as many as threefourths of firms being surveyed
were seriously
considering
implementing a CODA program.15 The availability
of CODAs and their need
to be tax qualified may have some offsetting effects on IRA utilization.
Under ERTA, employers
can establish voluntary
programs
that allow
workers to make their IRA contributions
through payroll deductions.
The problem
for an employer who establishes
both a payroll deduction IRA and a CODA is that IRA contributions
may lower the contribution limits in the CODA or endanger its tax qualification
altogether.
Many perceive CODAs as the more effective retirement
savings device
because they are not subject to the IRA contribution
limits. Moreover,
because CODA contributions
are not subject to the payroll tax, CODAs
provide an added tax incentive to individuals
with current compensation below the Social Security
taxable maximum.
Salary reductions for such workers, however,
will reduce their Social Security
entitlements.
Home Ownership--The
current
prevalence
of pension plans and
worker participation
in them are relatively
recent phenomena.
The
multiplicity
and extent of tax incentives
for retirement
savings are
even more recent. Public programs
and tax incentives that encourage
people to buy a house, however, have a much longer history. Table
II-13 shows the significance
of home ownership
in an aggregated
distribution
of assets and liabilities
for selected years. Home or residential property
ownership
makes up nearly a third of all household
assets and nearly two-thirds
of household
liabilities.
The nature of the home purchase
and mortgaging
process is such
that for many retirees today, the owned home constitutes
the largest
share of personal
wealth. In 1978, more than 71 percent of housing
I_Philip M. Alden, Jr., "Where Less Means
vo[. 18, no. 4 (April 1982), pp. 43-44.
66
More--See.
401(k)
Plans,"
Pe_tsion
World,
TABLE
Distribution
Current
II-13
of Household Assets and Liabilities
Prices for Selected Years, 1950-1979
in
1950
1960
1970
1980
$1,014.9
$1,661.2
$3,028.4
$8,178.1
Assets
Total Assets(Billio_ls)
Percentage
of assets held as:
Financial
assets
Owner-occupied
housing
Owner-occupied
land
Equity in noncorporate
business
71.7
14.6
2.0
53.1
18.8
4.3
55.7
18.6
6.0
46.1
23.3
7.2
27.7
23.7
19.7
23.5
$77.0
$228.1
$502.0
Liabilities
Total Liabilities
(Billio_ls)
Percentage
of liabilities
held
Home and other mortgages
Installment
credit
Other consumer
credit
Bank and other loans
Security
and other credit
$1,493.5
as:
57.2
20.1
13.2
3.8
5.7
Net Wortt¢'(Billio_s)
$937.9
Assets/Liabilities
63.9
19.7
8.8
3.2
4.3
61.7
21.0
7.5
5.7
4.1
$1,433.0
13.2
$2,526.4
7.3
65.0
20.9
4.8
5.6
3.7
$6,684.6
6.0
5.5
Source:
Note:
Federal Reserve Board: Flow of Funds Accounts.
This table 11-13 does not include pension fund reserves or privately held
consumer durables other than housing.
"Excludes reproducible assets o[ nonprofit institutions, nonprofit plant and equipment,
and land owned by nonprofit organizations.
units
with an
Social Security
clderlv
head
Administration
home owners
their rcsidencc.
At retirement,
aged sixtv-four
17
home owners
generating
financial
were
owner
occupied,
j6 A study
found that in 1975, 77 percent
to sixty-nine
can convert
reported
their
no
homes
for the
of the
mortgage
into
on
income-
assets,
or they can continue
living
in them,
enjoying
the
and personal
advantages
resulting
from owning
residential
I_u.s. Dcpartmcnt of Housing and Urban Development, Ammal Housing Sun'ev. 1978,
Part A: Gowral ttousml4 Characteristics (Washington, D.C.: U.S. Gmernment Printing
Office, 1980), table A-I.
_rJoseph Friedman and Jane Siogren, "The Assets o[ the Elderly as The,,' Retire,"
(Washington, D.C.: Abt Associates, Inc., 1980), p. 108.
67
property. On the financial side, the prevalence
of mortgage-free
home
ownership
among the elderly reduces the portion of monthly income
that must be spent to provide shelter. The Retirement
History Survey
conducted
by the Social Security
Administration
has been used to
compare
the housing circumstances
of persons aged sixty-six to seventy-one in 1977. The analysis found that elderly home owners were
spending about 23 percent of their income to meet these shelter costs,
whereas older renters were spending
about 33 percent on average. Is
Part of this differential
can be attributed
to higher incomes among
the home-owning
elderly,
but the prevalence
of subsidized
rental
arrangements
for low-income elderly offsets their higher housing costs
to some extent.
Not only do elderly home owners pay a smaller share of their income to meet their housing needs, but also they live in quarters
that
are somewhat
larger on average than those of their counterparts
who
rent. The elderly are not particularly
mobile as a group, and home
ownership
allows them to reside in housing that is familiar to them,
often in the setting of communities
where they have spent many years
of their lives. It provides them financial as well as personal security.
There is some concern
that many elderly people today are not efficiently using this substantial
asset to assure their retirement
income
security. Reverse annuity mortgages
(RAMs), which allow the elderly
to annuitize
their home equity while continuing
to live in their own
homes, are available
on only a limited basis, but as the programs
become established
RAMs may prove to be a valuable
retirement
income resource. Although
the value of home equity should not be
considered
a substitute
for pensions or Social Security protection,
it
is a potentially
valuable resource that can augment
the effectiveness
of retirement
programs.
Business Assets--In
addition
to saving specifically
for retirement
and household
equity, a small but significant
number of households
accumulate
business equity during their lifetimes. This group is important because traditionally
these people have been less likely than
wage and salary workers to acquire pension protection.
During 1979,
less than 15 percent
of the self-employed
were participating
in a
pension program. 19 Based on the Social Security
Administration's
I_Sally R. Merrill, "Home Equity and the Elderly," prepared for The Brookings Institution's Conference on Retirement and Aging, Washington, D.C.,October 21, 1982,p.
12.
t_Schieber and George, Retirement hwome Opportunities in a_lAging America, p. 83.
68
Retirement
History Survey, Michael Hurd and John Shoven, of the
National
Bureau of Economic
Research,
found that among households headed by a person aged fifty-eight
to sixtv-three
in 1969, 10.6
percent possessed wealth in the form of farm equity, 8.3 percent held
business equity, and 17.2 percent held property
other than their own
residences.
By 1975, among the surviving
persons studied in 1969,
these respective
rates had declined
to 6.9, 4.2, and 14.8 percent, z° As
this group aged into their mid- to upper-sixties,
the most significant
declines in real assets occurred among farmers and people with buMncss equity. Using separate
data, Peter Diamond and Jerry Hausman,
economics
professors
at the Massachusetts
Institute
of Technology,
found that "farmers
and businessmen
form a disproportionate
share
of those with consistently
high wealth (top decile year after year),
particularly
in the oldest age group. ''21 The results of these two studies, using entirely different data, are totally consistent.
Professor
Joseph Quinn of Boston College has noted that among
the elderly who continue to work there is a relatively
heavy preponderance of self-employed
workers.
Using data from the Retirement
History Survey, he found that self-employed
people nearing retirement age were less likely to be out of the labor force than were people
who worked in wage or salary positions. He attributed
this situation
to the less constrained
environment
of the self-employed,
as well as
to the absence
of institutional
rules that affect the elderlv's
work
behavior, x2
This combination
of studies suggests that people who accumulate
business wealth tend to continue
to rely on business income beyond
normal retirement
age. And business people who do retire often find
that liquidation
of their equity provides substantial
assets for their
retirement
income security. Hence, for business people, accumulated
business assets appear to substitute
to a considerable
extent for organized retirement
savings.
Other Financial Assets--During
1980 more than half of household
asset holdings
were either residential
properties
or business assets.
Table II-13, presented
earlier, indicates
that financial assets as a percent of total assets held by households
have steadily declined over
2°Michael
D. Hurd
and John
B. Shoven,
"The
Economic
Status
of the Elderly,"
NBER
working
paper, forthcoming,
1982.
2t Peter Diamond
and Jerry Hausman,
"Individual
Savings Behavior,"
paper prepared
for the National
Commission
on Social Security,
Washington,
D.C., 1980, p. 22.
22Joseph F. Ouinn, "Labor Force Participation
Patterns
of Older Self-Employed
Workers," Social Security Bulletin, vol. 43, no. 4 (April 1980), p. 17.
69
the past thirty years, as a result of inflation, which has driven up the
value of real property
assets more rapidly than financial assets. Although these asset distributions
do not separately
show private retirement
savings
such as those in IRAs, and pension
assets are
specifically
excluded, it is unlikely that a large share of the financial
assets represented
in table II-13 would fall into one of the other categories of retirement
savings (IRAs, CODAs, etc.) discussed
earlier.
Financial
assets did account
for 46 percent of household
wealth in
1980, but these assets are less unilormly
distributed
than property
or pension wealth.
Liquid assets, such as funds in checking accounts, savings accounts,
stocks and bonds, are the most common assets held by the elderly.
Friedman
and Sjogren tound that 81 percent of households
headed
by a person aged sixty-four
to sixty-nine reported some liquid assets
on the 1975 Retirement
History Survey. However, the average value
of held assets by this group was more than five and one-half times
the median amount, which indicates
that the wealthier
elderly hold
a disproportionate
share of assets. 23
The long-term
effects of tax incentives
aimed at individual
retirement savings are, of course, uncertain
at this point. If these programs
have their intended result, they will raise the level of savings, possibly
increase
the share of financial
assets in household
portfolios,
and
cause a wider distribution
of private savings in general.
Employment
Income
of the Elderly
Most analyses of income security tor elderly people do not address
their employment
income, chiefly because relatively few older people
participate
in the labor force. On the basis of the historically
low
labor-force
participation
rates of elderly women, it is safe to conclude
that, thus far, most women have not relied on earnings
to meet a
large share of their income requirements.
Elderly men, in contrast,
have traditionally
had higher labor force participation
rates than
women although
the male rate has been declining steadily for nearly
a century (see table II-14). This decline was relatively
slow around
the turn of the century;
the single greatest
decline occurred
during
the 1930s, when the United States experienced
the highest unemployment
rates in its history. That more than half of the elderly men
and more than nine out of ten elderly women did not work during
2_Joseph Friedman and Jane Sjogren, "Assets o[ the Elderly as They Retire," Social
Security Bulletin, vol. 44, no. 1 (January 1981),p. 26.
7O
TABLE
Labor-Force
Source:
Participation
and Older
II-14
Rates for Individuals
for Selected
Years
Age 65
Year
Men
(Percent)
Women
(Percent)
1890
1900
1920
1930
1940
1950
! 960
1970
68.3
63.1
55.6
54.0
41.8
41.4
30.5
24.8
7.6
8.3
7.3
7.3
6.1
7.8
10. 3
10.0
U.S. Bureau of the Census, Historical Statistics o]the U_lited States (Washington, D.C.: U.S. Government Printing Office, 1975), p. 132, Series D 29-41.
the 1930s
retirement
a pension.
tinues
to
is remarkable,
considering
program
and that only
that there was no Social
10 to 15 percent,
at most,
Security
received
Today
fewer than one in five men over age sixty-five
conwork.
The historical
reliance
of the elderly
on earnings
suggests
that it might
not be unreasonable
in the future
to expect
a
greater
portion
of the elderly's
income
to come from wages
and salaries. For this to happen,
though,
a trend dating
back a hundred
years
would
have to be reversed.
Cash
The
Assistance
1935
Social
Programs
Security
Act established
the
Old-Age
Assistance
(OAA) program
and the Aid to the Blind (AB) program
in addition
to
the Old-Age
Retirement
Insurance
program.
The OAA program
offered states grants-in-aid
on a matching
basis to enable
the states
to
help needy aged persons.
The federal
government
reimbursed
states
for expenditures
under
the program
using a matching
tormula
that
generally
resulted
in higher
federal
matching
to low-income
states.
The states designed,
implemented,
and administered
the programs
through
district
or county
offices,
or through
local agencies
under
state supervision
within
minimal
federal
requirements.
Federal
financing
came from general
revenues
while state financing
came from
either
state or local funds.
Later,
the Aid to the Permanently
and
Totally
Disabled
(APTD)
as OAA under
the Social
program
Security
was established
Act.
on the
same
basis
71
The 1972 Social Security amendments
established
the Supplemental Security Income (SSI) program, which was implemented
on February
1, 1974. SSI replaced
the OA, AB, and APTD programs
and
completely
altered the federal-state
relationship
in providing
assistance to needy persons in the adult aid categories. The Social Security
Administration
administers
SSI and regulations
are established
at
the federal level. The states were left with only a supplementary
role.
In January
1974 the federal guarantee
for a person without other
income and living in his or her own household
was $140; an eligible
couple in similar circumstances
was guaranteed
$210. Individuals
or
couples living in someone else's household were eligible for one-third
less. The federal program
is financed from general revenues.
States
were given the option of supplementing
the federal benefit. This supplement could be administered
either by the state itself or by Social
Security
in the state's behalf. Eligibility
is determined
on the basis
of income, resources,
and status as aged, blind or disabled.
SSI was intended
to provide a nationally
uniform income floor for
people eligible to receive benefits. It sought to raise benefits in states
where payments
were traditionally
low. The higher guarantee
levels
in conjunction
with uniform assets tests, lien, and provisions for relatives' responsibility
expanded
the coverage to a broader base of the
needy. The program
also sought to limit or decrease the fiscal burden
of adult welfare programs
at the state and local levels. Finally, the
federalization
of this program sought to provide uniform and efficient
administration.
The program
has been relatively
successful
in meeting its goals.
Participants
in one of the predecessor
programs
were automatically
converted
to SSI and generally
achieved a significantly
higher economic status because of the increased
benefit levels. The poorest of
people automatically
transferred
benefited most. 24 The program
also
extended
assistance
to more needy people.
One concern about the program
is that significant
numbers
of people who appear to be eligible for SSI do not participate.
While this
is probably
the case, empirical
analysis
has found that individual
perceptions
of need and actual benefit eligibility
are significant
in
explaining
nonparticipation
in SSI. People who perceive they have
adequate
resources
to get by on and those who are entitled to small
monthly
benefits are less likely than others to participate
in SSI.
24Sylvester
Assistance
18-46.
72
J. Schieber,
Populations,"
"First Year Impact of SSI on Economic
Status of 1973 Adult
Social Security Bulletitz, vol. 41, no. 2 (February
1978), pp.
Lack of information
about the program
and concerns
about social
stigma also help explain why some eligible people do not participate
in SSI. 2_
SSI benefits are indexed to increases
in the consumer
price index.
Since 1974, the basic federal guarantee
has doubled, reaching $284.30
for a single person and $426.40 for a couple in July 1982. SSI cash
benefits
administered
by Social Security
rose from $5.1 billion in
1974 to $8.5 billion in 1981. According
to published
Social Security
data, the number
of elderly SSI recipients
has decreased
from 2.3
million in 1974 to !.7 million at the end of 1981. 2_ But, the Social
Security
Administration
classifies
SSI recipients
according
to their
initial basis of entitlement.
Thus, at the beginning
of 1974, 87,000
recipients
over age sixty-five were classified as blind or disabled,
but
by the end of 1981, the number
of elderly blind or disabled SSI recipients
had climbed
to 433,000. 27 The total number of elderly SSI
recipients
has remained
relatively constant
over the period.
There is substantial
overlap in the SSI and Social Security
retirement for the elderly. At the end of 1980 about 70 percent of aged SSI
recipients
were also receiving
an average monthly
Social Security
retirement
benefit of $198.56. 2_ It is hoped that the future income
security role of SSI will diminish as other components
of the retirement system mature. Although
the percentage
of all elderly people
receiving cash assistance
benefits has steadily declined over the past
three decades, it is unlikely that the need for a cash assistance
program for the elderly will ever be totally eliminated.
In-Kind
Benefit
Programs
Beginning
in the mid-1960s
and accelerating
through
the 1970s,
public policy has moved toward meeting individual
needs through
in-kind benefits. Bv far the largest of these is the Medicare program.
Except for Medicare,
which is targeted at Social Security and Railroad Retirement
beneficiaries
over age sixtv-five and disabled
persons who have been receiving Social Securitv or Railroad Retirement
2_John
ipation
21.
2_U.S.
1982),
271bid.,
2sU.S.
plement,
A. Mencfee, Bea Edwards,
and Svlvester
J. Schieber,
"Analysis
of Non-particin the SSI Program,"
Social Security Bulletin, vol. 44, no. 6 (June 1981), pp. 3Social Security
Administration,
table M-19, p. _27.
table M-18, p. 29.
Social Security
Administration,
1980, table
Social
Social
Security
Security
Bulletin,
Bulletin
vol. 45,
Ammal
no. 4 (April
Statistical
Sup-
i63, p. 226.
73
benefits for two years or more, the remaining
benefits are granted
on a needs-tested
basis. 29
Table II-15 shows the totals for various kinds of federal benefits to
the elderly in 1979. By 1981, annual Medicare costs had increased to
$42.5 billion. 3° Health care programs
have continued
to grow more
rapidly than other benefits programs,
but there has certainly
been
significant
growth in each of these categories
over the past couple of
years.
The Medicare program
has to be considered
in the general context
of Social Security and broader retirement
policy issues. The remaining programs
are important
parts of what has come to be called the
social safety net. Although
programs
will continue
to have an important
role, retirement
policy should be developed with the goal of
minimizing
the need for these programs.
The nature and magnitude
of these programs
can be assessed only in the context of perceived
needs and budgetary
constraints
at any particular
time. To a large
extent, these needs and constraints
are determined
politically,
and
thus they defy projection.
Continuing
Evolution
of the U.S. Retirement
System
The programs
that now provide retirement
income security continue to evolve. Although it is possible to focus on separate
components of the programs
when deliberating
policy, it is necessary
to
TABLE II-15
Federal
In-Kind Benefits for the Elderly, 1979
In-Kind Benefits
Value
(Millions)
Medicare
$24,647
Medicaid
4,329
Food Stamps
512
Subsidized Public Housing
1,634
Other In-Kind
59
Total In-Kind Benefits
$31,181
Source: The Budget o[ the United States Government, Fiscal Year 1981 (Washington,
D.C., 1980),p. 267.
2_Amore complete description of these programs can be found in EBRI's Coverageand
Benefit Entitlement and Income Levels and Adequacy studies.
_°Budget of the United States Governme_lt,Fiscal Year 1983 (Washington, D.C., 1982),
pp. 5-161.
74
understand
where current
policies may lead us before we consider
various options that will change the mix of program
components.
EBRI has undertaken
a major retirement
policy research project to
evaluate
the long-term
implications
of present policies and the potential effects of various policy alternatives.
Chapter III presents
an
analysis of future income levels for the elderly by projecting
current
policies into the future. The remaining
chapters
take up the Social
Security problems
being broadly discussed
by politicians,
the news
media, and policy analysts concerned
with retirement
and economic
policy issues.
75
III. Retirement Benefit
Current Policy
Levels Under
Chapters
I and II described
the evolution of various programs
and
resources
that provide income security to elderly people. The modifications to the Social Security program now being considered
have
far-reaching
implications
not only for beneficiaries
and taxpayers,
but for other income security programs
as well. Before we consider
the Social Security financing situation and various policy options for
changing
the mix of program
components,
it is necessary
to understand where the current policies would lead and how the results of
current policies would compare
with the results of alternative
policies. This chapter, therefore, begins with the development
of a framework for evaluating
the potential
of current programs
and policies
that will provide income security for the elderly of the future.
The analysis in the chapter
is based on a microsimulation
model
that projects into the future the patterns
of work, earnings,
marital
status, retirement,
and death for a sample of the United States population between
the ages of twentv-five
and sixty-four
in 1979. The
model simulates
people's working careers, their retirement,
and the
level of income they receive from various sources throughout
their
lives. The analysis in this chapter
focuses on the sources and levels
of income that today's workers might expect at the present Social
Security normal retirement
age if current policies are continued.
The
model is also the basis for analysis in chapter VI. There the model is
used to evaluate
the implications
of various potential
changes to the
Social Security program.
A Framework
for Evaluation
One way to evaluate policy changes is to make the changes and
then observe the response. For example, the Social Security retirement age could be raised and the effects of that change monitored
as
the new age criteria were implemented.
If factors other than Social
Security's
retirement-age
criteria
are important
in determining
actual retirement
behavior, however, this policy change may not have
the desired result. In other words, the policy prescription
for solving
the problem
may be frustrated
bv the way workers and their employers act in response to it.
Another way to evaluate
policy is to construct
a model--a
mathematical abstraction
that embodies a behavioral
theory--which
would
77
approximate
the workings of the system being analyzed. Although it
is impossible
for such mathematical
tools to completely
capture realworld phenomena,
models help in understanding
current events and
in guessing the likelihood of future events under alternative
assumptions and policies.
The use of quantitative
economic
models dates back to Jan Tinbergen's 1939 analysis of the macroeconomic
structure
of the United
States economy. I An alternative
approach
to modeling
macroeconomic structures
was developed by Wassily Leontief in the early 1950s. 2
The latest approach
for explaining
economic behavior through modeling was originally
developed
by Guy Orcutt, 3 who devised a microanalytic
model
that could be used to analyze
socioeconomic
behavior.
Macroeconomic
models are used to project aggregate
economic
flows on the basis of alternative
assumptions;
they can deal with the
total economy or selected segments. Microeconomic
models, in contrast, use the individual
or the household
as their basic unit of analysis. While the micro unit has always been the basic building block
for economic
behavioral
theory, microanalytic
modeling has become
popular only in recent years, as household
survey data have become
available
and computer
technology
has advanced.
The Employee
Benefit Research Institute
has undertaken
a large
retirement
policy research project, based on a microsimulation
of a
sample of the United States population,
to evaluate
the long-term
implications
of present policies and the potential
effects of various
policy alternatives.
Estimating
the distribution
of future retirement
income requires the development
of representative
work and earnings
histories
that include periods of coverage
under retirement
plans.
This information
can then be used to calculate
retirement
benefits,
earnings
replacement
rates, and the like. In addition,
the level of
income from programs
such as Supplemental
Security Income can
be estimated
to obtain a more comprehensive
picture of the elderly's
income security over time.
To perform these tasks, ICF Incorporated
has developed
a model
that uses recent data on pension plan characteristics,
labor-force participation,
and pension coverage. A version of this model was develIJan Tinbergen, Statistical Testing o[ Business Cycle Theories (Geneva, Switzerland:
Society of Nations, 1939).
2Wassily Leontief et al., The Structure o[ the American Economy (New York: Oxford
University Press, 1951).
_Guy Orcutt, "A New Type of Socio-Economic System," Review o] Economics and
Statistics, vol. 58, no. 5 (May 1957),pp. 773-797.
78
oped in 1980 for the Office of Pension and Welfare Benefit Programs
at the U.S. Department
of Labor and for the President's
Commission
on Pension Policy. + During 1981, ICF substantially
enhanced this model
for the American Council of Life Insurance.
For the project discussed
here, ICF, under contract
for EBRI, has further revised the model so
that it can better measure
the impact of changes in Social Security
policy.
Pension and Retirement Income Simulation
Model--The
Pension and
Retirement
Income Simulation
Model (PRISM) has three basic components: an input database,
a work history simulation,
and a retirement benefit simulation.
The input database
contains
survey and
earnings histories on 28,000 persons. The work historv simulator
uses
dynamic
aging simulation
techniques
to generate
work, wage, and
family histories for records used in the simulation
from the population database.
The work history element of the model assigns a set
of actual plan characteristics
to each person covered bv an employer
retirement
program.
The model is linked to the ICF MacroeconomicDemographic
Model in order to produce long-term
estimates
consistent with the macroeconomic
and demographic
projection
of the U.S.
economv. The retirement
benefit simulator
calculates
the retirement
benefit payable from each of the plans in which each person participated, plus that person's
Social Security
entitlement
and benefits
from IRAs established
bv individuals.
Finally, the model calculates
benefits for low-income
individuals
from the Supplemental
Security
Income
program.
A more detailed
description
of the model is presented in appendix
A.
Assumptions
[+orthe Base Case Simzdations--To
actually
carry out
the simulation,
analysts
must make certain assumptions
about the
work histories and retirement
benefits of families. To the extent possible, the assumptions
used in the current policy simulation
parallel
assumptions
used in the intermediate
Social Security valuations, known
as the Alternative
II-B assumptions
(from the section
in the 1982
Social Security
Trustees
Report in which they are stated). A brief
description
of various key assumptions
follows.
Patterns
of employment
bv industry,
age, sex, hours worked per
year, and part-time/full-time
status do not change over time. The level
aJames Schulz and his colleagues
at Brandeis
University
pioneered
the initial development ot microanalytic
pension simulation
models. The model presented
here draws
on Schulz's
work and extends
it for application
to policy analysis.
79
of employment
is constrained
to match the ICF macroeconomic-demographic
model forecasts of employment
rates by age and sex during each year of the simulation.
Current
patterns
of wage growth
based on age, sex, and job-change
status are assumed to remain constant. In the aggregate,
real wages are assumed
to grow at the rates
forecast by the ICF macroeconomic-demographic
model by age and
sex. While the wage growth of an individual
or even of a particular
cohort may vary from the average, overall real wages grow in a pattern close to that assumed
in the Alternative
II-B scenario. For each
person, simulation
of job change is a function of age, part-time/fulltime status, and job tenure. These probabilities
are assumed
not to
change over time.
The model uses the Social Security Administration's
"Alternative
II-B" assumptions
on mortality
and fertility, which reflect projected
improvements
in mortality
as well as projected
changes in fertility
rates. These assumptions
are also consistent
with the ICF macroeconomic-demographic
model forecasts. Disability
rates are assumed
to remain constant
by age and sex over the simulation
period.
The current cross-sectional
patterns
of marriage,
divorce, and remarriage
by age and sex arc assumed to continue over the simulation
period; the assumptions
are consistent
with the assumptions
about
marital status used by the Social Security Administration
in its population forecasts. Prices are assumed to increase at the rate specified
under the Alternative
II-B assumptions.
Table III-1 shows these rates
of increase in the CPI.
In the current
policy simulation
of retirement
benefits, 70 percent
of married
men with an annual pension benefit of less than $3,000
in 1980 dollars are assumed
to elect not to take the postretirement
joint-and-survivor
option in their plan; 30 percent of married
men
with annual pension benefits of $3,000 or greater are assumed not to
take it. For married
women, it was assumed
that 75 percent
with
annual pension benefits less than $3,000 in 1980 dollars do not take
the postretirement
joint-and-survivor
option; 50 percent of married
women with annual
pension benefits of $3,000 or greater in 1980
dollars are assumed
not to take the option.
Table III-2 summarizes
the assumptions
used to estimate
participation in supplemental
thrift and savings plans for people eligible to
participate
in them. People who are vested in a defined-contribution
plan and then change jobs are assumed
to roll their lump-sum
payment over into an IRA if the value of the lump-sum
distribution
is
$1,750 or more in 1980 dollars and if they are age thirty or older.
People who have lump-sum distributions
with a value less than $1,750
8O
Assumed
Calendar
TABLE III-1
Consumer
Price Index
Used in Simulations
Increases
Consumer
Price
(Percent)
Year
1979 _
1980"
1981 '_
1982
1983
1984
1985
1986
1987
1988
1989
199O
1991 - 1994
1995-1999
2000 and later
Source:
_Actual
Index
13.3
12.4
10.3
6.9
7.9
7.4
6.6
5.8
5.5
5.3
4.9
4.5
4.0
4.0
4.0
1982 Annual Report o[Trustees
o[the Federal Old-Age a_d Suta,ivors lnst_ra_ce
and Disability l_zsura_we Trust Funds (Washington,
D.C.: Social Security
Administration,
1982), p. 29.
consumer
price index data are used for these years.
TABLE 111-2
Assumptions
about
Savings
Plan Participation
Employer
Hourly Wage Level
(1980 Dollars)
Less than $4
$4-$7
More than $7
Low
(Percent)
20
4O
60
Match
Medium
(Percent)
25
50
75
Rate a
High
(Percent)
30
60
90
Source: Developed by the author and project staff of ICF Incorporated.
;'Plans that match one dollar of employee contributions with less than fifty cents of
employer contributions are low-match plans. Plans that match one dollar of employee
contributions with fifty to ninety-five cents are medium-match plans. Plans that match
one dollar of employee contributions with one dollar or more of employer contributions
are high-match plans.
in 1980 dollars or who are younger than age thirty arc assumed
to
cash these benefits out. People with deferred vested benefits from
defined-benefit
plans are assumed to start receiving payments
in the
81
first year they are eligible. Similarly, widows of vested men who chose
the joint-and-survivor
option are assumed
to draw on these benefits
in the first year they are available,
provided
the widow is eligible
under the rules of the plan.
The initial benefit in defined-benefit
plans was indexed to changes
in wages for flat and unit benefit formulas. Defined-benefit
plan formulas based on final pay and all defined-contribution
plan formulas
were held constant.
No changes in participation,
vesting, or other
standard
provisions of plans were assumed.
Table III-3 summarizes
the assumptions
used in modeling the adoption of IRAs by noncovered
workers. These estimates
do not include
workers assumed to roll over vested benefits into IRA arrangements.
Ninety percent of noncovered
workers who adopt IRAs are assumed
to contribute
to them annually.
The proportion
of persons assumed
to adopt tax-deductible
IRAs
in 1982 under the provisions
of the Economic
Recovery Tax Act of
1981 is equal to 80 percent of the proportion
of uncovered
persons
who contributed
to IRAs in 1979 on an age and earnings
basis. In
future years, it is assumed that 80 percent of the people who adopted
IRAs will contribute
to them. New IRAs were assumed
to be established using the assumptions
in table III-3. Table III-4 shows the
contribution
levels assumed
for these IRAs.
Pension coverage
is assumed
to increase
at rates consistent
with
the moderate
growth assumptions
used in EBRI's Income Levels and
Adequacy study, s No growth in pension coverage
is assumed in the
mining industry,
the federal government,
state or local government,
or agricultural
sectors. Coverage is assumed
to grow at an annual
rate of 0.33 percent in the manufacturing
industry;
at 0.44 percent
TABLE III-3
Assumptions
about the Annual Probability of
Noncovered Workers Adopting an IRA
Family
Earnings
Level
(1980 Dollars)
Less than $12,500
$12,501 -$25,000
More than $25,000
Percentage
of Workers
by Age
25-39
40-54
55-59
60 or Above
0.40
0.60
3.75
0.80
1.20
3.25
1.00
1.40
3.50
1.00
1.80
5.00
Source: Developed bv the author and project staff of ICF Incorporated.
SEmployee Benefit Research Institute, Retirement Income Opportunities in an Aging
America: htcome Levels and Adequacy (Washington, D.C.: EBR[, 1982), p. 104.
82
TABLE III-4
Assumptions
Family Earnings
Level
(1980 Dollars)
about
IRA
Individual IRA
Contributions
Spousal IRA
Less than $13,500
70% of the smaller of
80% of the smaller of
(1) 15% of earnings or
(1) 15% of earnings or
(2) $2,000
(2) $2,250
$13,500 $25,000
70% of $2,000
80% of $2,250
More than $25,000
90% of $2,000
95% of $2,250
Source: Developed by the author and project staff of lCF Incorporated.
in the transportation
industrv
and among the self-employed,
0.57
percent per year in the finance industry; and at 0.87 percent per year
in the construction,
trade, and service industries.
Current
Policy
Simulation
Results
The model was used to simulate the work histories and retirement
income resources
available to a representative
sample of persons between the ages of twenty-five
and sixty-four
in 1979. This analysis
focuses on the sources and levels of income estimated
through the
simulation when the sample persons reach age sixty-five. In this way,
income levels and composition
can be viewed as they change over
time for successive
cohorts of people when they reach the current
normal retirement
age under Social Security.
PRISM estimates earnings and benefits from Social Security, pensions, IRA accruals,
and Supplemental
Security Income. This discussion will use the family as the unit of analysis, so the receipt and
level of income are reported on that basis. The two types of families
that are considered
in the analysis are: (1) single persons, including
persons who have never married, those whose spouses have died before reaching age sixty-five, and divorcees; and (2) married couples,
including intact couples generally at the point the older spouse reaches
age sixtv-five. The presentation
of the results breaks the prime working-age population
in 1979 into four age cohorts, based on age in 1979
(see table III-5). The assignment
of single persons to their respective
cohorts was straightforward.
As for married couples, when both husband and wife were in the same cohort,
the sources and levels of
familv income were estimated
at the point when the older person
reached age sixty-five in the simulation.
When husband and wife were
in separate
cohorts, the sources and levels of income were estimated
83
TABLE 111-5
Cohorts
for Analysis by Ages in 1979 and Years When
Cohorts Reach Age 65
Individual
Ages in 1979
25-34
35-44
45-54
55-64
Years Reaching
Age 65
2010 2019
2000-2009
1990 1999
1980-1989
Source: Computed by the author.
as each person reached age sixty-five and were reported
in both cohorts. Because the date of death is simulated,
some persons who are
included
as married
in one cohort are treated as single in a later
cohort when they reach age sixty-five because their spouses are assumed to have died.
Sources and Levels o/Income--The
elderlv are often characterized
as being primarily
dependent
on Social Security,
although
Social
Security
was never intended
to be the sole source of retirement
income for all Americans
when it was established.
EBRI's previous
research
has shown that significant
numbers
of elderly households
also depend on earnings,
pensions, and income from other assets as
major sources of cash income:' Chapter II of this report suggests that
the maturing
of the pension system in the United States and the
increased
incentives
tor individual
retirement
savings will change
the mix of cash resources
available
to the elderly in the future. The
results of the current policy simulation
also suggest that this will bc
the case.
Earnings--Table
III-6 shows the estimated
percentages
of families
with earnings
and the level of average simulated
family earnings
for
the various age cohorts. The trend of declining
receipt of earnings for
the elderly in the future was consistent
with long-term
retirement
patterns
and expectations.
The gradual
increase
in average family
earnings in 1982 dollars was consistent with assumed real wage growth.
While labor force participation
rates are low for all people over age
sixty-five, the labor torte participation
rates decline steadily beyond
that age. The treatment
of married
couples also tends 1o raise the
estimated
receipt of earnings
because the analysis generally
focuses
_Ibid.
84
TABLE
111-6
Age in 1979 and Estimated
Percentages
of Families
to
Have Earnings,
and Average Family
Earnings
in 1982
Dollars, at Age 65, by Marital
Status
All Families
Cohort
Age in
1979
25-34
35-44
45-54
55-64
Source:
Percentage
with
Earnings
36
38
40
44
Tabulation
Average
Amount of
Earnings
$19,754
19,384
15,825
13,331
Married Couples
Single Persons
Percentage
Average
with
Amount of
Earnings
Earnings
46
$22,377
49
21,198
48
18,479
55
15,498
of PRISM current policy simulation
Percentage
Average
with
Amount of
Earnings
Earnings
20
$10,635
22
13,039
27
8,486
28
6,917
results.
on the year in which the older spouse reaches age sixty-five. Aworking
wife of a sixty-five-year-old
retiree who is more than three years
younger than her husband would not be eligible for Social Security
retirement benefits and in many instances might reasonably be expected to work until at least age sixty-two.
The plausibility of the projections can be judged against estimated
earnings levels reported by the elderlv for a recent year. Table III-7
shows the 1979 earnings for elderly single persons and married couples estimated from the March 1980 Current Population Survey. The
rates of receipt of earnings at age sixty-five estimated by PRISM are
slightly lower for the group of people aged fifty-five to sixty-four than
the rates for people right at the normal retirement age for Social
Security when the March 1980 CPS was conducted. However, they
are very close. One factor that could account for the difference in the
CPS and simulation results is a slight variation in the measurement
period. The March CPS earnings data are gathered on the basis of
prior year experience. So persons who were sixty-five in March 1980
would have been reporting earnings in the year in which they were
sixty-four. The receipt of earnings for sixty-six-year-olds on the CPS
closely correlates with the PRISM results for the oldest cohort at age
sixty-five.
It should also be kept in mind that earnings during the year do not
necessarily indicate full-time or year-round employment in either real
life or the simulation. For example, the employment rates of the
elderly in March 1980 shown in table III-8 are consistentlv lower than
the earnings receipt rates in table III-7. The elderlv as a group are
more likely than younger workers to work only part time or peri85
TABLE
III-7
Estimated
Percentages of Elderly Families with
Earnings, and Level of Earnings in 1982 Dollars for
Elderly Families, by Marital Status in 1979
Age of
All Families
Elderly
Person in Percentage Average
March
with
Amount of
1980 _
Earnings Earnings
65
66
67
68
69
70
7i
72 or over
51.1
46.2
39.6
35.2
32.2
30.7
27. l
12.3
Married Couples
Single Persons
Percentage Average
with
Amount of
Earnings Earnings
Percentage Average
with
Amount of
Earnings
Earnings
$14,832
11,566
10,573
i 1,091
l 0,482
9,168
7,906
7,888
62.6
56.3
51.6
49.4
43.0
46.2
37.4
23.8
$17,554
12,989
12,803
13,197
13,419
l0,244
9,675
9,316
36.5
33.0
25.7
18.4
21.0
16.8
17.7
6.5
$8,607
8,732
5,675
4,913
5, i02
6,570
4,469
5,298
Source: EBRI tabulation of the March 1980Current Population Survey.
_'In the case of married couples, the age is the age of the older spouse.
TABLE
Employment
Married and
Living with Spouse
Men
Women
(Percent)
(Percent)
Age
65
66
67
68
69
70
71
72 or over
Source:
III-8
Rates of the Elderly
33.0
29.3
27.9
25.9
23.9
26.9
19.3
11.5
Single Persons
Men
Women
(Percent)
(Percent)
15.3
9.2
I 0.2
9.7
4.2
6.0
6.9
2.9
EBRI tabulationsot
in March 1980
25.3
27.1
17.3
26.1
17.2
15.4
13.4
8.1
25.0
23.1
18.9
10.8
16.5
12.6
12.5
3.7
the March 1980 Current Population
Survey.
odically.
It is not surprising,
thcrciorc,
that cross-sectional
employment
rates
measured
in a particular
week
of the year
would
be
somewhat
lower
than
annual
rates of employment
[or the elderly,
either
86
part
or lull
time,
measured
over
the
whole
year.
In the long term, the simulation
projects a declining
rate for the
receipt of earnings,
as a result of the continuing
trend toward earlier
retirements.
The early retirement
phenomenon
will be exacerbated
as more people become eligible for pensions. In fact, early retirement
may become more pronounced
than the simulation
suggests if employers continue
recent trends of liberalizing
early retirement
provisions in their pension programs.
Ahernatively,
it may turn around
as life expectancy
improves,
and if the retirement
age for Social Security were to be adjusted
upward. In the simulation
of the pension
system, PRISM does not provide for liberalization
of early retirement
provisions.
While the long-term
trend is toward a reduced
rate of receipt of
earnings,
the rate projected
for married couples is relatively
stable
for the three younger, ten-year cohorts. The primary explanation
lies
in the increased labor-force
participation
of married women. Because
married
women
today are more likely than their counterparts
in
earlier
generations
to have careers
that are comparable
to men's
careers,
they are also likelv to have somewhat
higher labor-force
participation
rates in their older years than married
women have
traditionally
had. So the stable levels of receipt of earnings projected
for the younger cohorts of married couples are partly a transitional
phenomenon
resulting from modified work patterns of married women
over the past ten to fifteen years.
There is a steady increase
in average earnings
at age sixty-five,
particularly
for the three oldest cohorts simulated.
This is a result of
real wage growth that is assumed in the simulation.
This increasing
earnings
phenomenon
persists into the youngest
cohort for the married couples. For single persons, average earnings
at age sixty-five
peak for the thirty-fiveto forty-four-year-old
cohort. They decline
somewhat
thereafter,
because of early retirements
among those participating
in pensions and because of the shift from full-time to parttime employment
among older cohorts.
Social Security--Table
III-9 presents
the estimated
rates of receipt
of Social Security and average family benefit levels for each of the
four decennial
cohorts. The estimates
are made at the point at which
people attain age sixty-five, in the same way that earnings
estimates
were developed.
For some persons, of course, this means that they
had been receiving benefits for some period prior to the point at which
the estimate was made. Under the current policy simulation,
the early
retirement
provisions
in the present law are simulated
over the full
period. At the same time, some people will not vet be receiving ben87
efits because they are continuing
to work at earnings
levels where
the earnings
test reduces their benefits to zero.
The effects of the declining
prevalence
of earnings reported earlier
are evidenced
by the increasing
rates of receipt of Social Security for
each successive cohort as these people reach age sixty-five. The average annual benefit levels shown in table III-9 are all in 1982 dollars.
There is a steady pattern of increasing benefits, in real terms, for each
successive cohort. This phenomenon
is the result of the benefit structure now in place that bases initial benefits on the level of real wages.
Because the model assumes
real wage growth, consistent
with expectations
for the future of Social Security,
initial benefit levels are
driven upward
by the inherent
growth in the system.
This benefit growth phenomenon
was expected and the growth in
average benefits estimated
here is consistent
with prototypical
workers often described
by the Social Security Administration.
Table III10 shows annual initial benefit entitlements
for three such prototypical workers
developed
by the Office of the Actuary at the Social
Security
Administration.
The benefit levels cannot be directly compared between
tables III-9 and III-10 because they are derived on
different bases.
The average benefit estimates
in table III-10, for example, assume
that the beneficiary
has earned exactly the average covered wage
during each year after 1937 or their twenty-first
birthday,
whichever
is later, and the year the person reaches age sixty-five. It is unlikely
that anyone would have a forty-four-year
career with no breaks for
unemployment
or sickness and be right at the average earnings
level
every year throughout
that career. This is not meant to criticize the
TABLE
III-9
Percentages
of Families
to
Receive
Social
Security
Benefits
at Age 65, and Average
Annual
Benefits
in 1982 Dollars,
by Marital
Status
All Families
Cohort
Age in
1979
Percentage
to Receive
Benefit
Average
Amount
of Benefit
Married
Percentage
to Receive
Benefit
25-34
93
$9,868
94
35-44
92
8,128
92
Couples
Average
Amount
of Benefit
Single
Percentage
to Receive
Benefit
$11,546
9,530
45-54
88
6,394
91
7,410
55-64
85
5,775
88
6,819
Source: Tabulations of PRISM current policy simulation results.
88
93
Persons
Average
Amount
of Benefit
$7,300
90
5,933
84
79
4,662
4,040
TABLE
III-lO
Past and Future Social Security Benefit Levels, in 1980
Dollars for Individuals Retiring at Age 65, 1952-2054
Annual Initial Benefit Amounts
Calendar
Year
1952
1955
1960
1965
1970
Low
Earner
Average
Earner
Maximum
Earner a
$ 2,600
3,600
2,900
3,1 O0
3,200
$ 3,500
3,600
4,000
4,200
4,600
$ 4,000
4,000
4,500
4,700
5,200
1975
1980
1990
2000
2010
3,400
3,900
3,700
4,400
5,200
5,000
5,900
5,600
5,700
8,000
5,900
7,400
7,500
9,500
12,000
2020
2030
2040
2054
6,1 O0
7,200
8,600
11,000
9,500
11,200
13,200
17,000
14,700
17,400
20,600
26,400
Source: Office of Actuary, Social Security Administration,
Note:
Benefits are rounded to nearest $100.
_'Earnings equal to the Social Security earnings base.
estimates
over time
in table III-10,
under
a stated
because
they do
set of assumptions.
show
November
how
19, 1980.
benefits
grow
The average
benefits
in table III-9, in contrast,
are derived
on the
basis of large numbers
of simulated
work histories,
including
a great
deal of variation
from the norms
applied
in the example
shown
in
table
III-10. PRISM
simulates
periods
of unemployment,
variations
in individual
that
affect
wage
benefit
growth,
levels.
early retirement,
The important
techniques,
the estimated
growth
pected.
In both cases, benefits
are
the future.
and many
other factors
point
is that under
both
in benefit
levels
projected
to grow
behaves
as
in real terms
exin
Pensions--Chapter
II provided
a fairly
detailed
discussion
of the
maturing
of the pension
system
in this country
which
implied
that
the rates of receipt
of pension
benefits
may be considerably
higher
in the future
than they are today.
89
Table III-11 presents the simulation
estimates
of rates of receipt of
pension benefits and average benefit levels for each of the four cohorts
considered
in this analysis. The oldest cohort, persons aged fifty-five
to sixty-four
in 1979, has by far the lowest estimated
rates for recipiency among the four cohorts. The estimates
for receipt of pension
benefits for that cohort may be somewhat
below the actual rates. By
1979, a substantial
number of people in the cohort would have already
retired.
Some of them would have been covered under a definedcontribution
plan and would have received
a substantial
cash distribution
prior to the beginning
of the simulation
period. As chapter
II discussed at length, such cash distributions
do not get recorded on
surveys such as the Current Population
Survey, which served to define
the baseline population
for the simulations
conducted
here. In subsequent cohorts, asset accumulations
under defined-contribution
plans
are converted
to a level life annuity, in nominal dollars, at retirement.
The benefit recipiency
rates are projected
to increase fairly rapidly
between the oldest and second oldest cohorts attaining
age sixty-five.
Beyond the retirement
of the second cohort these rates continue
to
grow steadily but slowly, especially
between the retirement
periods
of the third and the youngest cohorts. For workers aged twenty-five
to thirty-four,
between
two-thirds
and three-fourths
of the family
units were projected
to be eligible for a pension by the time they
reach age sixty-five.
Because there is a fairly direct linkage between the growth in wages
and individual
pension entitlements,
the average family pension benefits in 1982 dollars
are estimated
to rise steadily
over time. For
defined-benefit
plans that base benefits on years of service and final
TABLE III-I 1
Percentages
of Families to
Receive Pension Benefits at Age 65, and Average
Benefits in 1982 Dollars, by Marital Status
All Families
Cohort Percentage Average
Age in to Receive Amount of
1979
Benefit
Benefit
Married Couples
Single Persons
Percentage Average
to Receive Amount of
Benefit
Benefit
Percentage Average
Benefit
Benefit
25-34
71
$12,417
35-44
65
11,190
45-54
52
8,656
55-64
37
5,315
Source: Tabulations of PRISM current
90
75
$14,541
65
67
12,563
60
58
9,621
41
44
5,548
26
policy simulation results.
$8,701
8,823
6,496
4,718
average salary, the effect of growing wages is direct. In unit-benefit
plans, especially prevalent
in union-negotiated
pensions, increases in
benefit levels are generally
negotiated
in accordance
with negotiated
wage levels. In defined-contribution
plans there is also a direct link
between the annual contribution
(and, therefore, total retirement
asset accumulation)
and wages. In each instance, the assumed growth
in future average wage levels portends substantial
growth in pension
benefits for successive cohorts of retirees.
The results of these simulations
run counter to the conventional
wisdom that often influences
the development
of retirement
policy
in general or pension policy in particular.
For example, Alicia Munnell, a Vice-President
at the Federal Reserve Bank of Boston, concludes:
Because of the influence of industrv structure on pension
coverage, the percentage of the work force covered by pension plans is not expected to increase significantly in the
future. Industries with traditionally high pension coverage,
such as manufacturing,
are expected to employ a declining
share of workers, while employment in industries with low
pension coverage, such as retail trade is projected to increase. Moreover, small businesses, which employ the bulk
of noncovered workers are unlikely to adopt pension plans. 7
Setting aside the question of future growth in pension coverage for
the moment,
a basic question is whether the current
prevalence
of
pensions
will mean higher, lower, or constant
rates of receipt of benefits in the future. The analysis of Social Security in chapter I, referring to figure I-2, showed that rates of receipt of benefits for elderly
people under Social Security did not approach
rates of coverage
of
workers until thirty-five
years after the program
began paying benefits. The analysis of active participants
in pension plans relative to
beneficiaries
in chapter
II showed a clear pattern of increased
recipiency rates for defined-benefit
plans as they matured.
The analysis
in chapter II also showed that most pension plans in this countrv are
relatively
young, so even if there is no future growth in pension coverage, the maturing
of existing plans can be expected
to result in
higher rates of receipt of pension benefits in the future.
This conclusion is consistent with that of analyses that assume no future growth
implications
in pension coverage. In the simulation
work evaluating
the
of a mandato_
pension system proposed
by President
7Alicia H. Munnell, The Economics ofPrivate Pensio_ls(Washington, D.C.: The Brookings Institution, 1982). p. 200.
91
Carter's Commission
on Pension Policy, there were explicit assumptions that there would be no future growth of pension programs. 8 Yet
under these assumptions,
the commission
estimated
that the proportion of workers aged twentv-five
to twenty-nine
in 1979 who would
receive pension benefits at age sixty-five
would be 80 percent
for
married couples and 66 percent for single persons. _
More than half the wage and salary workers aged fifty-five to sixtyfour in 1979 working at least half time on a regular basis had already
acquired a vested right to a pension on their current jobs. More than
two-thirds
were participating
in a plan. Richard
Ippolito, Assistant
Administrator
for Policy, Planning, and Research at the Department
of Labor, estimates
that at least two-thirds
of the current
full-time
private-sector
work force will retire with a pension. Based on a study
in which the Department
of Labor examined
the administrative
records from a sample
of private pension
plans, the average annual
benefit of retirees during 1978 was $6,100 in 1982 dollars. I°
In comparison
with other estimates,
the simulation
results presented here are not out of line and may be relatively
conservative.
Analysts like Munnell may be correct in their predictions
that pension
coverage
will not grow in the future, but such predictions
either
ignore both long-term
and short-term
trends (discussed
in chapter II
of this report) or assume
that current
incentives
to establish
and
maintain
plans will be eliminated.
Moreover, even if coverage should
not continue
to grow, the future rates of receipt of pension benefits
will be higher than current rates.
Individual
Retirement
Savings--The
1981 Economic
Recovery Tax
Act greatly expanded
the potential of individual
retirement
accounts
by making them available
to workers already covered by a pension.
Table III-12 presents the simulated
IRA benefit recipiency
rates and
average annuities
purchasable
by the accumulations
at retirement.
The estimated
recipiency
rate for persons aged fifty-five to sixtyfour in 1979 is by far the lowest of the rates for the four cohorts. It
should be kept in mind that by the end of 1982, the first year of
expanded
availability
of IRAs, nearly one-third of that cohort will be
age sixty-five
and nearly 80 percent will be above age sixty. Many
_For a discussion o[ these assumptions, see Svlvester J. Schieber, "Trends in Pension
Coverage and Benefit Receipt," The Gercmtolo_ist,vol. 22, no. 6 (December 1982).
_President's Commission on Pension Policy, Comin_ o/ A_e: Toward a National Retirement Income Policy Appendix (Washington, D.C., 1981),chapter- 36, p. 1541.
"_Richard A. lppolito, "Public Policy Towards Private Pensions," presented at Western
Economic Association Annual Meeiings, Los Angeles, Calit., July 19, 1982.
92
TABLE
III-12
Percentages
of Families
to
Receive
IRA Benefits
at Age 65, andAverage
Family
Benefits
in 1982 Dollars,
by Marital Status
All Families
Cohort
Age in
1979
25-34
35-44
45-54
55-64
Married Couples
Single Persons
Percentage
to Receive
Benefit
Average
Amount of
Benefit
Percentage
to Receive
Benefit
Average
Amount of
Benefit
62
62
55
24
$2,615
2,696
1,686
768
68
64
59
27
$2,960
2,939
1,863
851
52
59
48
19
policy simulation
results.
Source:
EBR1 tabulations
of PRISM current
people
in this
will
cohort
have
already
retired
Percentage
Average
Benefit
Benefit
under
$ 1,939
2,291
! ,344
585
the earlier
lim-
ited IRA availability.
Nearly
70 percent
of the regular
wage and salary
workers
in this cohort
prior
to 1982 were automatically
excluded
from IRA participation.
The estimated
rate of receipt
for people
aged forty-five
to fifty-four
in 1979 is more than twice that for the oldest group,
largely
because
of the extended
exposure
to the IRA tax deductions
during
the longer
working
life under
the new policy.
The trend continues,
to some degree, with more
than 60 percent
of families
in the group
of people
aged thirty-five
to forty-four
in 1979 estimated
to receive
IRA support
when they reach age sixty-five.
The growth
in estimated
average
annual benefits
among
the oldest
three cohorts
is a direct
result
of the
period
of workers'
careers
under
the IRA provisions
in ERTA.
The estimated
recipiency
rate for single persons
in the youngest
cohort
is slightly
lower than the rate of the preceding
cohort
for two
reasons.
The first is related
to the size of the cohort
and projected
real
wage
growth.
The macroeconomic-demographic
model
constrains
the aggregate
wage growth
of this cohort
below average
wage
growth
of the total work force. The group
of people
twentv-five
to
thirtv-four
years
old in 1979 included
most of the baby-boom
generation.
Because
this particular
cohort
is so much
larger
than
the
preceding
or succeeding
cohorts,
competition
for jobs within
this
group will suppress
the overall
wage levels for these people
throughout their careers.
Since the IRA participation
estimates
are a function
of wages,
this phenomenon
will dampen
the IRA participation
rates
for the cohort.
The second
reason
that the IRA recipiency
rates do
not grow is related
to the projected
continuing
trend
toward
earlier
93
retirements.
Earlier withdrawal
from the work force reduces the period of exposure for picking up an IRA.
The early retirement
phenomenon
also affects the estimated
level
of IRA benefits in two ways. First, a shorter period of earnings
will
mean fewer years of contributions
to the IRA; fewer years of contributions
mean smaller
accumulations
with which a retirement
annuity can be purchased.
Second, and more important,
the IRA is
converted
to an annuity at the earliest year of eligibility after acceptance of pension or upon acceptance
of Social Security.
The annual
annuity's
value is adjusted
on an actuarial
basis, depending
on the
age at which it is accepted. Therefore, the earlier the retirement,
the
lower the annual benefit. Furthermore,
the annuities are paid in level
nominal dollars over the retiree's
lifetime, while average benefits at
age sixty-five are estimated
in constant
1982 dollars. Therefore,
the
earlier the retirement,
the more the benefit level is eroded by the
assumed
long-term
4 percent rate of inflation.
There is little evidence yet available
on which to base long-term
IRA utilization
rates. The assumptions
used to simulate the benefits
estimated
here may be conservative.
The newly eligible population
in 1982 was assumed to open accounts
in the first year at rates equal
to those reported
by the old eligibles during 1979 on a comparable
age and family-income
basis. The rationale
for using the 1979 IRA
participation
among the newly eligible population
was that these
people were already participating
in an employer pension program.
Some analysts argue that, other things being equal, participation
in
a pension reduces the need for individual
retirement
savings; therefore, the newly eligibles will be less likely to establish
IRAs than
similar people were under the old provisions.
There is another school of thought that argues that the expanded
availability
of IRAs will increase participation
rates in all income
and age classes. People who are participating
in a pension have higher
incomes, on average, than those not participating
and thus are more
likely to save. The Economic
Recovery Tax Act of 1981 reduced the
price of savings to pension participants
by expanding
IRA availability. Therefore,
it is likely that increased savings will result. This conclusion is also based on the assumption
that there will be a strong
"information"
effect on IRA participation
rates. The broad expansion
of IRA availability
has raised the general
level of knowledge
that
these vehicles exist, primarily
through the increased
marketing
efforts of financial
intermediaries.
The prospect of long-term
savings
of $20 billion or more a year has led to a variety of investment
opportunities
for individual
savers, and savings institutions
are widely
94
advertising
these opportunities.
The competition
for these savings is
providing
a broad level of understanding
of the IRA option and encouraging
many people to participate.
A survey conducted
for the Life Insurance
Marketing
and Research
Association
(LIMRA) in April 1982 found that 89 percent of eligible
households
knew of the change
in IRA provisions
in ERTA. This
knowledge
was found to be equally prevalent
among all age groups
except those under age twenty-five.
Their survey results showed a
strong correlation
between age and family income and the intent to
establish
an IRA in 1982. II
The results of the LIMRA survey suggest that IRA participation
and
contribution
rates will be higher than the rates used in the base case
simulations
presented
here. An alternative
simulation
was conducted
to test the effect of these higher rates on the potential
of IRAs to
provide
retirement
income. That sensitivitv
test provided
significantly higher estimates
of the number
of people contributing
to an
IRA over their working careers. Among members
of the oldest cohort
in the simulation,
43 percent
were estimated
to receive an IRA annuity, in comparison
with the base case simulation
result of 24 percent. Because the alternative
assumptions
captured
somewhat
more
low-income
workers and because
the pattern
of contributions
was
more irregular,
the average family IRA annuity at age sixtv-five was
$535 under the modified assumptions,
in comparison
with $768 under
the base simulation.
For the youngest cohort, the base case simulation
resulted in 62 percent of the families receiving an average IRA annuity
of $2,615 in 1982 dollars, at age sixty-five. The alternative
assumptions not only raised the proportion
receiving an IRA to 93.5 percent,
but also raised average annuities
to $3,325.
These results suggest that the somewhat
higher participation
rates
that may result from expansion
of the program
could make this retirement savings program a particularly
effective income supplement
for the elderly in the future. Although the alternative
assumptions
result in much higher utilization
rates and higher benefit levels over
the long term, we decided to use the more conservative
assumptions
and results throughout
the analysis of various policy scenarios.
Relationship
ofPensions
and IRAs--When
policymakers
originally
established
the IRA program
in 1974, one of their critical concerns
was that some workers would never acquire
a pension. For highly
iiLife Insurance Marketing and Research Association, The Public's Response to IRA
(Hartford, Conn.: LIMRA, 1982).
95
mobile workers and workers not covered by a pension plan for part
or all of their careers, the IRA was to be a substitute
vehicle through
which these workers could make individual
provisions
for their retirement.
With the passage of ERTA in 1981, the IRA program
was
expanded
to complement
pension participation.
The extent to which
pensions
and IRAs overlap to provide retirement
protection
is important.
Table III-13 shows the estimated
percentage
of families to
receive benefits and average benefit levels when IRAs and pensions
are considered
together. The table shows that estimated
receipt and
average benefit levels are expected to rise consistently
over the next
four decades. By the time the people now aged twenty-five
to thirtyfour retire 80 to 90 percent of them could be eligible for regular
retirement
benefits other than Social Security. The benefits provided
by these programs
are estimated
to be comparable
in size to the
benefits provided by Social Security.
How are these benefits to be distributed?
The average level of benefits could be quite high but the distributions
could be highly skewed.
Table III-14 shows the estimated
rates of receipt of IRA or pension
benefits in comparison
with the average salary for the highest five
out of ten years prior to the reference
person in the family turning
age sixty-five. The estimated
recipiency
rates show significant
increases at the intermediate
income levels, especially
among the two
younger cohorts. The significant
rates among the lowest income class
across all four cohorts are the result of early retirements.
People who
retire in their mid-fifties--and
early retirement
is increasingly
corn-
TABLE III-13
Age in 1979 and Estimated Percentages of Families to
Receive Benefits from IRAs and Pensions Combined at
Age 65, and Average Benefit Levels in 1982 Dollars,
by Marital Status
All Families
Cohort
Age in
1979
Percentage
to Receive
Benefit
25-34
35-44
45-54
55-64
87
83
70
49
Source:
Tabulation
96
Married
Average
Amount of
Benefit
Percentage
to Receive
Benefit
$11,976
10,694
7,692
4,424
of PRISM
current
91
86
75
56
policy
Couples
Single
Average
Amount of
Benefit
Percentage
to Receive
Benefit
$14,220
12,078
8,878
4,847
simulation
82
79
61
38
results.
Persons
Average
Amount of
Benefit
$8,185
8,393
5,393
3,501
TABLE III-14
Percentages
of Families
Receive
an IRA or Pension
Benefit,
by "High-Five"
Average
Family
Earnings
in Ten Years
Prior to Age
to
65
Average Family
Earnings
During "High Five"
Years
Less than $10,000
$10,000-$19,999
$20,000-$29,999
$30,000-$39,999
$40,000 or more
Percentage to Receive a Benefit by Cohort Age in 1979
25 to 34
35 to 44
45 to 54
55 to 64
72
83
89
86
94
68
74
81
87
94
46
67
72
73
92
29
41
50
59
68
Source: Tabulation of PRISM current policy simulation results.
mon and projected
to become more so--would
have very low or zero
average earnings
over the period considered.
Table III-15 compares
estimated
average Social Security benefits
with pension
and IRA benefits
for the various age cohorts
to the
average earnings
in their average "high-five"
years. Social Security
benefits are clearly larger than pension benefits for each of the lower
income classes. The differences
tend to decline and even reverse at
the higher preretirement
income levels. For most of the income classes,
Social Security and pension benefits consistently
rise with each successive cohort. For the income classes with average earnings at $15,000
and above, the growth in average pension benefits considerably
outpaces Social Security.
These results suggest that pensions
and individual retirement
provisions will play an increasingly
important
role
in providing
retirement
income security to future generations
of the
elderly.
Supplemental
Security Income--The
discussion
in chapter II indicated that the number of persons qualifying
for SSI after age sixtyfive has been declining
since the program
started in 1974. While the
number of blind and disabled
SSI recipients
reaching age sixty-five
largely offsets this decline in SSI statistics,
there have been real declines in total elderly SSI recipients
during the past couple of years.
The likelihood
of continued
labor-force
participation
by women at
current
levels or higher and the prospects
for future wage growth
suggest that work-related
retirement
programs will diminish the rate
of SSI recipiency
in the future.
97
I_ "_
..,,
98
o_I
r_
r-,_ o0
tno-,
"_
_n ,_ _- _ ¢_,)-
_,=_. =°°o°o°
The simulation
of the SSI program suggests that the rates of receipt
will decline over time. The average benefit rates are not estimated
to rise significantly
over time, which is not surprising.
The program
guarantees
are now tied to the CPI and will stay constant
in real
dollars. A word of caution
is in order in interpreting
these results,
however.
The random
process used to simulate
these results
will
cause some variance
from one simulation
to the next. When dealing
with high rates of recipiency
for a program
like Social Security, this
random variance
will be small in relative terms. When dealing with
low recipiency
estimates,
as in the case of SSI, this random variance
can be significant.
A separate
simulation
with identical assumptions
might estimate
significantly
higher recipiency
rates than those for
the younger two cohorts shown in table III-16.
Projected Income Levels [or the Elderly--The
previous section of this
chapter provided
estimates
of recipiency
and average income levels
from various sources of retirement
income. This section pulls these
various income sources together to estimate combined
income levels.
It should be kept in mind that these estimates
include only earnings,
Social Security,
pensions,
IRAs, and SSI. Some people may have
substantial
property,
asset, and in-kind income in addition
to the
sources considered
here.
Retirement Program Income Levels--Table
III-17 shows the average
family incomes provided by the selected sources considered
here. The
estimates
are made during the year in the simulation
in which the
person being referred to turns sixty-five. The results show a consistent
pattern
of higher income levels for both married couples and single
TABLE III-16
Percentages
of Families to
Receive SSI Benefits at Age 65 and Average Benefit
Levels in 1982 Dollars, by Marital Status
Cohort
Age in
1979
All Families
Percentage Average
Benefit
Benefit
Married Couples
Percentage Average
Benefit
Benefit
25-34
1.2
$5,527
35-44
1.0
2,552
45-54
3.9
2,959
55-64
5.9
3,237
Source: Tabulation of PRISM current
Single Persons
Percentage Average
Benefit
Benefit
1.3
$3,739
1.0
3,289
1.5
3,432
3.6
3,065
policy simulation results.
1.1
1.1
7.8
9.2
$3,133
1,564
2,817
3,337
99
TABLE III-17
Annual Family Income
Levels from Selected Sources a in 1982 Dollars at Age
65, by Marital Status
Age in 1979
All Families
Married Couples
25-34
$26,802
$34,088
35-44
23,883
29,709
45-54
17,579
22,469
55-64
13,376
17,347
Source: Tabulation of PRISM current policy simulation results.
_Estimates include earnings, Social Security, pensions, [RAs and SSI.
Single Persons
$ 15,697
i 4,921
9,846
7,127
persons. In the case oR single persons, the average income levels are
estimated
to more than double from the oldest to the youngest cohort.
For married couples, average income levels are estimated
to approximately double on this basis.
Replacement
of Earnings by Retirement Programs--The
level of income is an important
measure of standard
of living for each of the
cohorts over time. It does not provide a perspective
on the relative
standards
of living that exist at various
points in time, however.
Workers aged twenty-five
to thirty-four
in 1979 should have much
higher real earnings immediately
prior to their retirement
than people over age fifty-five. The relative
effectiveness
of the retirement
system over time can be judged by its capacity
to maintain
preretirement
standards
of living.
In order to estimate
the capacity
of pensions,
IRAs, and Social
Security to maintain
living standards,
a set of replacement
rates were
calculated.
These calculations
based the estimates
on the average
earnings
for the highest five years out of the ten years prior to attaining age sixty-five. Retirement
benefits were the aggregate of pension and IRA benefits estimated
at age sixty-five plus the estimated
Social Security entitlement
prior to application
of the earnings
test.
The replacement
rates are based on income after taxes.
Table III-18 shows the distribution
of the estimated
net replacement rates. The trend is clearly toward higher replacement
rates for
each successive cohort. Only 13 percent of families in the oldest cohort
have replacement
rates above 80 percent, while more than 46 percent
of the youngest cohort have rates above this level. Although pensions
and IRAs contribute
to this significant
growth, part of it is also attributable
to the tax estimates
on earnings
and retirement
income.
The tax brackets
were indexed on the basis of the assumed
rate of
100
i
TABLE
III-18
Estimated
Net Retirement Program Replacement
Rates
for Average
High-Five
Years of Family Earnings in
the Ten Years Prior to Age 65
Replacement
Less than
25%
Rates
25-49%
50-59%
60-79%
80-99%
More Than
100%
5.1
7.0
0.7
17.6
18.5
15.5
10.2
10.3
10.0
20.8
20.8
20.8
16.8
16.7
17.0
29.4
26.7
36.1
35 to 44
All Families
Married Couples
Single Persons
5.2
6.8
1.5
24.1
26.4
18.7
10.0
10.4
9.2
21.5
22.0
20.2
16.5
16.6
16.2
22.7
17.9
34.1
45 to 54
All Families
Married
Couples
Single Persons
9.3
10.6
6.0
33.8
36.3
27.4
11.2
! 1.1
I 1.5
19.6
19.2
20.6
12.4
12.7
11.7
13.7
10.0
22.8
55 to 64
All Families
Married Couples
Single Persons
21.0
21.8
18.8
40.8
38.5
47.2
11.6
1 ! .7
I 1.3
13.5
16.1
6.5
6.5
6.9
5.6
6.5
5.0
10.7
Cohort Age in 1979
25 to 34
All Families
Married Couples
Single Persons
Source:
Note:
Tabulation of PRISM current policy simulation
Includes pensions, IRAs, and Social Security.
price increases.
Because
the assumed
real wage
wages
growth
results.
are assumed
to grow faster
in the simulation
gradually
both marginal
and average
tax rates.
Since Social
Security
are not taxable,
they will replace
an increasing
proportion
tax earnings
over time.
Table
III-19 shows
estimated
median
replacement
rates
earnings
successive
for each
cohort,
the earnings
ment earnings
absolute
and
of the cohorts
for the "high-five"
the median
replacement
rates
categories.
This suggests
that retirees
levels can expect
to be considerably
relative
terms
in the future.
The complicated
process
by which
these
estimates
give rise to a certain
amount
of skepticism.
pensions
will be more widely
available
in the
not central
to the results
of these simulations.
recipiency
rates
are
not out of line
with
years.
increase
than prices,
increases
benefits
of afterof family
With each
in each of
at all preretirebetter
off in both
were
made
may
The assumption
that
future is important
but
The estimated
pension
the estimates
made
by others
101
TABLE III-19
Estimated
Re,_lacement,,Rates
for Median
Families
for
High-Five
Years
of Family
the Ten Years
Prior to Age 65, by Age
Average Family
Earnings During
"High-Five" Years
55-64
(Percent)
Earnings
Earnings
in 1979
CohortAge in 1979
45-54
35-44
(Percent)
(Percent)
of
in
25-34
(Percent)
Less than $5,000
100 +
100 +
100 +
$5,000-$9,999
49
80
96
$10,000-$ ! 4,999
49
62
74
$15,000-$19,999
54
57
71
$20,000-$29,999
44
56
74
$30,000-$39,999
38
47
74
$40,000 or more
31
53
62
Source: Tabulation of PRISM current policy simulation rcsuhs.
100 +
99
78
76
82
81
67
using different methodologies
or assumptions.
The estimates of future
IRA utilization
are also important
but appear reasonable
within the
limited information
now available.
The sheer magnitude
of annual
pension and IRA contributions
has to lead to the intuitive conclusion
that these programs
are growing in importance.
The simulation
results presented
here support this conclusion and vice versa. To ignore
the conclusion
that other programs
than Social Security will play a
significant
role in providing retirement
income security in the future
will preclude certain policy options, narrow others, and possibly dictate yet other options that make little sense in a broader perspective.
Implications
of the
The distribution
Results
and level of benefits
estimated
here would
seem
to indicate
that there may be some flexibility
for dealing with the
long-term
problems
discussed
in chapter
IV. In the short term there is considerably
less flexibility.
An inescapable conclusion
of the simulation
results is that Social Security
is the cornerstone
of the retirement
system in this country.
If the
long-term
viability of Social Security cannot be assured, significant
alternatives
have to be devised, and it is unlikely that such alternatives can be developed and implemented
in the near future. Therefore,
it is imperative
that the current system be made solvent in the short
term and confidence
restored,
so that the system will be there for
today's young workers when they retire.
102
IV. Social Security
Problems
Almost
everyone
today
is aware
Financing
that
the Social
Security
program
is experiencing
financing
problems.
There may be differences
of opinion about
the extent
of the problems
and about potential
solutions,
but there
is undisputed
Social
Security
Trustees
way:
agreement
that problems
exist.
The
Report
summarizes
the main problem
1982
this
As in last year's trustees reports, the 1982 annual reports
indicate severe financial problems
for the Social Security
program in both the short range and the long range. The
short range financial status is significantly
worse than estimated last year, because of continuing
unfavorable
economic conditions. The long range deficit for OASDI remains
about the same as that projected
last year.
Under present law, which provides for temporary
interfund
borrowing,
the Old Age and Survivors
fund would not be
able to pay benefits on time bv Julv 1983.
Based on the intermediate
II-A assumptions
....
the long
range average deficit for OASDI over the next 75 vears is
estimated
to be 0.82 percent of taxable payroll.
Based on the II-B assumptions,
which reflect somewhat lower
economic growth than in II-A, the long range deficit remains
the same as in last vear's report--l.82
percent of payroll.
Even if the OASI, DI, and HI Trust
they would fall short in 1984 under
Measurement
of Social
Security's
Funds were combined,
the II-B assumptions?
Financing
Status
It is common
to see press accounts
or other analyses
that refer to
trillions
of dollars
of unfunded
Social
Security
liabilities.
One measure of these unfunded
liabilities
is calculated
on what actuaries
call
a "closed
group"
a specified
date,
basis. The closed
no new workers
group concept
will contribute
assumes
that as of
to or be covered
ISummarv of the 1982 A_tnual Reports o]the Social Security Boards ofTrustees, Executive
Summa_' (Washington, D.C.: Social Security Administration
and Health Care Financing Administration,
1982), pp. i-iii.
103
under
the existing
system.
For example,
it is often assumed
that workers under
nineteen
years of age on the date for which
the estimate
is
made
will no longer
be covered
under
Social
Security.
This closedgroup
estimate
shows
the extent
to which
the system
is underfunded
for persons
now in the system.
Robert
liabilities
Myers has
calculated
presented
on this
estimates
of unfunded
basis;
table IV-I shows
Social
Security
these estimates
for the 1971-1981
period.
The unfunded
liabilities,
presented
table as the net deficit
for the closed
group,
are calculated
present
value of future
benefit
payments
(outgo)
minus
the
value of future
taxes and the trust fund balance.
The annual
figures
indicate
how much would
have
efits to the closed group
under
the law
date.
The changes
in unfunded
and flow of Social
Securitv
liabilities
during
TABLE
in the
as the
present
deficit
been required
to pay off benthat applied
on the valuation
over the
the period.
1970s reflect
the ebb
The quadrupling
of
|V-I
Actuarial Status of OASDI on "Closed Group" and
"Open Group, Limited Period" Base, 1971-1980
Year a
1971
1972 _
1973
1974
1975
1976
1977 (pro-1977
1977 (post-1977
1978
1979
1980
1981
Sources:
act)
act)
Valuation
Interest
Rate
(Percent)
Existing
Trust
Fund
(Billions)
5.25
6.00
6.00
6.00
7.38
6.60
6.60
6.60
6.60
6.60
6.08
6.08
$41
44
44
46
48
46
40
40
35
33
32
27
Net Deficit b
Closed
Group
(Billions)
$
433
1,865
2,118
2,460
2,710
4,148
5,362
3,456
3,971
4,225
5,601
5,858
Open
Group
(Billions)
$
8
- 140
176
1,312
2, l O0
4,177
4,787
786
929
847
1,464
1,555
Robert J. Myers, Social Security, 2nd ed. (Homcwood, I11.:Richard D. Irwin,
Inc., 1981) pp. 274, 303; and Office of the Actuary, Social Security Administration.
_'Asol June 30 ['or 1971-1975, and September 30 lot 1976-1979.
I'Exccss of' present value of future outgo over the sum of present value of luture taxes
and existing trust fund.
"Includes the effect of the 20 percent benetit increase enacted on July 1, 1972 (effective
for September 1972).
104
the unfunded
liabilities in 1972 reflects in part the effects of the 1972
amendments,
including
the 20 percent increase in benefits; but even
more, that jump reflects a basic change in thc method of valuing
future benefits using assumptions
that wages and prices would grow
in the future. Prior to 1972 the valuation
procedures
used static economic assumptions
for these two crucial
variables.
The unfunded
liabilities continued
to rise between 1972 and 1975 because of a combination
of benefit increases
tions. The 1977 amendments
and changes to the actuarial
reduced the estimated
Social
assumpSecurity
unfunded
liability
by more than one-third.
Adverse economic
conditions, resulting
changes to valuation
assumptions,
and redefinition
of the closed group to include persons over age fifteen combined
to
produce estimated
Social Security unfunded liabilities of $5.6 trillion
by the end of fiscal 1980. 2
The concept of unfunded
liabilities on this closed-group
basis in a
pay-as-you-go
program
that is nearly universal
is not particularly
significant
unless a policy decision is made to close the program out.
If that were to be done, then those liabilities would have to be paid
off to meet benefit payments
as they came due for the closed group.
A more realistic way to look at Social Security's
financing--based
on the assumptions
that the program
will continue
to operate in the
future and that new workers will continue to be covered--is
to compare the value of projected
future expenditures
with projected
tax
revenues. The long-term
unfunded
liabilities,
when calculated
in this
way, are estimated
for a limited period by Social Security's
actuaries.
Table IV-I shows the Old-Age, Survivors
and Disability
Insurance
estimates for the seventy-five-year
valuation period in the "open group"
column.
The annual
numbers
show the extent to which future tax
collections
plus the trust balance
fall short of future outgo on the
date of the valuation,
for the seventy-five-year
projection
period.
At the beginning of the 1970s, the unfunded liabilities,
on an opengroup basis, were negligible;
they represented
less than 1 percent of
the present value of projected
seventv-five-vear
tax collections.
The
projected
deficit started growing rapidly after 1973 and bv early 1977
represented
a 70 percent shortfall
in scheduled
taxes over the valuation period. The 1977 Social Security
amendments
made significant adjustments
to both the tax collection and benefit schedules and
reduced
the open-group
net deficit by 84 percent,
but the OASDI
program
was still underfunded
by nearly 10 percent for the seventy-'Robert J. Myers, Social Security, 2nd ed. (Homewood, i11.:Richard D. Irwin, Inc.,
1981), discusses these changes at greater length on pp. 273-275.
105
five-year valuation
period. Since 1977 the situation
has deteriorated
on the basis of the open-group
net deficit projections.
The net deficits on either the closed- or open-group
basis become
worse if the Hospital
Insurance
program
is added to the picture.
Although
actuaries
from the Health Care Financing
Administration
develop estimates
for the seventy-five-year
period, they publish only
twenty-five-year
projections.
On the basis of the twenty-five-year
projections, the HI program is running an open-group
net deficit of about
70 percent
of scheduled
taxes. On the seventy-five-year
projection,
the HI deficit exceeds the projected
OASDI deficits.
The fact that there are unfunded future promises on a closed-group
basis does not necessarily
mean Social Security
is inadequately
financed. But the open-group
projections
do suggest that in the long
term, the program
is out of balance. These projections,
however, aggregate the long-term
characteristics
of each or all of the programs
into a single number
that fails to capture
the dynamics
of the projections or the nature of the problem. An alternative
concept for evaluating the financial
soundness
system was
stated some years ago by George B. Buck, a Fellow in the Society of
Actuaries, and founder of one of the largest actuarial
consulting firms
in this country. He described
a properly
financed system as:
One which sets forth a plan of benefits and contributions to
provide these benefits, so related that the amount of the
present and contingent liabilities of the plan as actuarially
computed as of any date will at least be balanced by the
amount of the present and contingent assets of the plan
computed as of the same date. 3
It is in this context that Social Security now faces "severe financial
problems"
in both the short and long terms. The short-term
financing
crisis and the potential
long-term
financing problem can be considered separately
because the problems
are different in the two time
frames.
The Short-Term Problem--Table
IV-2 shows the actual and projected
financial
operations
of the OASI trust fund for selected years. The
table shows steadily
increasing
balances
in the trust fund through
3GeorgeB. Buck, "Actuarial Soundness in Trusteed and Government Retirement Plans,"
in Proceedings of a Panel Meeting; "What is Actuarial Soundness in a Pension Plan?"
sponsored jointly by the American Statistical Association, the American Economic
Association, the American Association of University Teachers of Insurance, and the
Industrial Relations Research Association, Chicago, Ill., December 29, 1952.
106
TABLE
Operations
Calendar
Operations
the
Calendar
Year
1940
1945
1950
1955
1960
1965
1970
1975
1976
1977
1978
1979
1980
1981
IV-2
of the OASI Trust Fund During Selected
Years 1940-1981 and Estimated Future
During Calendar Years 1982-1986 Under
Intermediate
Sets of Assumptions
Income
Total
(Millions)
$
368
1,420
2,928
6,167
11,382
16,610
32,220
59,605
66,276
72,412
78,094
90,274
105,841
125,361
Disbursements
Total
(Millions)
$
62
304
1,022
5,079
11,198
17,501
29,848
60,395
67,876
75,309
83,064
93,133
107,678
126,695 _
Net Increase
in Fund
(Millions)
$
-
Fund at
End of Period
(Millions)
306
1,116
1,905
1,087
184
890
2,371
790
1,600
2,897
4,971
2,860
1,837
1,334
$ 2,031
7,121
13,721
21,663
20,324
18,235
32,454
36,987
35,388
32,491
27,520
24,660
22,824
21,490
Projectional:
Alternative
II-A:
1982
1983
1984
1985
1986
$135,956 b
139,130
149,173
167,606
182,173
$141,770
155,637
169,272
182,573
196,104
$-
Alternative
II-B:
1982
1983
1984
1985
1986
$137,083'
137,005
149,144
167,147
180,669
$141,771
156,392
173,183
191,059
208,524
$-
5,814
16,507
20,099
14,967
13,931
$
15,676
831
-20,930
35,897
4,688
- 19,386
-24,039
-23,913
-27,855
$
16,802
- 2,584
-26,623
-50,536
-78,391
1982 Anm_al OASD[ Trustees Report, p. 51.
_Adjusted to include benefits for December 1981 that were paid on December 31, 1981,
than on January 3, 1982, which was a Sunday. These benefits are included in
1982 figure so that amounts for 1981 and 1982 each reflect 12 months of benefit
payments and are comparable to figures for their calendar years.
_'Includes $7.036 billion assumed to be borrowed from the DI and HI trust funds under
interfund borrowing provisions.
_lncludes $11.060 billion assumed to be borrowed from the DI and HI trust funds under
interfund borrowing provisions.
107
the 1950s. For a period during the 1960s, the fund's income was less
than annual disbursements,
but increases in the payroll tax and wage
base arid generally
good economic conditions
resulted in trust fund
growth of more than $14 billion between 1965 and 1970. In 1975 the
trust fund balance began to decline and it has been declining steadily
since then.
Until recent years the fund balances were sufficiently
large that a
financing deficit in any one year was cause for adjustments,
not for
alarm. Even though the trust fund declined
by nearlv $900 million
in 1965, the balance at the end of the year still exceeded that year's
total disbursements.
The program's
financing
was adjusted
during
the 1960s, and at the end of 1970 the trust fund still exceeded
the
total disbursements
for the year.
The ability to make gradual adjustments
today has been greatly
reduced.
Not only has the trust fund been declining
but disbursements have been growing rapidly. For example, between
1965 and
1970, annual disbursements
grew by $12.3 billion; in contrast,
1981
disbursements
were $19.0 billion higher than those in 1980 and the
trust fund balance was down to a two-month
cushion.
Under projections
using the two intermediate
sets of assumptions
posited by the Social Security
Board of Trustees
(known as Alternatives II-A and II-B), the OASI trust fund will be totally depleted
in
1983. The very earliest that Congress will seriously
consider
Social
Security
legislation
is early 1983. Yet, it is widely agreed that under
current
law, the OASI fund will be unable to meet the July 1983
payment on schedule. Never before has the OASI program been pushed
so close to the financial
brink.
The Disability
Insurance
program
is somewhat
more sound than
its Old-Age and Survivors
counterpart.
Table IV-3 shows the actual
and projected
financial
operations
of the DI trust fund for selected
years. Although the program has experienced
periodic financing deficits, it has been regularly
adjusted
to keep it actuarially
sound. Current Social Security legislation
allows the OASI trust fund to borrow
from the healthier
DI fund through the end of 1982. In fact, the legislation allows OASI to borrow on the basis of projected
operations
for up to six months in the future, so although the borrowing
window
closes at the end of 1982, the trust fund transfers can get OASI through
its first six months of operations
in 1983. Even if the borrowing
limit
is extended,
the OASI shortfall in 1984, under both sets of intermediate assumptions
will exceed the projected
DI trust fund balances.
Assuming
that the borrowing
window is effectively
closed, the DI
program
is projected
to be financially
solvent over the short term.
108
TABLE
IV-3
Operations
of the DI Trust
Calendar Years 1960-1981
Operations During Calendar
the Intermediate
Sets
Calendar
Year
1960
1965
1970
1975
1976
1977
1978
! 979
1980
1981
Income
Total
(Millions)
Fund During Selected
and Estimated Future
Years 1982-1986 Under
of Assumptions
Disbursements
Total
(Millions)
$ 1,063
1,247
4,774
8,035
8,757
9,570
13,810
15,590
13,871
17,078
$
Aher_lative II-A:
1982
1983
1984
1985
1986
$17,020 _
26,624
29,723
37,929
42,926
Alternative
II-B:
1982
1983
1984
1985
1986
$17,010 b
26,124
29,496
37,329
41,799
600
1,687
3,259
8,790
10,366
11,945
12,954
14,186
15,872
17,658
Net Increase
in Fund
(Millions)
$
Fund at
End of Period
(Millions)
464
440
1,514
754
1,609
2,375
856
1,404
2,001
580
$2,289
1,606
5,614
7,354
5,745
3,370
4,226
5,630
3,629
3,049
$18,517
18,996
19,670
20,573
21,639
$ -1,497
7,627
10,053
17,356
21,287
$ 1,552
9,180
19,232
36,588
57,875
$18,508
19,073
20,099
21,459
22,864
$
$ 1,551
8,602
17,999
33,869
52,804
-
-
Projections:
1,498
7,051
9,397
15,870
18,935
1982 Ammal OASD1 Trustees Report, p. 54.
$6.257 billion assumed to be loaned to the OASI trust fund under the inborrowing provisions.
bExcludes $5.747 billion assumed to be loaned to the OASI trust fund under the inborrowing provisions.
"Excludes
third
major
trust
fund in the Social
Security
family
is the
Hospital
Insurance
fund. The experience
of the HI program
has also
more
positive,
to date, than
has that of the OASI component.
IV-4 shows
the actual
and projected
operations
of the health
109
program
since
its
inception.
Hospital
Insurance
trust
three minor exceptions.
sharply
in the coming
years
costs.
Until
1982
the
annual
income
of
fund regularly
exceeded
disbursements
Disbursements
are projected
to increase
because
of persistent
inflation
in health
TABLE
IV-4
Operations
of the Hospital Insurance
Trust
During Calendar Years, 1966-1984
Disbursement
Total
(Millions)
Net Increase
in Fund
(Millions)
Fund
Calendar
Year
Income
Total
(Millions)
Fund at
End of Year
(Millions)
1966
1967
1968
1969
1970
! 971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
$ 1,943
3,559
5,287
5,279
5,979
5,732
6,403
10,821
12,024
12,980
13,766
15,856
19,213
22,825
26,097
35,725
$
999
3,430
4,277
4,857
5,281
5,900
6,503
7,289
9,372
11,581
13,679
16,019
18,178
21,073
25,577
30,726
$
944
129
! ,010
422
698
168
99
3,532
2,652
!,399
88
- 163
1,035
1,75 !
52 i
4,999
Altenlative
II-A:
1982
1983
1984
$38,139 _
42,824
46,239
$35,670
41,055
46,608
$
2,469
1,769
369
$21,217
22,986
22,617
Alternative II-B:
1982
1983
1984
$32,79T'
42,237
46, !45
$35,670
41,622
48,272
$ - 2,873
615
- 2,127
$15,875
16,490
14,363
$
944
1,073
2,083
2,505
3,202
3,034
2,935
6,467
9,119
10,517
10,605
10,442
11,477
! 3,228
13,749
18,748
Projections:
1982 HI Trustees Report, p. 29.
income lot 1982 is reduced by the amounts assumed to be loaned on December
by the HI trust fund under the interfund borrowing provisions. These amounts
$779 million and $5.313 billion under alternatives II-A and I1-B, respectively.
Current
provisions
also allow the OASI
fund to borrow from the HI fund, but as with DI, these provisions
expire at the end of 1982. According to the Social Security trustees,
if the three funds were commingled
beyond
1982, there would still
be potential
problems.
If commingling
were allowed, the combined
program
would barely be solvent through the 1980s under the Alternative [I-A assumptions;
the demise would come in 1984 under the
pessimistic
assumptions
used by the trustees.
Actual economic
experience
can affect the short-term
Social Security financing prospects.
Table IV-5 provides the various economic
assumptions
used to generate
the range of short-term
financing
estimates.
The Trustees
Report that was released April 1, 1982, reflects economic assumptions
being used early in the year. Tracing the actual
experience
of the economy during 1982 can serve as an indicator
of
which set of projections
may be more realistic.
Measurement
of that
experience
will not be available
until sometime
after the end of the
year. Based on the level of economic
activity early in 1982, the assumptions
used in cost estimates
in the Trustees
Report can be assessed relative
to later assumptions.
The Reagan administration's
mid-session
review of the 1983 budget posited assumptions
on the
crucial economic
variables
that were much closer to the [[-B than
the II-A scenario.
Under these assumptions,
the three trust funds
combined
would be insufficient
to pay benefits on a timely basis
through
1984. 4 Furthermore,
the Congressional
Budget Office has
projected
larger declines in real GNP and higher levels of unemployment than the administration's
mid-session
assumptions.
5 This all
suggests that, at least t0r the short term, the more pessimistic
midrange assumptions
in the 1982 Trustees Report are the more realistic-and
even they may prove to have been optimistic.
The Long-Term Problem--The
Social Security actuaries estimate the
long-term
cost of the programs
as a percentage
of total covered payroll. Comparison
of the annual cost estimated
in this fashion with
the legislated
tax rate indicates the adequacy
of financing provisions
for the system over the long term. Figure IV-I depicts the currently
legislated
OASDI tax rates in comparison
to the long-term
Social
4jeffrey L. Kunkel, "Estimated
Operations
o[ the OASI, DI, and H1 Trust Funds on the
Basis of the 1982 Mid-Session
Review Assumptions,"
Internal
Memorandum,
Office
of the Actuary,
Social Security
Administration
(August 5, 1982), p. 2.
SCongressional
Budget Office, The Economic
and Budget Outlook: AH Update (Washington, D.C.: CBO, September
1982), p. 59.
Ill
TABLE
IV-5
Economic Assumptions
Used in the Projections for
OASDI and HI in the 1982 Trustees Report
Percentage
Calendar
Year
OplimiMic
1982
1985
1995
2005 and
Real
GNIP_
of Average Annual Increase
Over Previous Year
Wages in
Consumer
Inpatient
Covered
PHce
Hospital
Employment
Index
Care Costs b
Annual
Unemployment
Rate
Assumptions:
8.2%
7.0
4.5
4.5
6.3%
4.2
2.0
2.0
16.5%
12.1
7.9
6.1
8.6%
5.8
4.0
4.0
Alternative
II-A Assumptions:'
1982
0.3%
1985
4.8
1995
3.0
2005 and later
2.9
8.6%
7.4
5.0
5.0
6.8%
4.8
3.0
3.0
16.6%
13.1
9.1
8.4
8.9%
6.4
5.0
5.0
Alternative
II-B Assumptio_ts:
1982
-0.8%
1985
3.0
1995
2.5
2005 and later
2.5
6.6%
6.9
5.5
5.5
6.9%
6.6
4.0
4.0
16.5%
13.7
10.0
9.3
9.1%
7.7
5.0
5.0
Pessimistic
Assumplio_ts:
1982
- 1.5%
1985
3.8
1995
1.8
2005 and later
2.0
6.3%
9.2
6.2
6.0
7.2%
9.2
5.2
5.0
16.5%
18.3
13.3
11.4
9.3%
8.8
6.0
6.0
laler
1.1%
5.1
3.4
3.4
Source: 1982 OASDI Trustees Reports, Executive Summary, p. 22.
_'Gross national product (the total output of goods and services) expressed in constant
dollars. The percentage increase in real GNP is assumed to change after the year
2005. The values for the vear 2060 are 3.4, 2.5, 2.1, and 1.0 percent for the optimistic,
Alternative [l-A, Alternative II-B, and pessimistic assumptions, respectively.
Iqncludes hospital care costs for all patients, not just those covered under HI. Figures
shown for "2005 and later" are tot 2005.
_Alternative II-A uses the economic assumptions underlying the president's 1983 budget,
adjusted to reflect the most recent data now available on wages and prices.
Security
cost projections
under
three alternative
sets of assumptions.
The combined
employer-employee
tax rate increases
in steps from
10.8 percent
of covered
payroll
in 1982 to 12.4 percent
in 1990; the
rate remains
flat thereafter.
The three cost projections
are based on
the Alternative
II-A and II-B and the pessimistic
assumptions
presented
in table
IV-5. Cost lines below
the tax line depict
projected
112
FIGURE IV-I
Legislated
OASDI Payroll Tax Rate and Projected
Rates Under Alternative
Assumptions
Cost
Percent of Payroll
3O
"_"
25
Legislated
Tax Rate
......
II-A Assumptions
,,,,,"
-.......
II-B Assumptions
Pessimistic
Assumptions
s S
J
I
20
,
I
J
..
•.,..""
js
I
I
t
I
I
j
15-
eo eeeee°'e°°e°eee_°eeeeeeee°
sj
6
•
o•
e"
e•
•
10"
1980
ee
•
•
I
1990
,e
• 'leeee
!
2000
eoe
°-
oo
I
2010
I
2020
I
2030
I
2040
I
2050
2060
Year
Source: 1982 Ammal Report ol the Board olTrustees of the FederalOld-Ageand Survivors
htsurattce and Disability Insurance Trust Fmtds (Washington, D.C,:Social Security Administration, 1982),pp. 67-68.
surpluses
for the program
on a current-cost
basis. Cost lines above
the scheduled
tax rate depict financing
deficits.
Under the II-A assumptions,
the 1985 scheduled
tax increase will
move OASDI back into financing surpluses
that will last until sometime between 2015 and 2020. Under the slightly more conservative
II-B assumptions,
the combined
OASDI programs
are projected
to
continue
running
deficits based on current
law until the 1990 tax
increase is implemented.
Also under these latter assumptions,
OASDI
moves back into deficit financing between 2010 and 2015. Under the
pessimistic
assumptions,
scheduled tax rates will not meet the OASDI
costs at any time in the projection
horizon.
Over the next twenty-five
years, the combined
OASDI revenues are
projected
to exceed benefits by an average of 1.55 percent of covered
113
payroll under the II-A assumptions
and by 0.64 percent under the IIB scenario.
Under the pessimistic
assumptions,
revenues would fall
short of meeting
projected
costs by an average of 0.62 percent of
covered payroll. If recovery from the recession
of 1982 is slow and
drawn out throughout
the 1980s, and if ultimate
real wage growth
falls somewhere
between
1.0 and 1.5 percent
per year, the actual
experience
of OASDI would be between the II-B and pessimistic
scenarios. In that case, the first twenty-five
year financing surplus would
largely disappear.
During the second twenty-five
years of the projection
period all
three scenarios
depicted
in figure IV-! result in financing
deficits
substantially
exceeding those now being experienced.
Under both the
II-A and II-B assumptions,
the cost levels tend to stabilize around
2030. Under the pessimistic
scenario,
the situation
continues
to deteriorate
over the whole seventy-five-year
projection.
Under all three
scenarios,
the short-term
financing
problem
of OASDI discussed
in
the previous
section of this chapter
appears
to be relatively
minor
compared
with the long-term
outlook.
The picture is somewhat
clouded by the financing prospects for the
Hospital
Insurance
program.
As indicated
earlier the HI actuaries
publish only twenty-five-year
projections
on the program.
The rationale is that the health status of the population
and the health care
provisions
change so significantly
over time that estimates
beyond
this time frame are not meaningful.
The HI cost projections
for the
1982-2005
period based on the II-A and II-B assumptions
are shown
in table IV-6.
While financing problems in OASDI can be separated
into a current
short-term
problem and a long-term problem with a respite of fifteen
to thirty years between,
the HI financing problem
bridges the gap.
Under the II-A assumptions,
the thirty-year
OASDI financing surplus
when combined
with the HI deficit reduces the surplus years to less
than fifteen. Under the II-B assumptions,
the combined
OASDHI programs will run a deficit in each of the next twenty-five
years under
current
financing provisions.
Under the pessimistic
assumptions,
the
prospects
become even more dismal.
The consistent
trend of increasing
HI deficits added to projected
OASDI deficits suggests that the second and third twenty-five-year
periods would require payroll tax rates two to three times those now
scheduled.
Under a prolonged
adverse economic
scenario,
the situation could be much worse. This prospect
has led economists
and
Social Security analyst Michael Boskin to proclaim:
"If we wait until
the baby boom generation
retires before we begin to deal with the
114
TABLE
IV-6
Cost and Tax Rates of the Hospital Insurance Program,
as a Percentage of Taxable Payroll
Calendar
Year
Expenditures
Under the
Program a
Trust Fond
Total Cost
Building and
of the
Maintenance b Program
Tax Rate
Scheduled
in the Law c
Difference
Alter_zative II-A:
1982
2.60% _'
1983
2.68
1984
2.80
1985
2.94
1990
3.68
1995
4.59
2000
5.40
2005
6.18
0.09%
0.09
0.09
0.09
0.09
0.09
0.09
0.09
2.69%
2.77
2.89
3.03
3.77
4.68
5.49
6.27
2.60%
2.60
2.60
2.70
2.90
2.90
2.90
2.90
- 0.09%
-0.17
- 0.29
- 0.33
- 0.87
- 1.78
- 2.59
- 3.37
Average d
4.40
0.09
4.49
2.86
- 1.63
2.98%"
2.75
2.90
3.06
3.93
5.00
6.01
7.03
0.10%
0. ! 0
0. I 0
0.10
0.10
0.10
0.10
0.10
3.08%
2.85
3.00
3.16
4.03
5.10
6. i 1
7.13
2.60%
2.60
2.60
2.70
2.90
2.90
2.90
2.90
-
Alternative
1982
1983
1984
1985
1990
1995
2000
2005
II-B:
0.48%
0.25
0.40
0.46
1.13
2.20
3.21
4.23
Average d
4.83
0.10
4.93
2.86
- 2.07
Source: 1982 HI Trustees Report, p. 37.
Note:
Taxable payroll is adjusted to take into account the lower contribution rates
on self-employment income, on tips, and on multiple-employer "excess wages"
as compared with the combined employer-employee
rate.
L'Cost attributable
to insured beneficiaries only. Benefits and administrative
costs for
noninsured persons are financed through general revenue transfers and premium
payments rather than through payroll taxes.
hAllowances for maintaining the trust fund balance at the level of a half-year's outgo
after accounting tor the offsening effect of interest earnings.
• Rates tOr employees and employers combined.
dAverage tot the twenty-five-year period 1982-2006.
_'Takes into account amounts to be loaned to the Old-Age and Survivors Insurance
trust fund under tile inter[und borrowing provisions. The loan is assumed not repaid
under Alternative II-B; it is repaid in 1998 under Ahernative II-A.
long-term
and age
deficit
warfare
in Social
Security,
we will see the greatest
tax revolt
in the history
of the United
States. ''6 This forecast
OMichael Boskin, "Rebuilding Social Security," a Heritage Foundation
nouncing a conference held on August 12, 1982 in Washington, D.C.
brochure
an-
115
is such a startling
contrast
to the outlook of ten to fifteen years ago
that it is worth pausing to see how the situation
and concerns have
changed.
Changing
Perspectives
In 1967 Paul A. Samuelson,
wrote:
later
a Nobel
laureate
in economics,
The beauty about social insurance is that . . . everyone who
reaches retirement age is given benefit privileges that far
exceed anything he has paid in.
How is it possible? It stems from the fact that the national
product is growing at compound interest and can be expected to do so for as far ahead as the eve can see. Always
there are more youths than old folks in a growing population. More important, with real incomes growing at some 3
percent per year, the taxable base upon which benefits rest
in any period are much greater than the taxes paid historically by the generation now retired. 7
Two of the crucial assumptions
in Samuelson's
assessment
of Social
Security
were population
growth and real income increases.
After
World War II there had been a substantial
increase in fertility rates
over the rates for the years prior to the war. In 1960, for example,
the fertility rate was 3.61, meaning
that for every 100 women who
entered
childbearing
age and survived
through their fertile period,
361 live births were expected.
The fertility rates of the 1950s and
1960s offered the prospects
of a continuously
expanding
work force
paying Social Security taxes to support continuous
growth in Social
Security benefits.
The 1960s were also a period of relative economic gains by workers.
Between
1960 and 1964, wages grew at an annual rate of 2.1 percent
faster than prices as measured
by the consumer price index. Between
1965 and 1969, wages continued
to grow 2 percent faster than consumer prices. This growth in the level of real wages increased the tax
base providing
added benefit support
without raising the relative
burden on workers over time.
Increases
in Benefits
As Social Security entered 1971, payroll taxes were 5.2 percent for
both employers
and employees on the first $7,800 of covered earnings.
7paul A. Samuel,;on,
p. 88.
116
"So_'ial
Security,"
Neu.su,eek,
vol. 69, no. 7 (February
12, 1967),
Congress had just given beneficiaries
a 15 percent benefit increase in
1970 and the prospects
for the program
looked good. On March 31,
the 1971 Advisory Council on Social Security issued its report, stating:
Adequate provision has been made in the law to meet all
the costs of the cash benefits program both in the short run
and over the long range future; the cash benefits program
is actuariallv sound. Income to the supplementary
medical
insurance part of the Medicare program will be more than
sufficient to meet the incurred benefit costs over the period,
established bv the law, for which monthly premiums have
been promulgated. However, unless income is increased, the
hospital insurance trust fund will be exhausted in 1973._
The 1971 Advisory Council recommended
that the supplementary
medical insurance
program
should be financed bv a three-way
even
split instead of relying on beneficiary
premiums
and general revenues
equally. 9 Employers
and employees
would each pay their shares
through the payroll tax and the third portion would come from general revenues.
There
would
no longer be a premium
on beneficiaries
under the proposal. The infusion of general revenues and
increased
payroll tax income would be combined
with the HI portion
of the payroll tax, and both HI and SMI benefits would be financed
through a single Medicare trust fund. The council estimated
that the
payroll
tax to finance the modified
program
would have to be increased from 0.60 percent to 1.30 percent of covered earnings for each
employer
and employee.
The Medicare
tax was projected
to rise to
1.65 percent of covered payroll bv 1980 under the council's proposal,
compared
with the .80 percent
under financing
provisions
then in
effect. Congress has never implemented
this recommendation
of the
1971 Advisory Council, but it did implement
several of the council's
other recommendations
that have significantly
affected the program.
SReport o[ the 1971 Adviso_ T Cotmcil o_t Social Security (Washington,
D.C., 1971 ), p. 77.
_Since 1973, beneficiaries
and general revenue contributions
have not shared the cost
of SMI equally.
During fiscal 1981, |or example,
the general revenue
transfers
were
about 2.6 times the participant
premiums
paid. This differential
has occurred
because
even though medical cost inflation has exceeded general benefit increases,
the elderlv's
premium
rate has not increased
more rapidly
than OASDI benefit rates. Moreover
the premium
rates for the disabled are the same as the rates [or the elderly in general,
even though treatment
|or disabled
people costs more than treatment
for the elderly
on average.
117
Introducing
Basic
Changes
Another recommendation
of the 1971 Advisory Council was that
the actuarial valuation procedure should be changed. Before 1972 the
estimates
of the long-range costs of the cash benefits program
were
based on the assumption
that wages and prices would remain stable
over the seventy-five-year
valuation
period. The council was convinced that increases
in earnings over time would be greater than
increases in benefit liability. The rationale was as follows:
The increased income to the program that results from rising earnings is greater than the increased benefit because
the contribution rate is a fiat percentage of all earnings up
to the earnings base maximum, while benefits as a percentage of earnings decline as earnings rise, that is, the
higher-paid worker gets a benefit that is a smaller percentage of his earnings than does the low-paid worker. I°
On the basis of this assessment,
the council was worried that every
time wages rose, the program would end up with an actuarial surplus.
The 1971 Advisory Council believed
that Social Security cost estimates should reflect expected
growth in earnings and benefits for
future years. The council argued that future costs should be estimated
on the basis of benefits provided
by current law as kept up to date
in current prices. In fact, the council also recommended
that benefits
should be automatically
adjusted to keep up with price increases and
that the contributions
base should automatically
grow with earnings.
The council believed that using "dynamic assumptions"
in the valuation procedure
would provide a more realistic estimate of the program's long-term
cost and strengthen
the underlying
fiscal discipline
of the program,
because improvements
in benefit levels that would
go beyond adjustment
for prices would be reflected as higher costs
to be borne by workers. One pleasant
by-product
of moving to the
new valuation
methodology
was that the payroll
tax burden was
estimated
to be lower for the next three or four decades than under
the static valuation
procedures.
Table IV-7 shows the payroll
tax
schedule
in effect in 1971 to finance Social Security benefits and the
revised schedule
recommended
by the 1971 Advisory Council.
On March 17, 1971, two weeks prior to issuance of the Advisory
Council's
Report, President
Nixon signed Public Law 92-5, which
I°Report
85.
118
o[ the 1971 Advisory
Council
on Social
Security
(Washington,
D.C.,
1971 ), p.
TABLE
IV-7
Payroll Tax Schedule for Employees and Employers in
Effect in 1971 and Schedule Recommended
by 1971
Advisory Council to Finance OASDI Benefits
Tax Rate
in Effect
(Percent)
Year
1972
1973
1974-1975
1976-1977
1978 1979
1980 1981
1982-1986
1987 2020
2021 2045
Source:
Tax Rate Recommended
by Council
(Percent)
4.60
5.00
5.00
5.15
5.15
5.15
5.15
5.15
5.15
4.70
4.65
4.45
4.40
4.35
4.35
4.20
4.20
5.50
Report o]the 1971 Advisory ('o.ncil on ._qocialSecurity (Washington,
p. 96.
provided
benefits
a 10 percent
across-the-board
retroactive
to January
1, 1971.
D.C., 1971 ),
increase
in Social
Security
The tax base was raised from
$7,800 to $9,000 for 1972. The tax rate [or the cash benefits
programs
was raised from 5.0 to 5.15 percent
on workers
and on their employers,
to take effect in 1976 (see table IV-7).
When the 92nd Congress
convened
in 1971, the first bill introduced
in the House,
H.R. 1, included
significant
Social
Security
legislation.
The bill also included
major welfare
reform
measures
that had been
passed
by the House
the previous
year. On June 22, 1971, H.R. 1 was
passed
by the House
and sent to the Senate.
The Senate
Finance
Committee
held hearings
on the bill during
July and August
but did
not consider
the bill further
until February
1972.
In early
1972, concern
over the slow progress
of H.R. 1 and interest
in providing
a Social
Security
benefit
increase
before
the elections
in November
led to separate
consideration
of Social
Security
legislation.
In February
1972, Wilbur
Mills, Chairman
of the House Ways
and Means Committee,
introduced
legislation
calling
for a 20 percent
benefit
increase
and raising
the taxable
maximum
income
to $10,200
in 1972 and $12,000
in 1973.
The tax rate schedule
in the Mills hill was based
on the 1971 Advisory
Council's
recommendations,
and endorsed
by the Social
Security
trustees
and the Nixon administration.
The Mills legislation
also
included
provisions
to adjust
benefits
automatically
to corre119
spond to increases in the cost of living, starting
in 1975. The House
Ways and Means Committee
report on the Mills bill specified a change
in the actuarial
method of Social Security cost valuation
in accordance with the Advisory Council's recommendations.
Toward the end of June 1972, when the Senate was considering
extension
of the public debt limit, Senator Frank Church introduced
an amendment
to the legislation
under consideration
that embraced
most of the provisions of the Mills bill. The 20 percent benefit increase
was to be effective in September
1972 instead of June, as under the
House bill. Annual taxable
maximum
earnings
were increased
to
$10,800 in 1973 and $12,000 in 1974. Beyond 1974 the maximum
earnings
level was to rise automatically
with wages. Church's amendment also set a new tax rate schedule based on recommendations
of
the Advisory Council. This new tax rate schedule rcvised HI contl'ibution
faced.
rates
to resolve
the actuarial
deficit
that
the program
then
The debt limit bill with the Social Security amendments
was passed
on June 30 and signed by the presidcnt
on Julv 1, 1972, as Public
Law 92-336. Members of Congress t0und themselves
in a happy political situation for the middle of an election year. They had provided
a 20 percent
benefit increase
that would show up in beneficiaries'
mailboxes
shortly be|0re an election;
thcv could further assure beneficiaries
that future benefits would not be eroded bv inflation. And
as Robert M. Ball notes, "The financing recommendations
of the Advisory Council made it possible to finance the existing Social Securitv
benefits with lower contribution
rates for the next 40 years than were
then in the law. ''11
In the meantime,
H.R. 1, including
several provisions
that would
further modify Social Security, continued
through the legislative process and became Public Law 92-603. It increased
benefits tot widows
and widowers;
liberalized
the earnings
test and indexed it to wage
growth for the future; changed
the benefit computation
procedure
[or men (to match the provision
lot women) to require three fewer
computation
years; established
a special minimum
benefit lot longcareer workers with low lifetime covered earnings;
provided a delayed retirement
incentive,
raising benefits
1 percent for cach vear
the worker did not claim benefits bctween the age of sixty-five and
seventy-two;
and extended
Medicare
to disabilitv-benefit
recipients
who had received cash benefits tot twentv-10ur consecutive
months.
IIRobert
M. Ball, "Social
History,"
,_ocial Sectlritv
120
Security
Amendments
ot 1972: Summarv
and Legislative
Bulletin*, vol. 36, no. 3 (March 1973), p. 12.
The bill that Congress passed in June 1972 reduced the payroll tax
rate from the rates that had been provided
for in the 1971 amendments. Table IV-8 shows the rates in effect prior to passage of Public
Law 92-336. Yet, four months later this payroll
tax reduction
was
completely
reversed, and tax rates for all future years but three were
raised over the rates that had prevailed
in 1971. The cost estimates
in Public Law 92-603 were based on the new dynamic cost-estimating
procedure
adopted
earlier in the year. This quick turnaround
on the
payroll tax reduction
was regarded
as necessary
to maintain
the financial solvency of the program.
Although this tax increase was not
recognizable
as such at the time, it was an ominous foreshadowing
of subsequent
events.
The 1973 Trustees Report on the status of the OASDI trust funds
was the first recognition
of a financing
problem.
The end-of-year
OASDI reserves wcrc projected
to decline somewhat
to 76 percent of
expected annual outlays bv the end of 1977. The long-range
projections showed an average deficit of 0.32 percent of taxable earnings
over the seventy-five-year
valuation
period. In each of the subsequent
four Trustees
Reports,
the Social Security
financing
situation
was
shown to deteriorate
markedly,
as table IV-9 shows.
Bv 1975, it was clear that corrective
action would be required
to
maintain
the Social Security program.
In the short-term,
the OASDI
trust funds were projected
to decline to levels inadequate
to meet
TABLE IV-8
Payroll
Finance
Tax Schedule for Employees and Employers
OASDHI Benefits Established
by Legislation
1971 and in June and October 1972
1971
Amendments
(Percent)
Year
1973
1975
June 30, 1972
P.L. 92-336
(Percent)
October 30, 1972
P.L. 92-603
(Percent)
5.65
5.50
5.85
1976-1977
5.85
5.50
5.85
1978-1979
1980
1981 - 1985
1986
1987- 1992
1993 2010
2011 and later
5.80
5.95
5.95
5.95
6.05
6.05
6.05
5.50
5.50
5.50
5.60
5.60
5.70
6.55
6.05
6.05
6.15
6.25
6.25
6.25
7.30
Source: Social Sect_ritvB,lletil, Ammal Statistical
Sztpplemem,
1977
1979,
to
in
p. 34.
121
TABLE
IV-9
Projections
of OASDI Reserve
Financing
in Successive
Projected Start-of-Year Assets as
a Percentage of Annual Expenditures
1977
1978
1979
1980
1981
Year of
Report
1973
1974
1975
1976
1977
Sources:
Ratios
and Long-Term
Trustees
Reports
76
53
42
46
47
49
32
37
36
24
29
27
21
18
Long-Term Financing Deficit
as a Percentage of Payroll
0.32
2.98
5.32
7.96
8.20
14
9
A_mual Reports o1 the Board o1 Trtlslees o1 the Federal Old-Age a_ld Snrvivors
lnst_ra_we a_td Disabili O' lnsura_we Trust Ftmds, selected years.
payment
financing
schedules.
In the seventy-five-year
long-term
projection,
deficil
averaged
more
than 5 percent
of payroll,
and
the
the
problem
grew with each succeeding
year. After the experience
of the
1950s and 1960s, when
growing
benefits
and sound
financing
had
been assumed
to continue
torever,
it was particularly
difficult
for
policymakers
Social
Security
in the 1970s
system.
Recognition
of a Structural
to understand
or cope
with
a troubled
Problem
Social Security
analyst
David Koitz has pointed
out that the initial
warning
Report
of a long-term
OASDI financing
deficit
was not the most significant
aspect
of the report.
He finds it
more instructive
to look at the sensitivity
of the long-term
financing
estimates
to thc assumptions
used in the valuation.
For example,
he
notes
that the trustees'
"likely
case" estimate,
using 5 percent
wage
and 2.75 percent
price
growth
assumptions,
yielded
a seventy-fiveyear
cost of 11 percent
of taxable
payroll.
Under
5 percent
wage
growth
with 3.25 percent
price increases,
however,
the projected
cost
of the system
.jumped
nearly
20 percent,
to 13 percent
of covered
payroll.
12
The problem
1972 amendments
formula
called
that
Koitz described
reflected
a technical
error in the
relating
to the method
of computing
benefits.
The
first for the computation
of average
monthlv
wages
12David Koitz, "The Indexing of Social Security," in llzdexation o/Federal
(Washington, D.C.: U.S. Government Printing Office, 1981) p. 147.
122
Programs
(AMW) based on the retiree's
covered
segmented,
and different
percentage
earnings.
factors
This AMW
were applied
was then
to each
segment
and summed
to determine
the primary insurance amount
(PIA) payable
to a worker
at age sixtv-five.
The 1974 Trustees
Report
showed
that under
certain
economic
assumptions,
percentage
formula
for
the products
percent
of
Social
Security
would
eventually
replace
an increasing
of workers'
final earnings.
Table
IV-10 shows
how the
June
1975, for example,
calculated
the PIA by summing
of 129.48 percent
of the first $110 of AMW plus 47.10
the next $290 and so forth.
When
the automatic
benefit
increase
was provided
to beneficiaries
in 1976, the computation
factors were also indexed.
Table IV-10 also shows
the effects
of indexation
on the benefit
formula
for 1976 and 1977.
The problem
into effect
bv
Lawrence
with the modified
the 1972 amendments
H. Thompson
of the
benefit
has
Social
computation
been succinctly
Security
system
stated
put
by
Administration:
The inflation
adjustment
mechanism
causes replacement
rates to rise whenever
there are price increases;
increases
in wages cause replacement
rates to fall whenever
money
wage levels rise. The net impact of the two, then, is to cause
replacement
rates either to rise or to fall depending
on
whether
the price effect dominates
the wage effect or vice
versa.
13
TABLE
Primary
Insurance
Amount
Selected
IV-10
Computation
Years
PIA Computation
Average Monthly
Earnings
First $110
+ next $290
+ next $150
+ next $100
+ next $100
+ next $250
+ next $175
+ next $100
+ next $100
Source:
Factors
for
Factor
June 1975
(Percent)
June 1976
(Percent)
June 1977
(Percent)
129.48
47.10
44.01
51.73
28.77
23.98
21.60
0.00
0.00
137.77
50.10
46.82
55.05
30.61
25.51
22.98
21.29
0.00
145.90
53.06
49.58
58.30
32.42
27.02
24.34
22.54
21.18
Social Secziritv BMletm Ammal Statistical St_ppleme_it, 1977 1979, p. 18.
13Lawrence H. Thompson, "Toward the Rational Adjustment of Social Security Benefit
Levels," PollO' A_za(vsis, vol. 3, no. 4 {Fall 1977), pp. 497-498.
123
Thompson
Social
based his assessment
on a study
that had been done by
Security
actuaries;
the results
of their analysis
are reflected
IV-I 1. The patterns
of income
replacement
under
the three
assumptions
led to quite
different
results.
For example,
sets
B assume
consistent
price
inflation
of 3 percent
per year. Set
assumed
4 percent
annual
wage growth
(i.e., 1 percent
real growth),
set B assumed
5 percent
annual
wage growth.
This 1 percent
differential
in assumed
wage growth,
holding
inflation
constant,
would
resulted
in strikingly
different
replacement
rates over time. By
turn of the century,
the scenario
characterized
by assumption
set
would
result
in replacement
rates ten percentage
points higher
than
TABLE
IV-II
Replacement
Rates for Successive Cohorts of Men
Retiring at Age 65 after Having Always Earned the
Median Taxable Wage in Employment
Covered by
Social Security
Assumed Average
Annual
of Increase
A
B
C
wages
prices
4
3
5
3
4
2
0.426
0.462
0.485
0.512
0.522
0.548
0.574
0.599
0.623
0.646
0.667
0.688
0.707
0.725
0.743
0.426
0.443
0.452
0.456
0.448
0.456
0.466
0.474
0.482
0.489
0.495
0.501
0.506
0.510
0.515
0.423
0.437
0.436
0.439
0.427
0.426
0.425
0.424
0.423
0.421
0.420
0.419
0.418
0.417
0.416
Replacement
Rates:
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
Assumption
Set
Albert Rettig and Orlo R. Nichols, "Some Aspects of the Dynamic Projection
of Benefits under the 1973 Social Security Amendments (P.L. 93-233)/' Actuarial Note no. 87 (Baltimore, Md.: Social Security Administration,
1974),
table 5.
the rates under assumption
set B. (The only difference in the two sets
of assumptions
was the one-percentage-point
differential
in wage
growth.)
Different inflation assumptions,
holding wages constant, also would
result in wide variations
in the replacement
rate streams. In sets A
and C, wages were assumed
to grow at 4 percent per year. In set A,
prices were assumed
to grow at a rate of 3 percent per year, while
in set C prices were assumed
to grow at only 2 percent. The onepercentage-point
greater growth in assumed
prices in set A resulted
in a replacement
rate in 2045 for the projected average worker nearly
80 percent higher than the rate for set C.
One particularly
significant
element
of the table is the relative
stability
of the replacement
rates under assumptions
of 4 percent
wage growth with 2 percent price growth. Myers's analysis leads to
the conclusion
that the 1972 benefit computation
procedure
would
result in relatively
stable Social Security replacement
of final earnings if wages grew in a 1.9 to 1.0 ratio in relation
to prices. If wages
grew more rapidly than this relative to prices, however, the earnings
replacement
capacity
would decline. If wages grew less rapidly than
1.9 times price increases, replacement
rates would steadily increase. 14
In this regard it is interesting
to compare
the short-term
expectations in 1972 with actual economic
experience.
The important
variables to consider
are prices, wages, and unemployment.
The rate of
price growth
is important
because
after 1975, benefits were to increase automatically
with the increase
in the CPI. A two-step
cash
benefit increase of 11 percent during 1974, with 7 percent payable in
March and the remainder
in June, effectively moved the adjustment
forward
to account for price increases beyond 1972.
The Effect o[ Short-Term
Economics--The
1972 Trustees
Report,
under mid-range
assumptions,
assumed that prices would grow at a
rate of 2.75 percent per year over the short term. Compounded
over
the five-year projection,
the estimate
was that prices would rise 14.5
percent
through
1976, as table IV-12 shows. In fact, prices, as measured by the CPI, increased
by 40.6 percent--nearly
three times the
expected
growth.
Since benefits
were adjusted
to reflect price increases,
revenue
demands
on the OASDI program
increased
more
rapidly than expected.
On the revenue collection
side, things did not work out as well as
expected
either. Actual unemployment
exceeded
the level expected
_Myers,
Social
Security,
p. 25.
125
TABLE IV-12
Comparison of Five-Year Economic Assumptions in the
1972 OASDI Trustees Report with Actual Experience
1972 Trustees
Report
1972
1973
1974
1975
1976
Total
CPI Increase
Assumeda Actual
(Percent) (Percent)
2.75
3.3
2.75
6.2
2.75
11.0
2.75
9.1
2.75
5.8
14.53
40.6
Real Wage Increase
Assumeda Actual
(Percent) (Percent)
2.25
4.0
2.25
0.7
2.25
- 3.6
2.25
-2.5
2.25
2.5
11.77
1.0
Unemployment Rate
Assumeda Actual
(Percent) (Percent)
4.2
5.6
4.2
4.9
4.2
5.6
4.2
8.5
4.2
7.7
4.2 b
6.5 b
Sources: Annual Reports o[ the Board of Trustees of tile OASDI Trust Funds, 1972;
Economic Report of the President, 1982.
_Mid-range assumptions.
hEstimates fur five-year unemployment totals are five-year averages.
in each of the five years in the short-term
projections,
so smaller
segments
of the work force were contributing
taxes than had been
expected.
Moreover, wages had been projected
to grow 2.25 percent
faster than prices in each year in the forecast; real growth in wages
is important
because it expands
the total base against which taxes
are applied. During the 1972 to 1976 period, real wage growth was
only about one-twelfth
of the increase projected
in 1972. The combined effects of higher than expected unemployment
with disappointing wage growth meant that revenues were not keeping up with rapid
benefit growth during this period.
Putting the Social Security program
on "automatic
pilot" in 1972
had been endorsed
as a conservative
measure.
The ad hoc benefit
increases
between 1969 and 1972 had far outpaced
inflation, so policymakers
thought
that automatic
indexation
would limit benefit
increases
to the growth in prices in the future. The practical
result
of the 1972 amendments
was to make benefit levels sensitive to economic conditions
rather than responsive
to explicit policy decisions
by the Congress. The adverse economic conditions
of the 1970s hit
right when Social Security
had become vulnerable
to such circumstances.
The Effect of Long-Term
Demographics--Ahhough
financial
difficulties
that Social Security
faced
stemmed
from economic and technical
problems,
126
the short-term
in the early 1970s
the growing proj-
ected
long-term
increased
OASDI
incidence
financing
of disability
deficit
in the
was
earlv
also
1970s
the
and
result of
an
changes
in
birthrate
assumptions.
In the 1977 Trustees
Report,
the projected
long-range
DI costs as a percentage
of taxable
payroll
were 1.8 times
those projected
in the 1973 report.
The birthrate
in the United
States
had declined
steadilv
for over a
century
prior to 1940. In 1840 there were approximately
52 live births
for every
1,000 persons
in the population.
Bv 1940 this had dropped
to 19.4 births
per 1,000. I_ After 1940 the birthrate
began
to increase,
with the most significant
growth
occurring
after World War II. After
1957, however,
declining
birthrates
again became
the norm,
as table
IV-13 shows.
The birthrate
is particularly
important
to a national
TABLE
Birthrate,
United
IV-13
States,
1940-1979
Year
Rate Per 1,000
Population
Year
Rate Per 1,000
Population
1940
194 t
1942
1943
1944
1945
1946
1947
1948
1949
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
19.4
20.3
22.2
22.7
21.2
20.4
24.1
26.6
24.9
24.5
24.1
24.9
25.1
25.0
25.3
25.0
25.2
25.3
24.5
24.0
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
23.7
23.3
22.4
21.7
21.0
19.4
18.4
17.8
17.5
17.8
18.4
17.2
15.6
14.9
14.9
14.8
14.8
15.4
15.3
15.9
Sources:
U.S. Bureau of the Census, Historical Statistics ofthe United States, Colonial
Times to 1970 (Washington, D.C.: U.S. Government Printing Office, 1975), p.
49; and U.S. Bureau of the Census, Statistical Abstract o[ the U_tited States,
1981, p. 60.
_U.S. Bureau of the Census, Historical Statistics of the United States (Washington,
U.S. Government Printing Office, 1975), p. 49, Series B 5-10.
D.C.:
127
pay-as-you-go
retirement
system because
it determines
the future
level of workers who will be paying for the benefits going to future
retirees.
The birthrate
is converted
to a fertility rate for purposes
of estimating
the future costs of Social Security.
(The fertility rate in a
given year is the average number of live births that a woman would
be expected
to have in her lifetime, if at each year of her life she
experienced
the birthrates
occurring
that year for all women her age.)
The measured
fertility rates for years between
1966 and 1979 and
those used in the average or intermediate
valuations
of Social Security done in those years are shown in table IV-14. The table shows
a consistent
pattern of assumed
fertility rates above those actually
experienced
in the year in which the estimate
is being made.
The effects of varying the fertility rate on the long-term
valuation
of Social Security
are shown in table IV-15. On the basis of these
sensitivity
estimates,
it is clear that a significant
portion of the actuarial deficit projected
in 1974 was related to changes in the birthrate assumptions
in the actuarial
valuation
of the program.
Had the fertility assumptions
used in the valuations
been changed
for years earlier, it is unlikely that Congress would have provided the
15, 10, and 20 percent benefit increases between
1970 and 1972. Certainly Congress would have been very unlikely to enact the benefit
increase
of 20 percent in 1972 if it had been generally
understood
that the benefit increase would put Social Security into a long-term
financing
deficit.
Modification
of the
System
By 1976 it was widely understood
that the Social Security program
would need modification
to get through the next few years. By 1975
the forecasts
of declining
balances
had become reality, as expenditures began to exceed income. It was clear to analysts that the initial
benefit formula indexation
had to be "decoupled"
from the cost-ofliving adjustments
(COLAs) being provided for postretirement
benefits. The debate ultimately
focused on two recommendations,
both
calling for a new method of determining
initial benefit levels with
continued
CPI indexation
of postretirement
annuities.
The first recommendation
came from a panel of actuaries and economists in a report prepared
for the Senate Finance Committee
and
the House Ways and Means Committee.
This panel came to be known
as the Hsiao panel after its chairman,
William Hsiao, who is both an
actuary and an economist.
The panel recommended
that initial ben128
TABLE
Actual
Sources:
and Assumed
IV-14
Total Fertility
Years
Rates for Selected
Year
Actual Rate
Social Security
Assumed Rate
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
2.72
2.56
2.46
2.46
2.48
2.28
2.02
1.90
1.86
1.80
1.77
1.83
1.80
1.86
2.5
2.5
2.5
2.5
2.5
2.5
2.5
2.5
2.1
2.1
1.9
2.1
2.1
2.1
U.S. Bureau of the Census, StatisticalAbstract o]the U_zitedStates, 1981 (Washington, D.C.: U.S. Government Printing Office, 1981), p. 58; Social Security
Trustees Reports, selected years.
efits for future
retirees
be based
on their earnings
indexed
for historical
growth
in prices.
The net effect of their
proposal
was that
initial
benefits
would
grow slowly
over time in real terms
but that
wage replacement
rates would
decline
gradually
as real wages grew.
Their
financing
recommendation
called
for a level tax rate of 10.3
percent
on employers
and employees
combined
for OASDI
in 1980
and beyond.
This rate was only slightly
higher
than provisions
then
in law for the period
1980 to 2010. Under
the actuarial
projections
based
on the intermediate
assumptions
Report,
the average
seventy-five-year
cost of their
proposal
was 11 percent
of covered
payroll.16
The second
proposal,
developed
by internal
government
staff and
advocated
by the 1975 Social
Security
Advisory
Council,
called
for
benefits
to be based
on earnings
indexed
for historical
growth
in
average
wages.
The main
intent
of this proposal
was that over time
Social
Security
should
replace
the same proportion
of preretirement
I_William Hsiao et al., Report of tlle Consultant Panel on Social Security (Washington,
D.C.: U.S. Government Printing Office, 1976), pp. 3-6.
129
TABLE
IV-15
Effects of Changing Fertility Assumptions
from
Alternative II-B of 1981 Trustees Report on OASDI
Actuarial Balance, as a Percentage of Taxable Payroll
for 2031-2055
Fertility Rate
Assumption
2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
2.9
3.0
3.1
3.2
Increase in Actuarial
Balance
II-B Assumptions
0.6
1.2
1.7
2.2
2.6
3.0
3.3
3.1
3.9
4.2
4.5
_
Source:
Robert J. Myers, "Sensitivity Analysis of Assumptions in Alternatives I and
II-B of 1981 Trustees Report," Memorandum no. 7 (Washington, D.C.: National Commission on Social Security Reform, March 15, 1982).
_The actuarial deficit for the period is 4.4 percent of payroll under the II-B assumptions
on the basis of currently legislated tax rates.
earnings
for each cohort of retirees.
The Ford administration
endorsed
this proposal
in 1976, but no legislative
action
was taken that year.
The seventy-five-year
cost of OASDI benefits
under this proposal
was
estimated
at 15 percent
of covered
payroll.
The Hsiao
panel
argued
against
the wage
indexation
formula
on
the basis of its projected
rising
costs.
Their estimates
were that expenditures
would
be about
50 percent
higher under the wage-indexed
formula
at the height of the baby-boom
generation's
retirement
claims
in 2030. They argued
as follows:
Perhaps the most important
lesson learned from the financial difficulties
now facing the OASDI program
is that an
element
of flexibility
must be built into its design. Abrupt
changes
in benefits and supporting
taxes must be avoided.
In our constantly
changing society and economy, public interests can best be served by a system with built-in margins
that will permit measured
response
to the needs of an uncertain future.
130
It has been pointed out that on reasonable economic and
demographic assumptions the payroll tax rates needed to
finance benefits payable in the first half of the next century
will rise to more than double present rates. An issue that
should not bc overlooked is what future tax rates \viii be
needed to finance any proposal otfered as an improved benefit structure. The Panel believes that future generations of
workers should not bc committed in advance to materialh
rising lax rates. _7
The panel firmly
should not decline
recommended
in real terms
that Social Security benefit levels
over time, but suggested
that Con-
gress should provide the marginal
increments
in benefits needed periodically
on an ad hoc basis rather than by wage indexation.
In addressing
the Social Security financing
problem in 1977, Congress opted for the wage-indexing
formula
on the benefit side and
higher payroll taxes on the financing
side. The 1977 amendments
reduced
the projected
OASDI long-term
actuarial
deficit from 8.2
percent of payroll to 1.4 percent. Congress believed at the time that
enactment
of the 1977 amendments
had assured financial
solvency
program,
excluding
Medicare,
until at least
2020. Although the long-term
problem loomed on the horizon, Congress believed that there was still time to deal with it.
Continuing
Problems
It soon became apparent
that the short-term
benefits consistently
ran ahead of the levels projected
in 1977, and revenues ran behind.
The problem
stemmed
from adverse economic conditions
to which
the program
was still sensitive.
According to the five-year projections
in the 1977 Trustees Report,
inflation was expected
to decline, while prices were forecast to rise
a total of 28.2 percent between 1977 and 1981. In fact, prices rose 60
percent, more than twice the forecasted amount, as table IV- 16 shows.
Wages were expected to increase nearly 13 percent more than prices
over the period, but in fact wage earners
lost ground to price increases. Unemployment
was expected to decline, while in fact it rose
to about 50 percent above the projected
level for 1981, and has continued to get worse during 1982.
The full effects of the 1977 amendments
have not vet been experienced. The transitional
benefit provisions
in these amendments
left
tTlbid., p. 2.
131
TABLE
IV-16
A Comparison
of Five-Year Economic Assumptions
the 1977 OASDI Trustees Report with Actual
Experience
Year
1977
i 978
1979
1980
1981
Total
CPI Increase
Assumed a Actual
(Percent) (Percent)
Real Wage Increase
Assumed a Actual b
(Percent) (Percent)
in
Unemployment Rate
Assumed _ Actual
(Percent) (Percent)
6.0
5.4
4.3
4.7
4.1
6.5
7.7
11.3
13.5
10.4
2.4
2.7
2.5
2.4
2.3
1.5
0.6
- 2.6
4.9
- 1.5
7.1
6.3
5.7
5.2
5.0
7. I
6.1
5.8
7.1
7.6
28.2
60.0
12.9
- 6.9
5.9 _
6.7 _
Sources:
Assumptions trom 1977 Amtual Report of the Board of Trustees of the Federal
Old-Age and Sura,ivors Insurance and Disability Insurance Trust Funds (Washington, D.C.: Social Security Administration,
1977); actual experience lrom
1982 Economic Report of the President; real wage calculations by EBRI.
"Mid-range assumptions.
bEstimates from the 1982 Trustees Report tot all years.
_Estimates for five-year unemployment
totals are five-year averages.
vestiges
of the dual indexation
problem
started
by the 1972 amendments
in the program
until
1982. Is Although
the maximum
taxable
wage level was raised
by the 1977 amendments,
it reached
the point
of once again being adjusted
by automatic
growth
only in 1982. The
scheduled
increases
in payroll
tax rates do not take full effect until
1990. The OASI trust fund balances
are insufficient
to guarantee
meeting the benefit
payment
schedule
in both the short and the long terms.
Considering
the failure
of the 1977 amendments,
the basic conclusion
of the Hsiao panel
that an element
of flexibility
should
be built into
the system
has become
particularly
poignant.
Still,
the recommendations
of the Hsiao panel would
have left the OASI program
in even
worse
financial
straits
than
it is in today,
since the panel's
recommendations
would
have resulted
in greater
instability
than has been
experienced
under
the 1977 law.
Because
the OASI trust fund
cial Security
has been reduced
The current
tax schedule
cannot
has become
practically
depleted,
Soto strictly
pay-as-you-go
financing.
meet the benefit requirements
in the
laThe net eft;cot of the transitional provisions was relatively minor except t0r workers
retiring at age sixty-two before 1979. Inflation was so high that most of those reaching
age sixty-two alter 1978 used the AIME method tot the determination of their Social
Security benefits. Beyond 1978, newly entitled disabilitv and survivor cases were
covered by the modified formula.
132
1980s, so adjustments
to the system have to be made. The basic policy
question now is how to adjust Social Security to assure its continued
viability,
while continuing
to provide economic security for the aged,
the disabled,
and survivors
of deceased
workers. The nature of the
problem--stabilizing
the system--and
the means of addressing
it are
discussed
in chapters
V and VI.
133
V. The Mathematics
of Social
Security's Financing Problems and
the Short-Term Policy Options
Numerous
proposals
have been put forward to resolve
curity's
financial
imbalance
in the short and long terms:
Social
Se-
• move forward the scheduled payroll tax increases now in law;
• expand the income base subject to the payroll tax;
• include in the tax base employee benefits not included in current wage
payments;
• finance part or all of Hospital Insurance from general revenue and allocate the HI portion of the payroll tax to the Old-Age and Survivors
Insurance program;
• finance part of the Old-Age and Survivors Insurance and Disabilitv Insurance programs from general revenues on a continuing or a countercyclical basis;
• reduce cost-of-living adjustments for a time;
• change the COLA procedure;
• tax Social Security benefits as regular income and earmark the revenues
for OASDI financing;
• reduce the projected growth in initial benefit entitlements;
• eliminate or reduce benefits for certain categories of beneficiaries;
• modify the benefit adjustments [or early and late retirees;
• expand coverage; and
• phase the program out altogether.
Each of these proposals
would have different
implications
in the
short and long terms. The proposals
also would have a range of distributional
effects, because of their differential
sharing of tax burdens
and benefit modifications.
Given the long history of attempting
to
balance the adequacy and equity goals in Social Security policy, these
concepts
will surely play a role in the selection
of any particular
option or set of options. Policymakers
must seek to establish
a workable solution,
while restoring
public confidence
that there will be
adequate
levels of income security for both current and future retirees
at a reasonable
cost. Whereas
the last chapter
considered
the magnitudes
of' the short- and long-term
Social Security
problems
and
their discovery,
this chapter
explains
the internal
mechanics
that
account for the program's
instability
and for the projected
financing
shortfalls.
The analysis
flows from the "mathematics
of Social Security," which is described
in simple equations.
These equations
are
then used to evaluate
a range of short-term
options that can help to
135
balance Social Security's
financing in the near term. The equations
also serve as the basis for a set of long-term
modifications
that are
evaluated
in the next two chapters.
The
Mathematics
of Social
Security
Financing
At present, Social Security is strictly a pay-as-you-go program which
implies certain fundamental
mathematical
relationships
in the financing of benefits to be paid in the near and distant future. It is
useful to consider the mathematics
because it identifies the general
policy options for resolving the financing problems. It goes as follows:
Total tax receipts = total benefits I
Tax receipts = the payroll tax rate (t) times
the number of workers (Nw) times average
covered earnings
(W)
Total benefits
= the number of beneficiaries
(Nb)
times the average benefit (B)
This can be stated in standard
mathematical
form in the following
way:
(1)t. Nw.W
- Nb.B.
Congress can manipulate
the variables
in the financing equation
in various ways. Congress can directly raise or lower the payroll tax
rate and average benefit levels. To a lesser extent, Congress can alter
the number
of workers covered by the payroll tax and the average
covered wage. If Congress were to expand coverage,
the number
of
workers paying taxes would immediately
increase
and the number
of beneficiaries
and average benefit levels would ultimately
be affected. By changing
the eligibility
requirements
and retirement
incentives, the benefit and beneficiary
levels also can be manipulated.
For example,
if Congress were to encourage
or mandate
later retirement, the decline in beneficiaries
might increase the number of covered workers. More covered workers and later retirement
would help
on both sides of the equation,
raising taxes and reducing
benefits.
While the number of workers and wage level are subject to legislative
manipulation,
they are also sensitive to prevailing
economic conditions and general benefit policies in the marketplace.
In the context of resolving
Social Security's
financing imbalances,
equation
1 has both short- and long-term implications.
If it is assumed
_Actually, the right side of this equation
should include administrative
expenses.
These
expenses
are omitted
here, however,
because they account for less than 2 percent of
total outlays
and do not vary significantly
over time. Hence including
them would
complicate
the analysis
without
changing
the basic results.
136
that Social Security will remain a pay-as-you-go
program,
it is possible to estimate
the magnitude
of adjustments
required
to balance
the income and disbursement
sides of the financing equation.
Then
we can assess various policy options that might actually balance the
system financially.
Short-Term Imbalances--The
five-year short-term
projected income
cash benefits
programs
(i.e., OASDI) under
the 1982 Trustees
Report II-A assumptions
is $930.6 billion. Under
the II-B assumptions,
it is projected
at $926.7 billion. These income
estimates
do not include interest payments
or expense (if the balance
becomes negative) but do include reimbursements
from the Treasury
for special age seventy-two
benefits and gratuitous
military credits.
Disbursements
for the period 1982 to 1986 are projected
to be $944.8
billion under the II-A assumptions
and $972.9 billion under II-B assumptions.
The disbursements
include total OASDI benefit payments
plus additional
costs of administration,
vocational
rehabilitation,
and
transfers to the railroad retirement
account. Under both assumption
sets, projected
payroll tax income accounts
for 99 percent
of total
program
revenues
and benefit payments
nearly 98 percent of total
disbursements?
On this basis, equation
1 captures
about 98 to 99
percent of the total OASDI operations
on a pay-as-you-go
basis. Under
the II-A assumptions,
the projected rcvcnucs fall about $14.2 billion-1.5 percent
short of meeting
thc program
cost over this five year
period. Under the II-B assumptions
the shortage
is projected
to be
$46.2 billion--5.0
percent of projected
revenues.
On a comparable
basis, the II-A OASI income is projected
to be
$778 billion for the 1982 to 1986 calendar
years. Disbursements
are
projected
to be $845 billion. Projected
revenues other than interest
income are projected
to fall $67 billion short of disbursements
over
the five years. Under the II-B assumptions,
the five-year income shortfall is projected
to be $99 billion. 3 The OASI trust fund at the end of
1981 held $21.5 billion in assets and was insufficient
to meet either
shortfall.
Just to maintain
that trust fund and any interest it might
accrue would require an increase of 12.9 percent in other income or
a decrease
of 11.4 percent in disbursements
under the II-B assumptions. Of course, some combination
of increased revenues or decreased
benefits could accomplish
the same result. Under the II-A assump21982 Anmml
Report o/ Trustees of the Federal
Disability
htstlrance
Trust Futtds (Washington,
1982), p. 56.
3Ibid., p. 51.
Old-Age and Sura,ivors Insurance
and
Administration,
137
tions,
arios,
the problem
the situation
is slightly less severe; under
is significantly
worse.
the pessimistic
scen-
Long-Term Imbalances--The
long-term
cost and revenue estimates
for Social Security are projected
as a percentage
of covered payroll.
In terms of the mathematics
of Social Security, this means that equation 1 is manipulated
in the following way:
(2) t = (Nb / Nw) • (B/W).
Equation
2 shows that the tax rate required each year to finance the
program
on a current-cost
basis equals the expected ratio of beneficiaries to workers times the ratio of average benefits to average covered wages. The Social Security actuaries
refer to their projections
of the right side of the equation
as "cost rate" of the program.
The
"t" on the left side is the payroll
tax rate. To the extent that the
legislated
tax rate and the projected
cost rate do not balance, a financing surplus or deficit is projected
for the program. The actuaries'
long-term
cost projections
are made on the basis of a seventy-fiveyear period, as discussed
in chapter IV. Table V-1 shows the average
cost rates projected
in the 1982 OASD[ Trustees Report over the next
seventy-five
years, along with the accrued
and average surplus or
deficit on the basis of currently
legislated
tax rates for the periods
shown under the II-A, II-B, and pessimistic
assumptions
used in the
valuation.
Under both the II-A and II-B assumptions,
the combined
OASDI
tax rates now in law are projected
to be sufficient
to meet the cost
of Social Security cash benefits over the next twenty-five
years. Under
the pessimistic
assumptions,
OASDI never reaches adequate
financing on a current-cost
basis. Even under the II-B assumptions,
the
current short-term
OASI deficits are sufficiently
large that the twentyfive-year average stays negative, but there is a period between 1995
and 2010 when annual payroll tax collections
are projected
to exceed
annual disbursements.
Under all three sets of assumptions,
the DI
program
is projected
to have a surplus on a current-cost
basis over
the whole valuation
period.
The OASI trust fund would be depleted
in 1984 under all three
scenarios.
The combined
OASDI trust funds would be inadequate
to
meet the financing
deficit in 1985. Based on the II-A assumptions,
the OASI trust fund by itself would recover in 1995; under either of
the other two scenarios,
the OASI trust fund alone would never recover. The commingling
of the OASI and DI trust funds would result
138
TABLE
V-I
Estimated
Cost Rates and Tax Rates for OASDI
Programs Combined and for DI and OASI Programs
Separately
for Alternative
Periods
(As percentages
of taxable payroll)
Average Cost Rate
ILA
II-B
III
Period
Combined
1982-2006
2007-2031
2032-2056
OASDI Programs
10.46
11.37
13.15
14.08
15.65
16.81
1982-2056
Average
Tax Rate
Average
II-A
Surplus
II-B
or Deficit
III
12.73
17.84
25.66
12.01
12.40
12.40
1.55
-0.75
-3.25
0.64
- 1.68
-4.41
-
0.72
5.44
13.26
-0.82
- 1.82
-
6.47
13.09
14.09
18.74
12.27
Alone
1. l6
1.57
1.54
1.23
1.65
1.61
1.36
2.00
2.07
2.07
2.20
2.20
0.92
0.63
0.66
0.85
0.55
0.59
0.72
0.20
0.13
1.42
1.50
1.81
2.16
0.73
0.66
0.35
OASI Program Alone
1982-2006
9.31
2007-2031
11.58
2032-2056
14.11
10.14
12.43
15.20
11.37
15.83
23.60
9.93
10.20
10.20
0.63
-1.38
-3.91
-0.21
2.23
-5.00
-
1.44
5.63
13.40
1982-2056
12.59
16.93
10.11
-1.55
2.48
-
6.82
DI Program
1982-2006
2007-2031
2032-2056
1982-2056
Source:
11.66
1982 Ammal Report o[ Trustees o[ the Federal Old-Age and Su_a'ivors htsura_we
and Disability Insurance Trust Funds (Washington, D.C.: Social Security Administration,
1982), p. 70.
in a two-year
deficit
under
scenario.
fund deficit
under
II-B, and a perpetual
the II-A
deficit
assumptions,
under
the
a nine-year
Alternative
III
For the long term,
then, policymakers
must focus on resolving
the
OASI funding
shortfalls.
Under
the 1982 Trustees
Report
II-A and IIB assumptions,
OASI has a pay-as-you-go
financing
deficit every year
in the valuation
period
beyond
2015. During
the second
twenty-five
years in the cost projections
shown
in table V-l, the average
shortfall
ranges
from
13.5 percent
of projected
revenues
under
II-A assumptions to 21.9 percent
under
the II-B assumptions,
and 55.2 percent
in
the pessimistic
scenarios.
During
the third
twenty-five-year
period,
the revenue
shortfall
under
the three
sets of assumptions
increases
to 38.3, 49.0, and 13 [ .4 percent
of revenues,
respectively.
The reason
for this deteriorating
situation
is largely
the result
of
changing
demographics;
it can
bc attributed
specifically
to the
proj139
ected
increase
in the
number
of beneficiaries
dependency
relative
ratio.
The dependency
to covered
workers--the
ratio
first
is the
factor
on the right hand of equation
2 (i.e., Nb/Nw). Table V-2 presents
three
sets of dependency
ratio projections.
Both the OASI and OASDI dependency
ratios
remain
relatively
stable
until the turn of the century.
Around
that time, however,
they rise very rapidly
because
of projected
rapid
increases
in the OASI recipiency
rates as the baby-boom
generation
passes
into retirement.
Under
the II-A and II-B assumptions,
the dependency
ratios
stabilize
again
around
2030, when
baby-boom
generation
retirements
are expected
to peak. Under
the pessimistic
assumptions,
the ratios
continue
to rise because
of the lower fertility
rate assumptions
in this
scenario.
Lower
birthrates
over the next three decades
would
lower
the number
of future replacement
workers
(i.e., taxpayers).
The maximum
effect would
be seen during
the last twenty-five
years
of the
projection
period.
TABLE
V-2
OASI and OASDI Beneficiaries
Per 100 Workers Under
1972 Trustees Report II-A and II-B Assumptions
Year
1982
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
Source:
140
II-A Assumptions
OASI
OASDI
27
27
27
28
28
28
30
34
38
42
45
46
45
45
45
45
45
31
30
30
31
31
32
34
38
43
47
49
50
50
49
50
50
50
II-B Assumptions
OASI
OASDI
27
27
28
28
28
28
30
34
39
43
46
46
46
46
46
46
46
31
30
31
31
32
33
35
39
43
48
50
50
50
50
50
51
50
III (Pessimistic)
Assumptions
OASI
OASDI
27
27
29
29
30
31
34
40
46
53
58
62
64
67
70
73
74
31
31
32
33
34
36
39
45
52
58
64
67
70
73
76
78
80
1982 Amlual Report of Trustees o/ the Federal Old-Age and Sun,ivors htsura_we
and Disability Insurance Trust Funds (Washington, D.C.: Social Security Administration,
1982), pp. 65-66.
Not only will the beneficiary-to-worker
ratio rise in the future, but
the changing
composition
of the beneficiary
population
will exacerbate the long-term
financing
problem
as well. This problem stems
from the fact that different classes of beneficiaries
do not all have
the same claim on the system. Table V-3 shows the average OASI
benefits
paid to different
classes of recipients
over the years and
compares
them with retired workers' benefits. The table shows that
for most categories
of recipients,
the relationship
between benefits
paid to persons
other than workers and benefits paid workers has
been relatively
stable. For example,
the average benefit paid to the
spouse of a retired worker has ranged from a high of 53.8 percent of
the average worker's benefit in 1950 to a low of 50.4 percent in 1980.
There was only a 3.8 percentage-point
swing in the ratio of spouse
benefits to worker benefits over the thirty-year
period.
The real importance
of the benefit comparisons
becomes apparent
when considering
the projected
changes in the relative sizes of the
beneficiary
categories.
In 1980, for example, 63.1 percent of all OASI
beneficiaries
were retired workers. Under the 1982 Trustees
Report
II-B assumptions,
retired workers are projected
to increase
to 72.6
percent of OASI beneficiaries
by the year 2000, 82.6 percent by 2030,
and 84.5 percent by 2060.
The change in the composition
of beneficiaries
is important
because
retired workers receive higher benefits on average than other recipients. The potential
size of the composition
effect can be estimated
by weighting
the projected
number of beneficiaries
in each class by
a "benefit equivalency"
factor. The benefit equivalency
factor converts each class of recipients
into retired-worker
equivalents
on the
basis of relative benefit levels. For examplc,
in June 1980 there were
30.4 million OASI beneficiaries
shown in the 1982 Trustees
Report. 4
If the 1980 benefit equivalency
factors in table V-3 are applied to all
beneficiaries
in each category,
the 30.4 million beneficiaries
are converted into 27.1 million retired-worker
equivalents.
Similar calculations can be performed
on the projected
beneficiary
categories
to
show the composition
effects that might be expected in the future.
Table V-4 shows the results of applying the 1980 beneficiary-equivalence factors to the 1982 Trustees Report II-B projection
of future
recipiency
levels. The table shows that the program
is projected
to
grow somewhat
more rapidly on a retired-worker-equivalent
basis
than the projected
growth in beneficiaries
alone would suggest. Thus,
although
changing
demographics
are largely responsible
for proj4Ibid.,
p. 84
141
c._
_'_
._
•-
_ _"_
_
_ _
._
_ _
_
_
_
_
_.
..-
___
_
_
_ __
_
_
__
__
.........
142
_
._
_
_
TABLE
Number
Equivalents
V-4
of Beneficiaries
and Retired-Worker
and Percentage
Growth Projected Over
1980 Levels for Selected Years
Beneficiary
Level
Retired-Worker Equivalent
Year
Number
(Thousands)
Percentage
Growth
from 1980
Number
(Thousands)
Percentage
Growth
from 1980
1980
1990
2000
2010
2020
2030
2040
2050
2060
30,384
36,428
39,814
45,359
57,753
69,138
71,440
73,034
75,215
_
19.9
31.0
49.3
90.1
127.5
135.1
140.4
147.5
27,148
33,351
36,744
42,216
54,272
65,279
67,993
69,562
7 1,730
_a_
22.8
35.3
55.5
99.9
140.5
150.5
156.2
164.2
Source:
Beneficiary levels based on actual level in 1980 and II-B projection presented
in the 1982 Annual Report o[ Trustees o[ the Federal Old-Age and Survivors
lnst_rance and Disability Insurance Trust Funds (Washington, D.C.: Social Security Administration,
1982), p. 84; the retired-worker equivalent levels were
derived by applying the 1980 benefit equivalence factors from table V-3 to
actual and projected beneficiaries bv class from the same projections as beneficiarv levels were taken.
;' 1980 is the base year for the remaining percentage calculations.
ected
increases
in the future
cost of Social
Security,
some socioeconomic
factors
also are causing
costs to rise. The projected
changing
composition
of the beneficiary
population
resulting
from these factors
would
cause
average
benefits
to rise in the future.
The implications
of these changes
can be seen by further
manipulation
of equation
2 as follows:
(3) W/B
In equation
to average
parentheses
the payroll
cost basis.
= (Nb/Ntt,)/t.
3, the term on the left side is the ratio of average
wages
benefits.
On the right
side of the equation,
the ratio
in
is the dependency
ratio
discussed
earlier,
while
"t" is
tax rate required
to finance
the program
on a currentBoth the dependency
ratio and the cost rate are estimated
by Social Security's
actuaries;
thus the implicit
wage-to-benefit
can be derived.
Table V-5 shows
the results
of this derivation
the
1982
Trustees
Report
ratio
under
II-B assumptions.
143
TABLE
V-5
Projected OASI Dependency Ratios, Cost Rates, and
Relationships
Between Average Benefits to Average
Wages for Selected Years
Year
Ratio of
Beneficiaries
to Workers
Cost
Rate
Ratio of
Average Wages
to Benefits
Ratio of
Average Benefits
to Wages
1982
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
0.2730
0.2685
0.2751
0.2790
0.2799
0.2842
0.3034
0.3400
0.3853
0.4297
0.4556
0.4632
0.4579
0.4552
0.4578
0.4599
0.4592
0. !042
0.1052
0.1054
0.1027
0.0975
0.0950
0.0994
0.1112
0.1272
0.1429
0.1523
0.1545
0.1520
0.1503
0.1509
0.1521
0.1522
2.62
2.55
2.61
2.72
2.87
2.99
3.05
3.06
3.03
3.01
2.99
3.00
3.01
3.03
3.03
3.02
3.02
0.382
0.392
0.383
0.368
0.348
0.344
0.328
0.327
0.330
0.333
0.334
0.332
0.332
0.330
0.330
0.331
0.331
Source:
Ratios calculated by the author. The ratio of beneficiaries to workers was
computed on the basis of II-B projections of OASI beneficiaries and covered
workers; the cost rates were taken directly from 1982 Annual Report of Trustees
of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust
Funds (Washington, D.C.: Social Security Administration,
1982), pp. 64 and
66.
In the
assumed
long-term
cost projections
to grow more rapidly
than
of the
prices.
OASI
Under
program,
wages
are
the II-B projections,
wages
are ultimately
assumed
to grow
1.5 percent
faster
per year
than
prices.
If initial
benefits
grow at the same
rate as wages,
and
postretirement
benefits
grow at the slower
rate of increasing
prices,
one might
expect
average
benefit
levels to decline
relative
to average
wages
over time. The changing
composition
of the beneficiary
population
to include
a higher
proportion
of retired
workers,
however,
will raise the level of average
benefits.
As a result,
the ratio of average
wages to benefits
is projected
the turn of the century.
Then,
to increase
gradually
until
as the baby-boom
generation
to begin to retire under current
eligibility
criteria,
using the II-B projections.
If the projections
made
144
shortly
after
is expected
the ratio stabilizes
on the basis of the
1982 Trustees
Report II-A or if the pessimistic
assumptions are used
instead of the II-B assumptions
the result is the same, only the ratios
differ.
In sum, then, under current law, the outgo of the OASI program
is
projected
to exceed revenues by 9 to 13 percent
on the basis of the
short-term
(five-year) projections.
On the long-term (seventy-five-year)
basis, projected
benefits exceed revenues bv 15 percent under the I[A assumptions,
by 25 percent under the II-B assumptions,
and bv 68
percent under the pessimistic
assumptions.
Stabilizing
the Financing
of Social
Security
Just as the mathematics
is useful in explaining
Social Security
financing problems,
it is also useful in evaluating
the policy options
for resolving them. Before discussing specific options it is helpful to
delineate
some general policy considerations.
Equation 2 was stated
as follows:
t = (Nb/Nw)
• (B/W)
where "t" is the payroll tax rate required
to sustain
the projected
benefit levels, or what Social Security actuaries
call the cost rate of
the program.
In the short term, the ratio of beneficiaries
to workers is unstable
because
of variations
in the economic
cycle. During a recessionary
period, the number of workers declines as unemployment
rises, and
the number
of beneficiaries
rises as people eligible for benefits who
would have continued
working are affected by unemployment.
The
opposite would be true during a recoverv.
Furthermore,
the ratio of average benefits
to average wages can
become unstable during periods in which either behaves erraticallv.
Under assumptions
that have been used in the Social Security valuations since 1972, the ratio of benefits to wages has been projected
to decline gradually
because of real wage growth. In fact, this ratio
has not declined at the expected rate and has actuallv increased
during several of the past ten years.
If the ratio of benefits to wages is to be insulated
against the kind
of erratic economic
behavior
experienced
in the past ten years, increases in benefits will have to be linked to an index of wages. This
ratio could be held constant
in the short term by using the average
wage index as a basis for increasing
postretirement
benefits in increments.
The ratio could be held constant
when real wages are not
145
growing
and decreased
when they are by indexing
benefits by the
lower of wage or price growth. And the ratio could be forced to decrease in the short term, by indexing benefits by something
less than
wage growth (e.g., wage growth rate minus 15). In the last case, the
ratio would not decline so rapidly during periods of rapid real wage
growth as it would if benefits
were indexed to prices. In the long
term, the recomposition
of the beneficary
population
would still stabilize the ratio of benefits to wages under the II-B assumptions.
The ratio of beneficiaries
to workers will never be absolutely
stable
in the short term. Assuming that the ratio of benefits to wages is
stabilized,
the only way the tax rate can be stable over economic
cycles in the short term is for there to be resources
other than the
flow of payroll taxes available
to meet Social Security
benefit requirements.
This means either that a trust fund has to be accumulated
or that borrowing
provisions
from other revenue sources must be
available.
There have been several analyses of the size of trust fund reserves
required
to administer
the Social Security benefit payment schedule.
These analyses generally conclude that the trust fund balances at the
peak of an economic cycle should be large enough to meet scheduled
benefits through the trough of economic downswings.
It is generally
assumed that if economic conditions
turn out worse than projected,
Congress will have enough warning
to make necessary adjustments
to the programs.
However, the time Congress needed to develop legislation
to address
the problem
in 1977 and the time it is taking
Congress to respond
to the current
financing
problem suggest that
some additional
trust fund reserves
might be required
to provide
more lead time for responding
to financing problems when they arise.
Even so, there is no guarantee
that a larger trust fund balance would
not also be depleted
if Congress merely extends the amount of time
it takes to react.
An alternative
source of Social Security
revenues that has been
recommended
for economic downturns
is countercyclical
general revenue infusions, to offset lower payroll tax collections
during periods
of high unemployment.
However, this proposal might exacerbate
the
normal
growth in deficits that occurs during recessionary
periods.
Larger government
deficits can lead to higher interest rates and retard recovery, thus prolonging
adverse cyclical effects on Social Security financing.
If neither
a trust fund nor alternative
revenues
are provided
to
stabilize
the program
during unstable economic periods, then something else has to adjust. For example, consider the case of an economic
146
downturn
with rising unemployment;
during such a period the ratio
of beneficiaries
to workers (i.e., Nb/Nw) will rise. If there are no resources available
other than payroll taxes (i.e., there is no trust fund)
in the short term to meet benefit obligations
and if the ratio of average
benefits
to average covered wages (i.e., B/W) is to remain constant,
the tax rate has to increase as unemployment
rises. If, however, the
tax rate is to be held constant,
as the ratio of beneficiaries
to workers
rises, it mav be necessary to hold benefit increases below levels that
would otherwise
be provided automatically.
Neither raising taxes nor
lowering benefits has been seriously
proposed
as the logical policy
response
to recessions.
Nonetheless,
short-term
Social Security
financing stability,
based on the simple mathematics
of the program,
will require such measures
if alternative
provisions
are not made.
The long-term
time frame provides
a bit more flexibilitv
but a
problem
of greater magnitude.
The tax rate (i.e., "t") in equation
2
equals the ratio of beneficiaries
to workers times the ratio of average
benefits to average wages. Under current law the ratio of beneficiaries
to workers
is expected
to rise markedly.
The analysis in the prior
section of this chapter
has shown that the average ratio of benefits
to wages is projected
to stabilize.
Both phenomena
are expected
to
occur shortly after the turn of the centurv.
Under the 1982 Trustees
Report II-A assumptions,
there is a projected OASI trust fund accumulation
at the end of the 1980s and
throughout
the 1990s. This accumulation
could help to buffer the
effect of the babv-boom
retirements
for a while, but is not sufficient
to fully absorb it over the long term. Under the II-B assumptions,
the
OASI trust fund is not projected
to recover from its current
shortterm deficiency.
If part of the DI tax rate were reallocated,
because
that program
apparently
is slightly overfunded,
the problem would
be less severe but would not go away. The HI trust fund will itself
be running substantial
negative balances under current law long before the baby-boom
generation
reaches retirement
age.
The long-term
financing
options are bounded bv Social Security's
mathematics.
Tax rates can be raised but there is a serious question
of how far. The ratios of beneficiaries
to workers can be affected bv
benefit eligibility
criteria and work incentives,
but the growing role
of pensions
and their own retirement
incentives
may significantly
dampen the effects of modifications
to Social Security. The wage base
can be raised in several wavs and the overall benefit structure
can
be modified,
but these actions
mean either higher taxes or lower
benefits for participants.
Finally, alternative
sources of revenue might
be tound, but there are no "free" revenues to be had.
147
Each of the potential
short- or long-term
solutions
to Social Security's
financing
problems
is going to be somewhat
controversial.
The policy question
is how to balance the equation
in a reasonable
fashion.
General Policy Considerations--Historically,
Social Security policy
has attempted
to balance
the countervailing
goals of adequacy
and
equity through its financing and benefit structure.
Until recently this
process has been relatively
uncontroversial
because virtually all beneficiaries
have received, or could expect to receive, benefits
that
substantially
exceed the value of their contributions.
The days are
quickly passing when all members of each retiring cohort of workers
can expect to receive more than the value of their combined employeremployee
payroll tax contributions.
The future balance of adequacy
and equity has to be considered
in the framework
of a broader set of
priorities.
Two additional
and equally important
policy goals for Social Security are solvency and public support.
If these goals are not met,
adequacy
and equity considerations
will become moot. The question
solvency has gravely shaken the confidence of old
and young alike. Many elderly beneficiaries
fear their monthly benefits will be cut off, and many young workers do not believe the
program
will even exist when they reach retirement
age. Without
confidence
that the program is solvent, continued
support will wither.
These intergenerational
concerns
about Social Security
link the
short- and long-term considerations.
The policymakers
seek solvency
with total disregard
for either adequacy
or equity. There is public
agreement,
cutting across the entire political spectrum,
that retirees
must not be ravaged by program
modifications.
There is a general understanding,
however,
that many of today's
retirees lead financially
secure and comfortable
lives. While it may
not be as generally
understood,
it is a fact that current retirees receiving Social Security are getting benefits relative to their final earnings, even after adjusting
for inflation, that are much higher than the
benefits earlier cohorts of retirees received or those that workers who
will retire in the future can expect. Figure V- 1 clearly shows
of the benefit changes during the 1970s on average workers;
were practically
the same for low- and high-wage
workers
is not just beneficiaries
who have retired since 1970 who
the effects
the effects
as well. It
have ben-
efited, because the large increases
for people already retired
the 1970 to 1972 period raised their benefits comparably.
148
during
FIGURE V-I
Replacement
of Preretirement
Worker
Retiring
at Age 65,
Earnings
for Average
by Year of Retirement
Percent
6O
5O
40
30
I
I
I
I
t
l
i
1955
1960
1965
1970
Year
1975
1980
1985
1990
Source: Office of the Actuary, Social Security Administration.
The linking of Social Security
benefits
to price increases
in the
1970s insulated
retired people from the major source of income erosion-the
risk of inflation. This linkage occurred at a time when the
shock of energy price increases had started to reverberate
throughout
the economy.
Workers were not so insulated,
and they have experienced real declines in earnings.
The wringing
out of inflation,
furthermore,
has not only reduced workers' wages in real terms; in many
instances
it has also taken their jobs.
In addition,
there is a growing concern
that young workers who
must support the program
may not receive a fair return from Social
Security when they retire. The analysis in chapter I showed that under
currently
legislated
tax rates and benefit schedules,
some workers in
the future can expect to get back less from Social Security than the
value of their employer-employee
contributions.
The perception
that
some workers may not get their "money's
worth" out of Social Security has already
led some critics to conclude
that the program
should be radically
reconfigured
or phased out.
149
Focusing just on rates of return to Social Security provides a relatively narrow perspective
on retirement
policy, but it is a perspective
that has been encouraged
by the development
of Social Security policy which historically
has often been made in a vacuum. The fact is
that more than 90 percent of wage and salary workers with earnings
above the maximum
taxable earnings
base are participating
in an
employer
pension program. 5 Although some young workers may face
low or negative returns on their Social Security contributions,
these
will tend to be earners in the upper-middle
or high-wage
brackets.
Among such workers,
pension coverage
is most prevalent
and the
probability
of receiving a pension is the highest. Such workers would
also be likely to set up an IRA or to participate
in a CODA during
their working lives. Employer
contributions
to tax-qualified
pension
plans are not taxed until benefits are paid. Furthermore,
the interest
accruals
on employer
or employee
contributions
are not taxed as
income until distribution,
either. IRA and CODA accumulations
and
the interest accruing to such accounts are also taxed at distribution.
In each case the tax code allows the distribution
of benefits
to be
taken over a period of time or averaged
over a number of years to
minimize
the amount of taxes paid on these retirement
accumulations. In most instances,
a person's income level after retirement
will
be lower than prior to retirement,
so the marginal
and average tax
rates applied
to retirement
distributions
are generally
lower than
they would have been if the income had been paid and taxed during
the worker's
career. This preferential
tax treatment
makes each of
these vehicles more effective for middle- and upper-income
workers
than they would otherwise
be. To focus only on low rates of return
on Social Security for persons participating
in other retirement
programs ignores the added retirement
benefits provided through other
components
of the federal tax system.
Yet the continuing
tax treatment
of pensions
is uncertain.
In a
recent book, Alicia Munnell, a Vice-President
of the Boston Federal
Reserve Bank, called for the taxation of pension accruals or complete
elimination
of tax concessions
for employer
retirement
programs. 6
Merton Bernstein,
a law professor
at Washington
University
in St.
Louis, Missouri, argued in 1980 that the tax concessions
to pensions
should be phased out and the added tax revenues be used "toward
SSylvestcr
J. Schieber
and Patricia
M. George, Retirement
Income Opportunities
in an
Aging America: Coverage and Benefit Entitlement
(Washington,
D.C.: EBRI, 1981), p.
41.
_'Alicia H. Munnell,
The Economics
ings Institution,
1982), p. 59.
150
o[ Private
Pensions
(Washington,
D.C.: The Brook-
meeting the needs of the Social Security system. ''7 Bernstein,
now a
consultant
to the National Commission
on Social Security Reform,
has more recently
written:
"The voluntary
nature of private plans
and the quite unpredictable
patterns
of employment
make the coverage and benefit results of private plans difficult to predict. ''8 Certainly the future of pensions cannot be precisely predicted, but neither
can the future of Social Security,
as it now exists. The pension coverage rates that prevail today and the maturing
of plans discussed
in chapter
II suggest that the percentage
of elderly people receiving
pension benefits in the future will be significantly
higher than now
unless there is a radical change in tax policy.
If the tax concessions
to pensions were eliminated,
the future prospects for supplemental
retirement
programs
would be greatly diminished.
Administrative
costs
and regulatory
compliance
requirements
would cause manv employers
to eliminate
their plans.
It would be cheaper
for them to pay the benefits to workers in the
form of direct salary. If such a policy were to be implemented,
the
Social Security money's worth issue would become far more credible
and sharpen
young workers' hostility toward the program.
Meeting the combined
Social Security
goals of adequacy,
equity,
solvency, and support
suggests a sharing of the adjustment
burden.
In seeking short-term
solutions,
policymakers
should keep in mind
the long-term
implications
and vice versa.
Short-Term
Policy
Options
If the OASI, DI, and HI trust funds were combined,
there is a slim
possibility
that the combined
payment
schedule could be met until
the OASI financing
picture improves
after 1990 but the HI picture
gets much worse then. To do nothing in the hope that the program
"might"
survive the short-term
problem
would be a serious error.
The erosion of confidence
in Social Security since 1972 suggests there
is a limit to what the public will take. The potentialpublic
displeasure
from a policy ofdoing nothing and being wrong is far greater than the
hostility that wiU result as actual adjustments
are made along with an
assurance
the problems are being solved. Taking action inadequate
to
solve the problems will also further erode confi'dence in the system.
7Merton C. Bernstein, "Social Security: America's Bcst Bet," prepared statement to
the President's Commission on Pension Policy, March 13, 1980,p. 6.
SMerton C. Bernstcin, "Problem Areas in Private Pensions and State and Local Government Pensions," General Memorandum, National Commission on Social Security
Reform (May 4, 1982),p. 1.
151
In view of the fact that HI is on an inexorable
path to its own
financing
crisis, the HI trust fund should not be used to meet shortterm OASI financing
beyond the current
borrowing
period. The DI
fund has only limited excess reserves, but these should not be reduced
below a level to get it through a worst-case
scenario. Solving the OAS1
problem by creating or exacerbating problems in the other two programs
is not a solution.
If these restrictions
are accepted
then it is fairly easy to define the
policy options. At the beginning of this chapter the revenue and benefits sides of Social Security were defined mathematically.
For the
sake of describing
policy options these will be considered
separately.
Equation
4 is derived from equation
1 with a significant
modification and describes the revenue side (R) of Social Security as follows:
(4) R = T + (t-NoW)
Equation
4 differs from equation
1 by the addition
of "T," which
represents
the potential
infusion of general tax revenues.
Action by
Congress could affect each of the variables
on the right side of the
equation.
The way in which each can be manipulated
is discussed
separately.
General Revenue Financing--Congress
could infuse general revenue
into the OASI fund either directly or indirectly.
It could do so directly
by appropriating
funds to Social Security or by allowing
the trust
fund to borrow from the general fund. In the latter case there would
be a question of whether repayment
would ever be made. Under the
1982 Trustees
Report II-B assumptions,
the OASI trust fund would
remain in deficit beyond
1983 in all years projected
under current
law. Under the II-B scenario,
the general revenue borrowing
to get
OASI through
the short term would never be fully repaid. Alternatively, general
revenues
could be indirectly
infused into the OASI
trust fund by financing part or all of HI through the general fund and
reallocating
the released payroll tax revenues to OASI.
The problem with infusing general revenues into Social Security
at this time is that there are no surplus general revenues, only general
deficits. On the basis of preliminary
July 1982 economic assumptions
the Congressional
Budget Office (CBO) projects the total federal deficits to be between $160 and $180 billion in each of the next three
fiscal years. 9 There have been several
proposals
submitted
to Congress
9Alice M. Rivlin, prepared statement before the National Commission on Social Security Reform. August 20, 1982, p. 2.
152
to take Social Security out of the unified budget in order to remove
the OASDHI financing debate from budgetary
debate. Yet in a glaring
contradiction,
some advocates
of removing
Social Security from the
unified budget also advocate general revenue infusions into the program. Such a combined
policy would unquestionably
put Social Security in the budget battle because any general revenue contributions
to the trust funds would adversely
affect the resulting
budgetary
balance
whether
they were paid out in OASDHI benefits or not. In
short, the surest way to get Social Security in the budget battle is to
provide general revenue financing.
Raising Payroll Tax Rates--Under
current taw the OASDHI payroll
tax rate is scheduled
to rise to 7.05 percent of taxable payroll on both
employers
and employees
on January
1, 1985. The rate is to rise to
7.15 percent in 1986 and to 7.65 percent in 1990. If the 1985 and 1986
increases were moved forward to 1984, CBO projects additional
trust
fund revenues of $10.8 billion in 1984 and $6.2 billion in 1985; moving
to the 7.65 percent rate in 1984 would generate
increased
revenues
of $22.8 billion in 1984 and $23.3 billion in 1985) 0
Raising payroll taxes may be required as a partial solution to the
short-term
financing problem. This course almost certainly would be
resisted by those political factions that have fought vigorously for tax
reductions
in recent years. Increasing
the tax liabilities
of both employers and their workers might be opposed
bv a broad economic
coalition
as well.
Expandi_g Coverage--Congress
can increase the number of workers
who are paying the payroll tax bv legislating
coverage
of workers
now exempt from Social Securitv. There are now approximately
2.5
million federal civilian employees,
3 million state and local workers,
and roughly
500,000 to 1 million employees
of private,
nonprofit
organizations
who are not covered by the program
on the basis of
their current employment.
The potential
revenues for the Social Security trust funds that would result from expanded
coverage would
be significant.
Coverage
of new federal civilian
workers hired after January
1,
1983, would generate
$9.6 billion in additional
revenues during the
first five vears. II Covering all federal workers more than ten vears
t°Ibid., p. 15.
ItSvlvester J. Schieber, "The Cost and Funding Implications of Modifying the Civil
Service Retirement System" (Washington, D.C.: EBRI, 1982),p. 20.
153
from normal
retirement
on that date would result in additional
OASDHI revenues exceeding
$35 billion in the first five years. Coverage of all nonprofit
employees
on that date would result in added
tax collections
of more than $6 billion within five years. Coverage of
new state and local employees
hired after January
1, 1985 would add
contributions
of more than $13 billion before 1990.12
The argument
has been put forward that mandatory
universal coverage would be a further
expansion
of a program
that is already
beyond its limits. Actually, less than 20 percent of the approximately
6 million workers now in noncovered
employment
will never receive
Social Security
benefits; these workers constitute
only 1 percent of
the current
work force. The other 80 percent
will eventually
take
covered
employment.
Although
universal
coverage
would significantly increase the base of covered earnings it would have little effect
on the number of workers who become covered during their working
careers.
The issue of expanded
coverage
is more than a financing
issue. It
goes right to the heart of the equity of the Social Security program.
The redistributive
aspect of Social Security
subsidizes
people with
periods
of noncovered
employment
who ultimately
receive OASDI
benefits. During 1980 more than 80 percent of Civil Service Retirement annuitants
over age sixty-five were also receiving
OASDI benefits. The subsidies
they receive because of the vagaries
of Social
Security were never meant to be perpetuated.
The issues surrounding
the coverage
expansion
debate are quite complex and are discussed
in detail in chapter
VII.
Rede[i'ning Taxable Wages--There
are two basic methods by which
the payroll tax treatment
of wages could be changed to raise additional revenues. One method would be to raise the taxable maximum
earnings level, (1) by eliminating
or raising the cap on both employers
and workers, or (2) by making total employer
payroll subject to the
payroll tax. Some policy analysts prefer the latter form of this proposed method because,
they argue, benefits
would not have to be
raised if the earnings
base were not raised for workers.
The second method of increasing
the levels of wages subject to the
payroll tax would be to subject nonwage benefits to the payroll tax
in one of two ways. One way would be to count some or all of the
nonwage
components
in employee
benefits as wages for payroll tax
12Sylvester
J. Schieber,
"Universal
Benefits and Costs" (Washington,
154
Social Security
Coverage
D.C.: EBRI, 1981), p. 20.
and Alternatives:
The
purposes.
Conceptually,
there are overwhelming
attribution
problems if this were to be accomplished,
but even if that objective were
set aside such a policy would raise other issues as well. The two largest
benefit components
in the private
sector are pensions
and health
benefits. In 1980, pension contributions
and health benefits premiums
probably
cost employers
in the neighborhood
of $100 billion. If this
amount
could be attributed
to individual
workers, their taxable incomes would rise. This attribution
would have no effect on the payroll
tax liabilities
of workers with incomes above the taxable maximum,
but for lower- and middle-income
workers,
the attribution
would
mean added tax liabilities
without any change in
effect, this would amount to a tax increase for the
least afford it. Such a redefinition
of wages would
erable opposition,
especially
in light of the fact
employees
do not even pay Social Security
taxes
laries.
pretax income. In
people who could
meet with considthat many public
on their basic sa-
The second method proposed
to capture
nonwage
benefits would
be to index the payroll tax rate to account for growth in such benefits.
Under this proposal, if nonwagc benefits grow as a percentage
of total
compensation
paid to workers,
the payroll tax rate would be automatically
increased
to keep total payroll tax collections
a constant
percentage
of total compensation.
Since different levels of benefits
are provided
to workers, the inequity of such a proposal should be
easy to see. The most inequitable
aspect of such a policy is that it
would hit hardest
the low-wage
worker who often doesn't
receive
such benefits at all.
Social Security Benefit
specifies the expenditure
can be stated as follows:
Adjustments--The
right side of equation
position of the Social Security program.
1
It
(5) E - Nb-B
The expenditure
level (E) can be controlled
bv varying either the
number
of beneficiaries
(Nb) or the average benefit levels (B). It is
unlikely that anyone would seriously consider any policy option that
would significantly
affect the number
of OASI beneficiaries
in the
short term. It is also unlikely that Congress would reduce monthly
benefit levels to current
recipients
or significantly
redefine
benefit
entitlements
for persons who will retire in the near future.
Indexing--Several
short-term
proposals to slow the projected growth
in benefits would modify the benefit indexation
procedures
on either
a one-time
or short-period
basis. Table V-6 shows CBO's estimated
155
TABLE
Social
V-6
Security
Outlay Savings
Under
Cost-of-Living
Adjustments
by Fiscal Year
Different
Total
1983
(Billions)
Eliminate
1983 COLA
1984
(Billions)
1985
(Billions)
1983-1985
(Billions)
$2.2
$9.2
$9.5
$20.9
Delay COLAs from July
to October
2.2
2.1
2.8
7.1
Cap COLAs at 4
percent
0.6
2.7
4.4
7.7
Set COLAs at growth
in wages minus 1.5
percentage
points _
0.2
0.9
0.9
2.0
Source: Congressional Budget Office.
_This option would result in small savings in outlays in the short term because of
projected low productivity growth. Over the longer term, however, outlays could be
either higher or lower than under current law, depending upon the relative behavior
of wages and prices.
savings
under some of these options.
Given the assumptions,
the complete elimination
of the 1983 COLA would
be the most effective
of
the options
considered
in the table. Concerns
about adequacy
of benefits for people
at the bottom
of the income
scale may dictate
that
at least some incremental
benefits
be provided.
Given the high rates
of return
on contributions
and high replacement
of final earnings
for
current
beneficiaries,
a dollar
cap on indexed
benefits
might
allow
full assurance
of inflation
protection
for the more needy. At the same
time it would provide
limited
savings by slowing
the growth
of higherlevel benefits.
Taxing
Benefi'ts--Another
alternative
would
provide
for the taxation of Social
Security
benefits
as regular
income.
The increased
general
revenues
would
be earmarked
to be paid
back to the Social
Security
trust funds.
There are several
variants
of this proposal.
The most extreme
would
treat all Social
Security
cash benefits
regular
income.
If both OASI and DI benefits
were
taxed and
revenues
earmarked,
Social
Security
actuaries
have estimated
long-term
additional
revenues
at "roughly"
payroll.
If only the OASI benefits
were treated
156
1.4 percent
as regular
as
the
the
of covered
income,
the
additional
trust fund revenue would be roughly
1.2 percent of payroll. 13 One argument
against this approach
is that employee payroll
taxes are not themselves
deductible
for purposes of computing
income
taxes. The employer
contribution
is a business expense and is not
taxed. Thus, although
some of the contribution
has not been taxed,
treating
all benefits as regular income would amount to double taxation of employee contributions.
This criticism
has led to consideration
of a second variant
that
would treat only benefits in excess of employee contributions
as regular income. This would bring the tax treatment
of Social Securitv
benefits
in line with tax policy on other retirement
programs.
Employer pension
benefits, for example,
are taxed when benefits paid
exceed employee contributions
that were taxed in the vear that thev
were earned. For most beneficiaries,
the full benefit would be treated
as regular income within two years after thev retire.
A third variant
would treat onlv 50 percent
of cash benefits
as
regular income lot tax purposes.
The argument
for this approach
is
that the employee
has already paid taxes on half the contributions
that result in the benefit entitlement.
This proposal would have little
or no effect on those beneficiaries
who rely solev on Social Securitv
for their retirement
income securitv. This option would generate additional long-term
trust fund revenues of 0.5 percent of covered payroll if onlv OASI benefits were included and 0.6 percent if DI benefits
were included as well. 14 If this proposal
were implemented
on Januarv 1, 1983, CBO estimates
that added tax revenue would reach $4.5
billion in 1983, and $6.5 and $7.0 billion in the two succeeding years. 15
The taxation of Social Securitv benefits has met with considerable
political opposition
in the past and probably would be seriouslv contested if it were proposed for the future. Several considerations,
however, mav make such a policy seem more reasonable.
First, treating
50 percent
of benefits
as regular
income would affect the level of
benefits only for higher-level
beneficiaries.
For a single person over
age sixty-five and thus receiving a double exemption,
the tax would
not affect anvone receiving
a monthh'
benefit below $716 if Social
Security
were their onlv source of income. For married
couples in
_3Steve Goss, "Rough,
Preliminary
Social Security' Monthly Benefii
Transfer ot Additional
Revenues
Security"
_41bid.
Administration,
October
Estimates
of Long-Range
Cost Impact ot Subjecting
Pavments
to Federal Income Tax with Provision
for
to OASDI Trust Funds," O[t:icc o[ the Actuary, Social
26, 1982.
t_Alice M. Rivlin, prepared
statement
bclorc
curity RetotIn,
August 20, 1982, p. 15.
the National
Commission
on Social
Se-
157
which both spouses were age sixty-five or over, this tax would not
affect monthly benefits below $1,233 where Social Security was the
sole source of income.
Taxing Social Security benefits would also reduce the level of "tax
expenditures"
going to pension plans because it would raise the marginal tax rates on annuitants,
especially
those receiving particularly
generous
benefits. Furthermore,
in the short term, treating
half of
Social Security benefits as regular income would be nearly as effective-raising
$18 billion in the first three years--as
completely
eliminating the 1983 COLA, which would save an estimated
$21 billion
over the three-year
period. Completely
eliminating
the COLA increment in 1983 would definitely
raise official poverty rates among the
elderly and would be widely opposed on those grounds.
But taxing
half of the Social Security benefits of the elderly would have virtually
no effect on the elderly with lower to middle incomes.
Selecting
Short=Term
Policies
Tying the COLA increment
to wages on some basis should be seriously considered
because it would eliminate
one major element of
instability
that now persists
in the program.
Although tying COLA
to wages might slightly reduce the incremental
benefits provided
in
the future, the effects of the linkage would be so diffuse as to be
unnoticeable
by the average beneficiary.
If in fact we are now entering
a period in which wage growth will exceed price increases by more
than 1.5 percent, as some analysts suspect, this may be a most propitious time to accomplish
such a policy change. If real wages grow
more rapidly than expected moving to such a COLA procedure
could
actually
increase benefits slightly in the near term. This would be a
small price to pay to stabilize
the program
for the longer term. If
Congress
wishes to maintain
Social Security on "automatic
pilot,"
the indexation
signal that it follows has to be steady. Even if the
change to wage growth minus 1.5 points does reduce benefits slightly,
the added peace of mind that current
and prospective
beneficaries
would gain from the knowledge
that the program
is solvent would
more than offset the pain of the reductions.
Beyond this, if Congress decides to "share the pain" of balancing
OASI financing
in the short term, the burden will be more evenly
distributed
than will be the case if one particular
group is singled
out to bear the full burden. For example, table V-7 shows a set of five
modifications
that could be made that would move toward eliminating
158
the deficits
the OASI trust fund is now incurring.
Some mar-
159
ginal reallocation
of the DI trust fund build up now projected
would
further help the OASI fund to accumulate
a sufficient hedge against
future unforeseen
circumstances.
There are other combinations
of
options that can be considered
but exempting
any one group from
the burden of adjustment
will increase the burden on other segments
of society. It may seem unfair not to capture
more of the required
adjustment
through even greater payroll tax increases.
It should be
kept in mind, however, that taxes already increase automatically
as
wages grow and the maximum
taxable income rises. Furthermore,
many of the current workers in the short term, will also feel the longterm program
adjustments
as well.
Long-term
policy alternatives
must reconcile the possibility of significantly
higher tax rates against the level and distribution
of benefits in the future. The short-term
solution may lead to significant
trust fund accumulations
toward the end of this decade and through
the 1990s; those accumulations
could cause broad fiscal problems
and increased
pressures
tbr benefit expansions.
The long-term
perspective also has to take into account
the continuing
evaluation
of
the other retirement
income security systems in this country.
Because the long-term
Social Security dilemma
and the various
distributional
implications
of specific proposals are so complex, chapter VI is devoted to the analysis of a range of options.
160
VI. Social
Term
Security
Beyond
the Short
Chapter V suggests that in the long term, either revenues must rise
or benefits be reduced if the Social Security mathematical
equation
is to be balanced. Some analysts argue that conditions may be much
better after the turn of the century than current projections indicate
and that it is premature
to make adjustments
to Social Security now
in an attempt
to balance the system in the future. Merton Bernstein,
for example,
argues that increased immigration,
higher productivity,
and the prospects
of higher labor-force
participation
bv the clderlv
may render the long-term
problem moot. I Other analysts argue that
we should attempt
to balance the system now based on current projections,
and let Congress
reexpand
the system later if conditions
warrant. 2
One apparent
problem with ignoring the long-term
financing
deficits in Social Security
will be the difficulty
of reestablishing
the
credibility
of the program
with today's young workers.
The widespread fear that Social Security will not be there for them will persist
unless something
is done. Whether or not the traditional
meaning of
bankruptcy
is appropriate
when applied to Social Security, the term
will be applied
to the program
if deficits are projected.
From the
original report of the Committee on Economic Security in 1935, through
the first forty years of operation
there were always adequate financing
provisions
in the Social Security program
to meet the projected
benefit schedules.
To modify that funding policy now would represent
a
significant
change in the tradition
of the program.
Social
Security
Benefits
Under
Current
Law
During the debate over the structure
of Social Security in 1976 and
1977, there was widespread
agreement
that the automatic
cost-Qfliving adjustment
process established
under the 1972 amendments
had to be modified.
Two major alternatives
were put forward
and
seriously
considered.
The two differed chiefly in the treatment
of
covered earnings used to calculate
retirees' initial benefits and in the
automatic
adjustment
of the benefit formula. Since 1975, a multitude
_Merton C. Bernstein, "Social Security: America's Best Bet," prepared statement to
the President's Commission on Pension Policy, March 13, 1980.
2William Hsiao et al., Report oI the Consultant Panel on Social Security (Washington,
D.C.: Congressional Research Service, 1976).
161
of proposals
have been put forward to balance Social Security in the
long term. Each of these has a set of implications
for the structure
of Social Security
and its redistribution
of income. If these implications are to be appreciated,
the mechanics
of the current system
must be understood.
Before 1979, when the transition
to the formula established
by the
1977 amendments
began, benefits for most people were calculated
on the basis of their average covered earnings
since 1950. 3 The 1977
amendments
significantly
modified
the benefit calculation
procedures. Instead of using average monthly wages to calculate
benefits,
each worker's wages were to be adjusted--"indexed"--to
account for
the historical
growth
in average earnings
levels. For the monthly
benefit calculation,
however, the modified system still relies on historical wages, which are indexed. These wages are technically
referred to as average indexed monthlv earnings
(AIME).
In addition to modifying the treatment
of earnings, the 1977 amendments also changed
the benefit formula
for deriving
the primary
insurance
amount used to calculate actual benefit entitlements.
4 The
benefit formula for deriving the PIA is itself indexed by average wage
growth. The benefit formula has three replacement-rate
thresholds
and each threshold
is indexed by wage increases. For people reaching
age sixty-two
in 1982, the PIA is 90 percent of the first $230 of their
AIME, plus 32 percent
of the next $1,158, and 15 percent
of any
remaining
AIME above $1,388. The dollar factors, often referred to
as the Social Security
benefit formula
"bend points," are indexed,
but the percentage
factors remain
constant
over time. The PIA is
adjusted
to account for age at retirement
plus any dependent
benefits
in determining
the monthly benefit amount.
The actual benefit paid to the individual
recipient
and his or her
dependents
is complicated
to derive, because it is subject to a great
many variables,
as the discussion
in appendix
B attests. Some analysts perceive
the calculation
procedure
as a Rube Goldberg device
greatly in need of simplification.
Nonetheless,
the calculation
procedure does define a benefit structure
now in operation,
and it helps
to define a set of proposals
that various students of the system have
3people with a long history of low earnings have their benefits calculated under the
"special minimum" method. In addition, a limited number of retirees' benefits are
alternatively calculated under the "old start" method which accounted |or covered
earnings prior to 1951,if it results in a higher benefit level.
4A detailed description of the benefit calculation procedure is included in appendix
B. That discussion also describes the way in which earnings and the benefit formula
bend points are indexed to account for annual wage growth.
162
made to balance
its projected
financing
shortfalls.
Some of these
proposals
antedate
the 1977 amendments,
while others have arisen
during the recent deliberations
of the National Commission
on Social
Security Reform.
The
Earlier
Debate
The major alternative
to wage indexing of earnings and the formula
bend points considered
during the deliberations
on the 1977 amendments was recommended
bv the Hsiao panel in its 1976 report to the
Senate Finance and House Ways and Means Committees.
s The panel
suggested
that a worker's benefits should continue to be based on the
average of that person's earnings history. They argued that historical
wages should be adjusted
to account for changes in the dollar's purchasing power between the year that wages were earned and the year
of retirement.
This "price indexing"
of wages in combination
with
price indexation
of the PIA formula bend points would protect initial
benefit levels against the erosion of inflation and provide slight benefit increases
with the growth in real wages. The Hsiao panel also
proposed
a safety-valve
measure that would slow the growth in benefits if prices were to grow more rapidly than wages for a sustained
period. If this were to occur, they proposed
that the formula
bend
points and postretiremcnt
benefits be indexed by the rate of growth
of wages instead of the higher growth in prices. This measure--the
lower of wage or price indexation--was
to be invoked in instances
when the ratio of wage growth to price growth declined in five consecutive years. 6
The debate
over the wage-indexing
procedures
actually
implemented
bv the 1977 amendments
versus the price-indexing
recommendation
bv the Hsiao panel centered
on what each was expected
to accomplish.
The wage-indexing
system sought to maintain
Social
Security's
earnings
replacement
capacity
over time. Because wages
are expected to grow more rapidly than prices over time, maintaining
replacement
rates would mean higher real benefit levels for successive cohorts of retirees. Advocates of the price-indexing
mechanism
argued that Social Security should strive to grant "nearly equal purchasing power to comparable
workers who retire at different times. ''7
_William
Hsiao et al., Report
D.C.: Congressional
Research
°Ibid., p. 6l.
7Ibid., p. 21.
of the Ccmsulta_tt
Service,
1976).
Patzel o_ Social
Security
(Washington,
163
The policy question Congress faced in 1977 was whether
to guarantee the purchasing
power of initial Social Security benefits of future
cohorts of retirees or to guarantee
the replacement
of preretirement
earnings. Price indexing of wages and PIA formula bend points meant
that the real level of benefits would be maintained
for workers with
the same real lifetime covered earnings.
It also meant that Social
Security
would replace
smaller
percentages
of the preretirement
earnings
for successive
cohorts of retirees. The wage-indexing
procedure actually
implemented
sought to guarantee
replacement
rates
over time. Hence, as workers with equal real lifetime covered earnings
reach retirement
in successively
later years, those retiring later will
receive consistently
higher real benefits than the workers who preceded them into retirement.
This occurs because real average earnings for all workers are expected to grow over time.
The Hsiao panel came down in favor of price indexing because it
provided
Congress
with greater discretionary,
power over the program. They argued:
Congress would do best if it were to recognize that a fully
automatic system is a less desirable goal than is a partly
automatic system that embraces a limited objective and
leaves to the future the key decision on how far beyond that
limited objective the financial condition of the country and
of the system itself will permit. An important implication
is that this leaves Congress the flexibility to decide how the
increase should be divided among different classes of beneficiaries, reflecting the social needs of the time. 8
This issue reappeared
in the deliberations
of the 1979 Social Security
Advisory
Council, two years after the passage of the 1977 amendments. The majority of the 1979 Advisory Council favored continued
wage indexation,
but five of thirteen members
dissented
on this recommendation.
They proposed that starting
in 1995, each successive
cohort of retirees with the same real earnings history should receive
the same real benefit. They argued that implementation
of this proposal would leave to later Congresses
the power: (1)to determine
whether higher levels of real earnings warranted
higher levels of real
benefits; and (2) to impose the higher taxes needed to support them.
Their proposal was based on two premises:
Our first reason is based on our judgment that future Congresses will be better equipped than today's Congress to
qbid., p. 22.
164
determine
the appropriate
level and composition
of benefits
for future generations.
We fully anticipate
that later Congresses would indeed elect to increase real benefits as real
wage levels rise over time. We doubt, however,
that thev
would choose to do so in the precise wav implied
bv the
present method of automatic
adjustment,
nor that the average percentage
increase would necessarily
be the same as
present law prescribes.
Congress
might elect to give more
to certain groups of beneficiaries
than to others, or to provide protection
against
new risks that now are uncovered,
But precisely
because we cannot now forecast what form
those desirable
adjustments
might take, we feel that the
commitment
to large increases in benefits and taxes implied
undcr current law will deprive subsequent
Congresses,
who
will be better int0rmed
about future needs and preferences
of needed flexibility
to tailor Social Security
to the needs
and tastes of the generations
to come.
Our second reason is that, as per capita income rises, the
case tot increasing
the amount
of mandatory
"saving"
for
retirement
and disability
through
Social Security
is far
weaker than was the rationale
for establishing
a basic floor
of retirement
and disability
protection
at about the levels
that exist today. 9
Opponents
of the price
indexing
of wagcs
argue that it puts in place an ever-decreasing
rates if wages
do grow more rapidly
in the
argue that future
increase
and that
ards
dexing
of living
and the benefit
formula
structure
of replacement
future
than prices.
They
standards
of living will be adjusted
as real earnings
Social
Security
should
help to maintain
those stand-
for future
cohorts
of retirecs.
Proponents
of price
in-
respond:
At levels of real income prevailing
in the 1930s (or perhaps
even in the 1950s), it can well be argued that it was appropriate, indeed, highly' desirable--perhaps
even necessary for
the preservation
of our society--that
government
should,
bv law, have guaranteed
to the aged and disabled
and their
dependents
replacement
income sufficient
to avoid severe
hardship,
and to have required
workers (and their employers) to finance this system with a kind of "forced saving"
through payroll tax contributions.
But as real incomes continue to rise, it is not so easy to justify' the requirement
that
'_Henrx' J. Aaron, Gardner Ackley, Mar,,' C. Falvey, John W. Porter, and J. W. Van
Gorkom, "Supplementacy
Statement in the Future Course of the Replacement Rate,"
in Social Secllrit 3' Financing and BeHel}ts (Report of the 1979 Social Security Advisory
Council, 1979), pp. 213 214.
165
workers and their employers "save" through payroll tax
contributions to finance ever higher replacement incomes,
far above those needed to avoid severe hardship. I°
The implications
of the different
benefit determinations
are significant in the context of the mathematics
of Social Security discussed
in chapter
V and the long-term
financing
projections
discussed
in
chapter
IV. The second column in table VI-I shows currently
legislated OASDI tax rates minus the projected
cost rates in the 1982
Trustees Report based on their Alternative
II-B assumptions
lot various averaging
periods. The OASDI program
is projected
to run a
surplus of 0.64 percent of covered payroll for the first twenty-five
years. For each of the subsequent
twenty-five-year
periods and the
full seventy-five-year
period, the current tax rate falls short of meeting
the cost rate of the program.
The third column in table VI-I shows
the net savings of moving to price indexation
of earnings
and the
benefit formula bend points starting
in January
1985 under the II-B
assumptions.
In each of the two twenty-five-year
periods t0r which
there are financing deficits, and tot the full seventy-five-year
projection period, the movement
to price indexing of both earnings
and
formula bend points for benefit calculation
would seem to more than
balance the long run OASDI financing.
Before we immediately
proceed to that conclusion,
however, a word
of caution is in order. Under the II-B assumptions,
real wage growth
is assumed
in every year beyond 1982. The ultimate
rate of growth
of real wages is assumed to be 1.5 percent (i.e., wages are assumed
to grow faster than prices at a rate of 1.5 percent per year over the
long term). If wages grow more slowly in real terms or if prices grow
as fast or faster than wages for sustained
periods, then moving to
benefit determination
on a price-indexing
basis will save less than
these projections
estimate.
The reason for the cost savings under these assumptions
is that in
the future, initial benefit entitlements
will grow less rapidly
than
earnings.
This would cause the ratio of average benefits to average
earnings (B/W), discussed in chapter V, to decline over time. The rate
of decline of B/W under II-B scenarios
would more than offset the
rate of increase of beneficiaries
to workers (Nb/Nw) in the financing
equation.
As a result, the long-term
projected
cost rate would fall
below legislated
tax rates if price indexing of earnings
and formula
bend points were implemented
and the II-B scenario were realized.
TABLE
VI-I
OASDI Financing Surplus and Deficit Under II-B
Assumptions and Net Savings as a Percentage of
Payroll from Moving to Price Indexing of Earnings and
Bend Points
Surplus or
ofDeficit
Annual
WageIndexed
System
Both Earnings
and Bend
Points
Earnings
Only
Bend Points
Only
25- Year Averages
1982 2006
2007-2031
2032 2056
.64
1.68
- 4.41
0.27
2.76
5.45
0.14
1.20
1.85
0.14
1.81
4.13
75- Yea r Average
1982-2056
- 1.82
2.83
1.06
2.03
Sources:
Note:
Price-Indexing
1982 OASDI Trustees Report, p. 64; and Office of the Actuary, Social Security
Administration, September 2, 1982.
The estimates are based on the 1982 Trustees Report Alternative II-B assumptions, modified to reflect the actual 1982 benefit increase of 7.4 percent.
The linking to the consumer price index begins in all cases in 1983, first
affecting benefits in 1985.
Options for Modifying Social Security's
Procedures
The
Option
prospect
of continually
declining
Benefit Calculation
replacement
rates
and
the
magnitude
of cost savings
from price indexing
both earnings
and bend
points
has led to a set of hybrid
price-indexing
proposals
and other
possible
formula
modifications.
These would
provide
some long-term
savings,
but less than those
shown
in table VI-1 for price
indexing
both earnings
and formula
bend
points.
The following
paragraphs
briefly
describe
the options
for modifying
the current
procedures
for
calculating
Social
Security
benefits.
Index Earnings
by Price Increases--One
proposal
would
index
torical
earnings
bv the price
index
but continue
to index
the
points
on the benefit
formula
bv the rate of increase
in wages.
indexing
earnings
would
result
in somewhat
lower replacement
final earnings
than the current
procedure
of earnings
indexing
Under
long-term
assumptions
of constant
increases
in prices and
hisbend
Price
of
does.
wage
167
growth, both the current
benefit calculation
procedure
and this option would result in stable replacement
rates. The long term, however,
is made up of a series of short-term
periods. Over the years, the
relative
growth of wages and prices has varied considerably
from
year to year. These variations
would result in different weighting
patterns
for historical
annual earnings
tot each worker when that
person reaches age sixty-two.
Thus, the change in the treatment
of
earnings
would result in different distributions
of AIMEs, and thus
a different
distribution
of Social Security benefits, based on actual
lifetime earnings
patterns. The net savings from the option shown in
table VI-I, if implemented
in January
1985, is insufficient
to reduce
the projected
cost rate in either the second or third twenty-five-year
period to meet the projected
shortfall
in those periods. It also falls
0.76 percent of payroll short of meeting the seventy-five-year
average
cost rate projected
under the II-B assumptions.
This option would be sensitive to the correspondence
with actual
growth
in wages and prices. If real wages grow more slowly than
assumed over the long-term
projection
period, this option would result in smaller savings than projected.
Index
Formula
Bend Points by Price Increases--Another
variant
of
the Hsiao panel's recommendation
would continue
to index wages
by the rate of average wage growth but index bend points in the
benefit formula by price increases. The twenty-fiveand seventy-fiveyear projected
savings under the II-B assumption
set are also shown
in table VI-1. The projected
savings in the second twenty-five-year
period exceed the projected
shortfall under the II-B assumptions.
In
the third twenty-five-year
period, the savings are within roughly 0.3
percent of payroll of meeting the projected cost. For the seventy-fiveyear projection
period the savings would be sufficient,
however,
if
the II-B scenario
is realized.
Of the three price-indexing
options, this one would be most sensitive to the relative rates of price and wage increases. If wages rise
more rapidly than 1.5 percent in excess of prices, the savings would
exceed those projected. At the same time, this option would result in
gradually
declining replacement
rates if the II-B scenario occurs. This
decline of replacement
rates would accelerate
during periods in which
wages grow more rapidly relative to prices than assumed.
During a
period of sustained
price growth in excess of wage growth, however,
replacement
rates would rise at the worst possible time. As a result,
average benefits would rise relative to average wages (i.e., increasing
the B/W ratio discussed
in chapter V).
168
Options fi)r Limiting Replacement-Rate
Reductions--The
concern over
perpetually
declining
replacement
rates and the prospect
of introducing new volatility
to the program
have led to consideration
of
options that would limit the adjustments.
These options would modify the rate of growth in the formula bend points for a limited period
of time.
Rapid Bend-Point
Adfl_stment [or Limited Period--Koitz
considered
freezing the bend points until the long-term
cost rate of the OASDI
system fell to the level of the long-term
tax rate contained
in current
legislation.
Based on assumptions
being used in the program's
valuation in 1980, the Social Security actuaries
estimated
that the bendpoint freeze would have to last three years. If the freeze were to last
three years, the actuaries
also estimated
that the ultimate
replacement rates for the hypothetical
average worker would decline from
approximately
42 percent of final earnings
to 39 percent. _]
In May of 1981, the Reagan administration
proposed reducing bendpoint indexing
to a rate of 50 percent of wage growth for a six-year
period, beginning
in 1982 and running through 1987. While this proposed reduction
to bend-point
growth was only half the reduction
considered
by Koitz, applying
it twice as long resulted
in similar
savings and replacement-rate
reductions.
Any adjustment
benefit formula will affect
several dimensions
of the program.
The relatively
rapid adjustment
of Social Security replacement
rates downward
would certainly raise
serious equity questions,
regardless
of when it was done. These questions would be especially
appropriate
if people retiring
in the immediate
future incurred
such replacement-rate
reductions,
because
people retiring
during
the 1970s and early 1980s have already
received much higher replacement
of earnings than future retirees can
now expect. A further argument
is that people near retirement
have
defined expectations
of Social Security.
Being near the end of their
careers, they cannot adjust sufficientlv
to significant
changes in their
benefit
entitlements
and may end up with inadequate
incomes
throughout
their retirement.
Slow Bend-Point
Growth
Gradually
on a Limited
Basis--Both
ade-
quacy and equity considerations
suggest that caution should prevail
in implementing
a long-term solution to the Social Security financing
ItDavid Koitz, "The Indexing of Social Security" in lndexatio_zo[ Federal Programs
(Washington, D.C.: U.S. Government Printing Office, 1981),p. 190.
169
problem.
Still, if the program
is to get the level of public support it
requires,
people must perceive that the program
will be solvent over
the long term. To this end, Robert J. Myers has presented
an option
to the National
Commission
on Social Security
Reform that would
reduce replacement
rates gradually
over a number of years. 12 Under
this option, the bend points in the PIA formula would be indexed at
75 percent
of the rate of growth of wages for a limited number
of
years. Myers has described
the effects of slowing bend-point
growth
in this fashion beginning
in 1984 and continuing
for either twelve or
twenty years. The projected
cost savings under the II-B scenarios are
shown in table VI-2.
Myers notes that the actual cost effects of this proposal will depend
on future economic conditions.
If real wages were to rise more rapidly
than projected
under the II-B assumptions,
the actual cost reductions
would exceed those estimated.
At the same time, the level of preretirement
earnings
replaced
by Social Security would decline more
than expected.
Myers suggests that this decline could be prevented
by limiting
the decline in the bend points, so they would not fall
below 80 percent of the level they would have been if full indexing
were continued.
Once the 80 percent "trigger"
point is reached subsequent
bend-point
adjustments
would be at the full rate of wage
growth.13
The implementation
of such a procedure
would gradually
reduce
the replacement
of preretirement
earnings.
Limiting the decline as
Myers suggests would stabilize replacement
rates at a level that could
be predetermined.
For example,
the "80 percent trigger point" that
he discusses would reduce ultimate OASDI replacement
rates by about
10 percent (Note: not ten percentage
points). If the II-B scenario were
to actually occur, this decline would be phased in over a sixteen-year
period.
This proposal
has several characteristics
that make it more appealing than some of the other long-term
options discussed
earlier.
First, it limits the adjustment
in benefits, which will make it much
easier for workers and employers
to design savings and pension programs to maintain
living standards
in retirement.
Second, it does not
depend on the economic
scenarios
being played out in accord with
J2Robert J. Myers, "Possible
Solutions
to Long-Range
Financing
Problems
of OASDI
Program,"
Memorandum
no. 24 (Washington,
D.C.: National
Commission
on Social
Security
Reform, June 4, 1982), pp. 4-6.
_3Robert J. Myers, "Cost Aspects of Indexing
OASDI Benefit Formula by 75% of Wage
Increases
for a Limited
Period,"
Memorandum
no. 36 (Washington,
D.C.: National
Commission
on Social Security
Reform, July 2, 1982).
170
TABLE
VI-2
OASDI Financing
Assumptions
and Net Savings as a Percentage of
CoveredPayroll
from Indexing PIA Formula Bend
Points by 75 Percent of Wage Growth for Specified
Periods
Net Savings
Surplus or Deficit
of Current WageIndexed System
Period of 75 Percent
Bend-Point Indexation
1984-1995
1984-2003
25- Yea r A verab{es
1982-2006
2007 2031
2032-2056
0.64
- 1.68
- 4.41
0.26
1.09
1.36
0.29
1.60
2.10
75- Year Average
1982 2056
- 1.82
0.90
1.33
Sources:
1982 OASDI Trustees Report, p. 64; and Robert J. Myers, "Cost Aspects of
Indexing OASDI Benefit FormuLa by 75% of Wage Increases for a Limited
Period," Memorandum no. 36 (Washington, D.C: National Commission on
Social Security Re|otto, July 2, 1982), p. 3.
assumptions,
have been
which
discussed.
is a problem
The rate
in the price indexation
options
of wage growth
will determine
rapidly
the trigger
point
is reached.
Finally,
even during
tion to the lower replacement
rates, each successive
cohort
should
receive
higher
benefits
in real-dollar
terms.
Options
There
for
Changing
is a valid
Work
concern
and
that
Retirement
any
reductions
that
how
the transiof retirees
Patterns
in Social
Security
benefits
may increase
the prevalence
of elderly
people
who live out
their retirement
years with inadequate
incomes.
This concern
has led
to many
proposals
that seek to extend
the period
of work,
thus increasing
tax revenues
while
decreasing
the period
of benefit
receipt
and total lifetime
benefits
paid to the average
retiree.
It can be argued
that these proposals
already
discussed.
imply a benefit
These proposals
longer,
yet provide
benefits
into the system
for a shorter
for extending
expectancy
with this
the working
suggest
increased
reduction
similar
in size to those
seek to keep workers
in their jobs
comparable
or equal
to those
number
of years.
Proponents
lives
potentially
longevity
of workers
argue
longer
productive
phenomenon,
these
that
now built
of options
increases
lives. In
proponents
in life
keeping
reason
171
that normal
retirement
ages should
adjust to changing demographics.
be adjusted
or encouraged
to
Increase Normal Retirement
Ages--In
1981 the National
Commission on Social Security (not to be confused with the National Commission on Social Securitv Ret0rm) recommended
that Social Security's
normal retirement
age be gradually
increased
by three years beginning around the turn of the centurv. The commission
proposed raising
retirement
age by three months per year over a twelve-year
period.
Table VI-3 shows the exact phasing in of these increases,
per their
recommendations.
There have been several variants of this basic proposal dating back
to the 1975 Social Security Advisorv Council. The primary differences
in the options that have been suggested
relate to the time when the
transition
would start or the length of the transition
period.
Robert J. Myers has presented
to the National Commission
on Social Security
Reform an option for automatically
adjusting
Social
Security's
retirement
ages. This proposal calls for raising the normal
retirement
age in quarter-year
increments
to age sixty-six for persons
who reach age sixty-two after 1994. Then, in 1995, the longevity improvements
reflected
in the U.S. Life Tables for 1989-1991 over the
1979-1981
tables would be taken into account for further adjusting
the Social Securitv
retirement
age. The proposal
would begin the
adjustment
seven years after the new longevity levels had been determined.
If life expectancy
were determined
to have increased
in
1995, the retirement
age would increase in quarter-year
increments
starting
in 2002 for people reaching age sixty-two.
The adjustments
would continue
until life expectancy
beyond the normal retirement
age was only one-third
the number of vears between age twenty and
the normal retirement
age. In 2005 and every subsequent
ten years,
the redetermination
process would be repeated.
Under the II-B demographic
assumptions
age would reach age
sixty-seven
in 2005, sixty-eight
in 2009, sixty-nine
in 2023, and seventy in 2052. As the retirement
age rises, the number
of years of
earnings
used to compute
benefit entitlements
would rise one year
for each year's increase in the normal retirement
age. j4
Change Actuarial Ad#4slmenl Faclors--A
variant of raising
ment ages would gradually
increase the age at which a retiree
retirewould
14RobertJ. Myers, "Cost Aspects of Increasing the Normal Retirement Age Under Social
Security by an Aulomatic-Adjustment Method," Memorandum no. 29 (Washington,
D.C.: National Commission on Social Securitv Reform, June 28, 1982).
172
TABLE
National
VI-3
Commission
on Social Security Proposal
Phasing in Later Retirement Ages
Year
Age for
Full Benefits
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
201 I
2012
65
65
65
65
65-V4
65- %
65-V4
66
66-'/4
66-1/2
66-3/4
67
67-V4
67-1/2
67- V4
68
for
Age for
Reduced Benefits"
62
62-1/4
62-I/2
62-s/4
63
63-_/4
63-%
63-3/4
64
64-V4
64-1/2
64-s/4
65
65
65
65
Source:
National Commission on Social Security, Final Report, Social Security in
America's Furore (March 1981), p, 122.
increase in the age at which reduced benefits are payable starts three years before
increase in the age at which full benefits are payable. Thus, workers in a particular
"birth cohort" (age group) who reach age sixty-three in 2001 and age sixtv-six in
2004, tor example, would be affected equally regardless of whether they chose to claim
early retirement in 2001 at age sixty-three or full benefits in 2004 at age sixty-six.
receive
the full PIA. Under
current
law the PIA is payable
to a single
person
at age sixty-five.
The PIA is reduced
by five-ninths
of 1 percent
each
month
prior
to age sixty-five
that benefits
were accepted.
monthly
benefit
for a person
retiring
at age sixty-two
is only 80
percent
of the PIA.
Representative
J. J. Pickle, Chairman
of the House Ways and Means
Social Security
Subcommittee,
has introduced
legislation
that would
raise the age at which
the full PIA is payable
to sixty-eight.
His legislation
(H.R.
3207) would
also change
the reduction
factor
to oneof 1 percent
for each month
prior to normal
retirement
age that
benefits
were
accepted.
Although
his bill would
raise
the normal
retirement
to age sixty-eight,
it would
leave the early retirement
age
sixty-two.
His legislation
specifies
a transition
mechanism
that
would
require
a double
benefit
calculation.
It would
calculate
a ben173
efit under the current formula for persons retiring in 1990 and after.
It would also calculate
a benefit under a modified formula that provides the full PIA at age sixty-eight.
The PIA for early retirees would
be reduced
one-half of 1 percent for each month prior to age sixtyeight that the person retired. This would provide 64 percent of the
PIA at age sixty-two or a 6 percent reduction
for each year of retirement prior to age sixty-eight.
The transition
from the first formula
to the second would be gradual.
Persons reaching
age sixty-two
in
1990 would receive 90 percent of the benefit from the current formula
plus 10 percent from the modified
formula. The 1991 cohort would
receive 80 percent from the current formula and 20 percent from the
modified
formula. These shares would continue
to adjust by 10 percent per year until the transition
was complete
in 1999, when only
the modified formula would be used.
Another method of accomplishing
the same result would be to implement
the new adjustment
factors by one quarter
per year. The
advantage
would be that a single benefit formula could be used, thus
reducing
the administrative
complexity
of transition.
For example,
the ultimate
actuarial
adjustment
factors specified in this bill could
be implemented
over a twelve-year
period, as table VI-4 shows. Under
this transition
mechanism,
age would be increased by one quarter per year until it reached age sixty-eight.
With
each increment
in the retirement
age the actuarial adjustment
factors
would change. When the transition
is completed,
people retiring at
age sixty-two
would receive 64 percent
of their PIAs instead of the
80 percent
now provided by the system.
One of the arguments
in favor of this method of raising the Social
Security normal retirement
age is that it would continue
to provide
early retirement
benefits at age sixty-two.
Opponents
of raising the
early retirement
age in lockstep with the normal retirement
age argue
that even with increases in the longevity in the future, the prevalence
of ill health, disability,
and indeterminate
economic conditions
will
require income maintenance
programs
for some persons in their early
sixties. Although people who argue this may not find the Pickle concept to be the optimal solution to Social Security's
financing problem,
they find it more palatable
than other possible changes in the retirement age.
If average wages grow at least 1.5 percent
a year in real terms
during
the transition
process shown in table VI-4, each successive
cohort of retirees at age sixty-two should realize slight benefit growth
in real terms. To the extent the added incentives
for working longer
174
°_o_
_._!
_
E
_
_
_'=
•=_ _
_
_o_o_o_o_o_o
_+
_._
175
are effective, average monthly
benefits for new retirees
tinue to rise during the transition
period.
should
con-
OASDI Savings with Later Retirement
Ages--As
with each of the
other policy options discussed
in this chapter, a primary
consideration is the implication
of changing policy for OASDI financing. Table
VI-5 shows the projected
savings from the three retirement
age proposals just discussed under the II-B assumptions.
None of the options
by itself would completely
eliminate
the long-term
financing deficit.
According
to the actuarial
projections,
the 1981 proposal by the
National
Commission
to raise early and normal retirement
ages by
three years is the least effective of the options. The most effective is
the automatic
adjustment
in retirement
ages by increasing
longevity
because, according to the projections,
it pushes the normal retirement
ages somewhat
higher than either of the other proposals.
The Pickle bill and its gradual reduction of the actuarial adjustment
factors would have about the same net financing
effect as indexing
the PIA formula bend points by 75 percent of wage growth for sixteen
years discussed
earlier. None of the retirement-age
proposals
considered here would match the 2.03 percent of payroll savings projected
if PIA formula bend points were indexed by price growth in the future,
assuming
the II-B scenario is realized.
If the only policy concern is to restore financial balance to Social
Security
then policymakers
should simply pick the option that proTABLE
VI-5
OASDI
Financin_
Surplus
and Deficit
Under
II-B
Assumptions
and Net Savings
as a Percentage
of
Covered
Payroll
Following
Raising
of the Normal
Retirement
Age
Surplus
or
Deficit
of Current
System
(Percent)
25-Year Averages
1982-2006
Retirement
National
Commission
(Percent)
Age Proposal
Automatic
Adjustment
(Percent)
Pickle
(Percent)
0.64
0.12
0.16
0.21
2007-2031
- 1.68
1.41
1.98
1.40
2032-2056
- 4.41
1.55
2.89
1.89
1.03
1.68
1.17
75- Year Average
1982-2056
Sources:
176
- ! .82
1982 OASD1 Trustees
Administration.
Report,
p. 64; and Office of the Actuary,
Social
Security
vides adequate
savings
to meet the projected
deficit
of the system.
But, as the discussion
thus far in this chapter
has indicated,
each of
these
proposals
has different
impacts
across
society.
Although
the
goal of assuring
Social
Security's
financial
solvencv
is paramount,
attaining
that goal must
be accomplished
with an eve toward
the
adequacy
and equity
aspects
of the program.
Distributional
on Income
Implications
Levels
of Benefit
Formula
Adjustments
To evaluate
the implications
of various
long-run
Social
Security
policy options,
the PRISM microsimulation
model
described
in chapter IV was modified
|or this pro.icct.
The potential
range and combination
of options
that could be simulated
is almost
infinite.
Budget
constraints,
time limitations,
and a limited
number
of options
under
serious
consideration
serve to define
a handful
of options
that were
analyzed.
Specifically,
five alternative
modifications
to the Social
Security
benefit
determination
process
were considered:
1. Index
uing
wage
1985,
earnings
by the assumed
rate of increase in prices while continto index the benefit formula bend points bv the assumed
rate of
growth.
This modification
was assumed
to begin on January
1,
and to continue
indefiniteh'.
2. Index the PIA formula bend points bv the assumed
ratc of growth in
prices while continuing
to index historical
earnings by the assumed rate
of growth in wages. This modification
was assumed to begin on January
1, 1985, and to continue
indefiniteh'.
3. Index the PIA formula bend points by 75 percent of the assumed
rate
of growth in wages while continuing
to index historical
earnings bv the
full wage growth assumption.
This modification
was assumed
to begin
January
I, 1984 and to continue
tot sixteen vears.
4. Raise Social Security's
early and normal retirement
ages by one quarter
per year until both Rave been raised by three vears. This was assumed
to begin for the cohort of individuals
reaching
age sixty-two
in 1998
and to continue
t0r twelve cohorts. Under this proposal bv the National
Commission
on Social Security, the age for early retirement
would reach
sixtv-five in 2009 and the age tot normal retirement
would reach sixtyeight in 2012.
5. Raise Social Securitv's
normal
retirement
age one quarter
per year
starting
in 1990, andmodifv
the earh' retirement
actuarial
adjustment
factors in accordance
with the schedule
shown in table VI-4. This implementation
procedure,
which captures
the essence of the Pickle proposal, would provide approximately
the same cost savings. It is simulated
in this way because it simplifies the benefit calculation
procedure
during
the transit ion.
177
Implications o[Modifying the Belle/i't Formula--Three
of the simulated
modifications
maintained
the current program's eligibility criteria but
modified the benefit calcuRation procedure.
As ah'cady noted, anv one
of the three modifications could be expected to slow the growth of future
initial benefit entitlements.
This analysis was undertaken
to assess the
distribution
of the various modifications
on the level of Social Security
benefits and the income of the elderly in the future.
These simulations
assumed
that people would not change their
behavior
in response
to reduced
Social Security benefit levels; that
is, the work, savings, and retirement
behaviors simulated
in the current policy scenario
were assumed
to persist under each of these
alternatives.
(It is clear that reduced benefit expectations
from Social
Security might encourage some people to work longer than they would
have under current
benefit promises,
to save more for their own retirement,
or even to find .jobs with better pension protections.)
Nor
did these simulations
of alternative
Social Security benefit calculation procedures
assume that employers
would modify their pension
plans in response
to reduced benefit levels, Some plans almost certainly will be modified
through collective
bargaining
or in response
to employers'
desires to maintain
target benefit levels.
Assuming
no behavioral
response on the part of workers or employers seemed to provide a conservative
perspective.
It is unlikely
that simply because Social Security benefits grow slightly more slowly
that there would be massive changes in behavior that would reduce
alternate
retirement
income resources.
If anything,
behavior should
move in the other direction.
Another reason for not assuming
behavioral responses
to these options was that this course was consistent
with Social Security actuaries'
assumptions
for projecting
the cost
savings of these options. Finally, as the following analysis suggests,
the decline in total income will be somewhat
less, on average, than
the magnitude
of the Social Security reductions.
Table VI-6 presents
the simulated
average family Social Security
benefit levels at age sixty-five under four policy scenarios. This reference age of sixty-five is the same as that used in the current policy
simulation
results discussed
in chapter
III. In fact, the first column
of average benefit levels in table VI-6 repeats the current policy benefit estimates
presented
in chapter III. The remaining
benefit columns
reflect the modified estimates
based on the three modifications
to the
benefit calculation
procedure.
As expected, each of the modifications
results in progressively larger
benefit reductions
for each successive cohort of retirees. The average
benefit reductions
do not vary greatly when those for married couples
178
_o_
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__
_
__
179
are compared
with those tor single persons. The main differences
can
be seen in comparing
reductions
for cohorts. For the oldest cohort
the reduction
would be negligible,
because most members of lhe oldest cohort would have retired before any of the options were implemented. The baseline age in the simulation
was the age of the person
in 1979. By 1984, the youngest
reference person in the oldest cohort
would already be age sixty. Each of the alternative
policy options is
applied to persons attaining
age sixty-two
in the first year the new
policy is implemented.
For the option that would index bend points
by 75 percent of growth in wages, the first year of implementation
would be 1984. For the other two options, the first year would be
1985. The two different dates were not picked to complicate
the analysis but to correspond
with the cost projections
made by Social Security actuaries.
Starting them one year apart has no significant effect
in the long-term
analysis.
The initial benefit reductions
are slightly more rapid under the
limited wage indexation
of the formula bend points than under the
other two options, because of the assumed slow growth of real wages
during the early years of the simulation.
Under the II-B assumptions,
wages are assumed to grow only 0.3 percent more than prices in 1985,
gradually
increasing
to 1.5 percent in 1995. Since wages and prices
are assumed to grow at roughly the same rate in the early years, little
savings result from moving to the price index. Limiting
the bendpoint growth to 75 percent of wages, however, virtually guarantees
a slowdown
in benefit growth, regardless
of how wages or prices grow.
This variation
in the effects on early cohorts points to some of the
caveats that policymakers
will want to consider
in comparing
these
options. The relationship
between wages and prices will determine
the effectiveness
of either of the price-indexing
options. If there is no
real wage growth for a sustained
period, these options will generate
no savings at all. If the rate of price increase exceeds wage growth,
the price-indexing
bend-point
option would increase the costs of the
program.
Alternatively,
if real wages grow more rapidly
than expected, limiting bend-point
indexation
to 75 percent
of wages will
garner much greater savings and benefit reductions
than estimated.
This suggests that the trigger mechanism
discussed earlier should be
given serious consideration.
After the early years in the simulation,
the situation
changes. The
limited wage indexing of bend points is applied only between
1984
and 1999. Thus, by the time the two youngest cohorts reach retirement age, the bend points will be growing again by the full rate of
wage growth. The price-indexing
options, on the other hand, would
180
have their greatest
effects on the two younger cohorts.
The price
indexation
of the bend points would have the greatest effect of any
of the alternatives
considered
for the youngest cohort. Under the longterm II-B assumptions,
price indexation
of the bend points translates
to a 70 to 75 percent wage indexation
of the formula in perpetuity.
Another facet of table VI-6 is important
for considering
Social Security modifications.
The options for changing the benefit calculation
procedure
are often characterized
as benefit reductions.
That characterization
is correct relative to current law, but the Social Security
Act has been an extremely
flexible piece of legislation over the years.
To assume
that the current
law or one implemented
in 1983 will
remain unchanged
beyond the turn of the century is not realistic. The
simulation
results presented
in table VI-6 suggest that even if the
rates of growth in benefits are slowed for some future period, average
real benefits will continue
to grow.
The Response ofPensions and Other Resotzrces--The
analysis in chapter
III suggested
that the rise in other income resources
for the elderly
would tend to reduce the share of total income provided by Social
Security for future retirees. Table VI-7 shows the results of the pension/IRA benefit estimates
under the current policy and under alternative benefit calculation
options.
The estimated
average pension/
IRA benefits actually increase marginally under the options that would
cause the largest Social Security
benefit reductions.
This pension
response occurs because of automatically
increased benefits from plans
that are integrated
with Social Security.
Because of the prevalence
of integrated
plans, the pension benefit
increases
might be expected to be even larger than those projected,
but they are restrained
bv two factors. First, although
the majority
of private
pension plans in this countrv are integrated
with Social
Security,
the prevalence
of integrated
plans is highest among small
employers;
EBRI's analysis of the 1977 pension plan filings with the
IRS in compliance
with ERISA found that 92.6 percent of all plans
had fewer than 100 participants.
At the same time, at least 90 percent
of all plan participants
were in plans covering more than 100 members.
The second factor is that many integrated
plans, especially
those
of smaller employers,
arc defined-contribution
plans. The contribution rates to these plans will not be affected by any modifications
to
the Social Security benefit formula.
Pensions
will directly
make up some of the difference
in Social
Security benefits. They will also help to minimize the relative impact
181
_
_
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_..
E
_."
_
._=
182
=
-ooo
_ooo _ooo
dddd
dddd
dddd
oooo
oooo
2_2_
of Social Security
modifications
because they broaden
the income
base. Table VI-8 shows the simulated
combincd average incomc lcvels
at age sixty-five
from earnings,
savings, Social Security', pensions,
IRAs, and SSI. The estimated
income reductions
resulting
from various policy changes arc relatively
smaller
than the Social Security
benefit reductions
shown in tablc VI-6. The prospect
of income reductions of only 3 to 4 percent for elderly people thirty to forty years
hence suggests that none of these options has unduly damaging
effects. Another wav to interpret
table VI-8 is to say that instead
of
there being a doubling
of average
family income at age sixty-five
between the oldest and youngest cohorts, the average income might
go up only 1.9 times if the formula bend points are indexed at the
rate of 75 percent of wages over the specified period.
Distribzltional
Considerations--Before
making any decisions about
changes
to Social Security,
policymakers
must consider
the distributional effects of ahernative
policies. Each of the three benefit formula modifications
considered here would tend to affect the distribution
of benefits
in roughly the same way. To simplify' the analysis of the
distributional
effects of modifying the benefit formula, the discussion
that follows focuses only on the option that would index the formula
bv 75 percent of wage growth for sixteen vears. Because total Social
Security' benefit reductions
would be greatest for the youngest cohort
in the simulations,
the discussion
focuses on that group. Table VI-9
breaks down the Social Security benefit reductions
based on average
family earnings
for the "high five" of the prior ten years bcfore agc
sixty-five for this group.
The largest Social Security benefit reductions
occur in the low- and
high-income
ranges. At the lower end of the income spectrum,
benefits
are heavily influenced
by the 90 percent factor in the PIA formula.
Slowing the growth of the portion of AIME affected by the 90 percent
factor would slow the growth of benefit levels fairiv directly.
The
second factor in the formula provides
only 32 percent of AIME in
monthly
benefits at age sixty-five. For each dollar reduction
in the
AIME treated bv the 90 percent factor the PIA is reduced
$0.58. At
the top end, basicalh'
the opposite occurs. Thc uppermost
factor is
15 percent o[ AIME. Slowing down the bend-point
growth will push
an increasing
portion of the high earner's
AIME into the low-factor
category.
For each AIME dollar treated at the lower rate, the higher
earner loses $0.17 in the PIA calculation
relative to the middle factor.
Since the bend point at which the upper factor changes is much
larger than the Iowcr factor ($1,388 vs. $230 in 1982), slowing down
183
_
i _°
om
•184
_ _A._AA_:
__
185
the growth
rate would retard the upper factor to a much greater
extent. For example, if the 1983 bend points were determined
on the
basis of 10 percent wage growth, they would grow to $253 and $1,527.
If they were augmented
by only half the wage growth rate, they would
grow to $242 and $1,506. In this example, the slower augmentation
would retard the lower factor by only $11 but the upper one by $122.
The middle-income
worker would lose less than workers at either
extreme because most of the AIME is subjected
to the middle factor.
In short, the low-income
workers would lose a lot because the bottom
factor is the basis for most of the benefit; the middle-income
worker
would lose a similar amount on the bottom factor, but the loss would
average over a larger benefit from the middle factor; and the highincome worker would lose at both bend points in the formula.
Pension benefits increase somewhat
across the benefit spectrum,
generally
more toward the middle of the preretirement
earnings distribution
than toward either end. Because of the smaller income base
at the bottom of the earnings
distribution,
the Social Security modifications can be expected to have a somewhat
greater effect on levels
of disposable
income for the low-income
retirees
than on those for
their higher-income
counterparts.
Implications
of Taxing
Benefits
In the discussion
of short-term
policy options in chapter V, we
pointed out that taxing half of Social Security
benefits might be
considered
because this action would have distributional
implications different from those associated
with limiting postretirement
COLA increases.
The argument
for the taxing option is that in any
consideration
of benefit reductions,
policymakers
should attempt to
minimize the impact on the low-income
elderly. Taxing only half of
the benefits, it is argued, will hit only upper-income
retirees drawing
income from various sources. The Office of the Actuary in the Social
Security Administration
has developed
a rough estimate
that the
revenues
from the tax, if earmarked
trust
funds, would reduce the long-term deficit by about one-half of 1 percent of covered payroll.
The long-term implications
of such a policy in combination
with
one of the other benefit modifications
were estimated
through an
additional
simulation.
Fifty percent of benefits are assumed to be
subject to the federal income tax beyond January 1, 1984. This simulation included the modification
to the benefit determination
that
would
186
index PIA formula
bend points
by 75 percent
of wage growth
for sixteen years. This combination
of two policy changes simultaneously would have the smallest effect on workers in the cohort aged
fifty-five to sixty-four
in the simulation,
and the greatest
effect on
workers in the cohort aged twenty-five
to thirty-four.
Table VI-10 shows the results of the simulation
for these two cohorts. Income at age sixty-five is broken into income categories
by
$400 monthly or $4,800 annual increments.
The table shows the simulated family income under the current
policy sccnario and shows
the incremental
effect of implementing
the bend-point
modification
by itself, and then adding the taxation
of 50 percent
of benefits on
top of it.
As expected,
the income taxation
of 50 percent of Social Security
benefits has a larger effect on family income at the higher income
levels than at the bottom of the distribution.
For the older cohort in
table VI-10, which is largely unaffected
by the bend-point
indexing
modification,
taxing 50 percent of benefits would maintain
families
with incomes below $400 per month. For families with incomes below
$800 per month, the reduction
is estimated
to be 0.3 percent of their
income under current policy. At the top end of the income spectrum
the average reduction
was estimated
to be roughly 3 percent.
The taxation
of 50 percent of benefits dovetails
with the reduced
benefits resulting
from the change in PIA calculation
procedures.
It
tends to significantly
reduce the regressive
effects of changing
the
benefit formula on family income. Without the taxing option, people
in the bottom income classes would have 6 to 7 percent lower family
income than they would have under the current
policy simulation.
At the same time, people in the top income categories
would experience reductions
of only 3 to 4 percent. If half of Social Security
benefits were taxed, the people at the bottom would not gain back
any benefits, but those at the top would have familv income reduced
by about 9 percent. Thus the combined
modification
would spread
the adjustment
more evenly.
Implications
of Raising
the
Retirement
Age
The last two modifications
to Social Security that were simulated
would gradually raise the normal retirement
age. Thc first of these
would begin raising the early retirement
age bv one quarter per year
starting in 1998 and would be completed
in 2012 when the normal
retirement
age reached sixty-eight.
The second would raise the normal retirement
age by one quarter per year starting in 1990. Under
this second option, the early retirement
age would be maintained
at
187
TABLE
VI-10
Average Disposable Income at Age 65 in 1982 Dollars
Under Current Policy and Alternate Formula and
Taxing Provisions
Indexing Bend Points by 75 Percent of Wage
Growth
Base Case
Income Group
By Age in 1979
Ages 25-34
Less than $4,800
$4,800-$9,599
$9,600-$14,399
$14,400-$19,199
$19,200-$23,999
$24,000-$35,999
$36,000 or more
Ages 55-64
Less than $4,800
$4,800-$9,599
$9,600-$14,399
$14,400-$19,199
$19,200-$23,999
$24,000-$35,999
$36,000 or more
Source: Tabulation
Benefits Not Taxed
Average
Income
Average
Income
$ 3,149
7,070
11,862
16,666
21,627
29,223
45,596
$ 2,936
6,632
11,036
15,691
20,501
28,056
44,401
Percentage
of Base
2,940
2,938
7,040
7,037
11,864
11,834
16,446
16,443
21,310
21,305
27,539
27,533
46,830
46,828
of PRISM simulation results.
Taxing 50 Percent of
Benefits
Average
Income
Percentage
of Base
93.2
93.8
93.0
94.1
94.8
96.0
97.4
$ 2,929
6,581
10,767
15,086
19,542
26,519
41,693
93.0
93. I
90.8
90.5
90.4
90.7
91.4
99.9
100.0
99.7
100.0
100.0
100.0
100.0
2,938
7,022
11,679
16,206
20,886
26,865
45,470
99.9
99.7
98.4
98.5
98.0
97.6
97.1
sixty-two
but the actuarial
adjustment
factors
would
be modified
accordance
with the schedule
specified
in table VI-4.
These simulations
assumed
that there
would
bc a behavioral
in
re-
sponse
as a result
of the increased
Social
Security
normal
retirement
age. The probability
of accepting
Social
Security
benefits
at each
year of age above sixty-two
was adjusted
during
the transition
period.
Thc probabilities,
which were adjusted
scparatcly
for men and women,
were modified
to increase
retirement
ages in parallel
with the retirement
rates dcvclopcd
by Social
Security
actuaries
and used to
estimate
the cost effect of each of these options.
Increasing
the normal
retirement
age for Social Security
is bound
to increase
the incidence
of disability
among
older workers,
and the disability
probabilities
in
these simulations
wcrc adjusted
in accordance
with probabilities
developed
by the Social
Security
actuaries
as well.
188
Alternative
probabilities
of retirement
and disability
could have
been specified. But to do so would suggest that the financing estimates
developed
in these options should be modified.
The purpose of this
exercise
was not to question
the actuaries'
cost estimates,
but to
evaluate the distributional
implications
of various policy options under a stated set of assumptions.
Raising both early and normal retirement
ages and beginning
the
transition
in 1998 as described
earlier in table V1-3 would primarily
affect the youngest two cohorts in the simu|ation
analysis. A person
forty-four
years old in 1979 would be sixtv-three
in 1998. The remainder
of the cohort aged thirty-five
to forty-four in 1979 would be
subject to the transitional
provisions
in the proposal. The oldest persons in the youngest cohort would be sixty-four in 2009, the year that
the age for early retirement
under the proposal
reaches age sixtyfive. The youngest
cohort, therefore,
would be subject to the later
retirement
years after the transition
was complete.
No behavioral
response
was assumed
for either of the two oldest cohorts
in the
simulation
because the people in these cohorts would not be affected
by the policy modifications.
There are several ways that the effects of this policy alternative
could be considered.
Table VI-11 shows the results of the simulation
of the policy option for raising retirement
ages for the youngest
two
cohorts of workers. The table presents
the average income and percentage
of people receiving
income from the specified sources. The
decline in average family Social Security
benefit levels is the result
of a combination
of factors. Raising the retirement
age in the specified
fashion is bound to drive up the average age at retirement,
and this
happens
in the simulation.
As the retirement
age is increased,
the
reference
year for calculating
the PIA is increased.
Each time the
reference vear is raised, the bend points in the PIA formula are raised
bv the assumed
rate of wage growth. As a result PIA levels tend to
rise. The increases
in the statutory
retirement
ages, however, were
greater
than the increases
in the actual retirement
ages that were
simulated
here, corresponding
with the Social Security
actuaries'
assumptions
regarding
the potential
response
to this option. When
actual retirement
age increases
more slowlv than the normal retirement age, the average actuarial
reduction
factors across a cohort will
increase. The increase in the actuarial
reduction
factors reduces benefits, on average, by more than the indexing of bend points for later
retirement
increases
than in the simulation.
For the older cohort,
average familv Social Securitv benefits at age sixty-eight
decline 4.2
percent below the average in the current
policy simulation.
For the
189
TABLE
VI- 11
Average Family Income from Specified Sources in 1982
Dollars at Age 68 Under Current Policy and Alternate
Policy Raising Social Security's Retirement Ages by
Three Years
Average Income at Age 68
Increased Retirement-
Age in 1979
Current Policy Case
Percentage
Average
Receiving
Amount
Income
Age Case
Percentage
Average
Receiving
Amount
Income
Percentage
Change in
Average
Amount
Ages 25-34
Social Security
Earnings
Pensions or IRA
$10,542
20,975
l 1,766
96
26
88
$ 9,776
21,301
12,113
94
33
88
Total Family
Income
26,042
NA
26,901
NA
3.3
8,719
16,584
9,979
95
28
82
8,355
17,132
9,960
96
29
82
-4.2
3.3
-0.2
Ages 35-44
Social Security
Earnings
Pensions or IRA
Total Family
Income
Source: Tabulation
21,171
NA
21,180
of PRlSM simulation rcsuhs.
-7.3
1.8
2.9
NA
0.0
younger
cohort,
the decline
is 7.3 percent
since this group feels the
full effect of the implementation
of the higher
retirement
age.
There
are offsetting
effects
in other
income
sources
as earnings
increase
in two dimensions,
recipicncy
and average
level. In the older
cohort,
recipiency
increases
only marginally
at the reference
vcar of
age sixty-eight.
In this simulation
the average
age at retirement
for
men is assumed
to rise to 65.5 years at the end of the transition,
which
contrasts
with an average
retirement
age of 63.2 years at the beginning of the simulation.
The average
retirement
age of women
was
also assumed
to rise in accordance
with the assumptions
developed
by the Social
Security
actuaries.
to increase
during
the transition,
ance to defer retirement.
Work
Although
earnings
can be expected
people
may have a natural
reluctand retirement
decisions
are almost
certainly
affected
bv social as well as economic
often work and socialize
with others
near their
a friend,
sibling,
tance
to dcl_'rred
creases
in Social
190
or neighbor
retirement,
Security's
expectations.
People
own age. The fact that
retired
early may stimulate
some
especially
during
any transitional
normal
retirement
age.
resisin-
The
vations
PRISM
simulations
and their
effects
did not attempt
on the retirement
to capture social motidecision.
They merelv
increased
the probabilities
of working
longer on a gradual
basis over
a twelve-vear
period.
For the older cohort
of workers
shown
in table
VI-12, all but the very youngest
workers
would
be facing
normal
retirement
ages below
sixty-eight
even during
the transition.
While
the actuarial
increments
for late retirement
gradually
increase
with
the retirement
age, it is unlikely
that labor-force
participation
rates
for people
over age sixty-eight
would
increase
significantly
during
the transition
period.
At the completion
might
be expected.
o[ the transition,
Somewhat
more
TABLE
Average
Dollars
Policy
Family
at Age
Raising
a pattern
of later retirements
early
retirement
would
likely
VI-12
Income
from
Specified
68 Under
Current
Policy
Social
Security's
Normal
Age by Three
Years
Sources
in 1982
and
Alternate
Retirement
Average Income at Age 68
Increased RetirementCurrent Policy Case
Age Case
Age in 1979
Ages 25-34
Social Security
Earnings
Pension or IRA
Total Family
Income
Ages 35-44
Social Security
Earnings
Pension or IRA
Total Famil
Income
Ages 45-54
Social Security
Earnings
Pension or IRA
Total Famil'
Income
Source: Tabulations
Average
Amount
Percentage
Receiving
Income
Percentage
Change in
Average
Amount
96
26
88
$ 8,565
21,013
I 1,794
95
30
88
- 18.8
0.5
0.2
26,042
NA
25,028
NA
-
8,719
16,584
9,979
96
28
82
7,331
16,383
10,008
95
34
82
- 15.9
- 1.2
2.9
21,171
NA
20,763
NA
-
1.9
7,268
14,938
6,252
93
31
72
7,061
13,795
6,373
94
34
72
-
2.8
7.7
1.9
NA
-
0.7
Percentage
Receiving
Income
$10,542
20,915
l 1,766
Average
Amount
15,993
NA
15,878
of PRISM simulation results.
3.9
191
prevail than under current
policy, but a segment of each cohort of
workers would work until normal retirement
age and beyond. This
would not only raise the level of earnings
among the elderly, but the
extended
work life would also increase pension and IRA accruals for
elderly workers. The combined
effects may well raise the level of total
income available
to many of the elderly, albeit from a somewhat
differently
weighted combination
of sources.
Raising Social Security's
normal retirement
age gradually
while
maintaining
the current
early retirement
age would have an effect
somewhat
different
from the effect of raising both in unison. First,
even with greater actuarial
reductions,
the continued
availability
of
retirement
at age sixty-two would induce some early retirement.
The
incentives
to work beyond the normal retirement
age would be the
same under the Pickle proposal
as under the National
Commission
proposal.
Because there would be some additional
early retirement
and no additional
late retirement,
the increase in average retirement
age would be somewhat
less under the Pickle proposal
than under
the other alternative
for raising the retirement
age discussed earlier.
The proposal to raise both early and normal retirement
ages increased
the average retirement
age between 2.0 and 2.3 years in the simulation. Still, raising normal
retirement
age and adjusting
the early
retirement
actuarial
factors back to age sixty-two were assumed
to
raise average retirement
ages between 1.0 and 1.3 years. This would
have distributional
effects somewhat
different from those of the former option for raising retirement
ages.
The transition
to the Pickle proposal was assumed to begin in 1990
in the simulation
and to affect persons age sixty-two that year. Anyone
reaching
age sixty-two
in 1990 would have been fifty-one years old
in 1979. Thus, this proposal
would affect all but the oldest cohort
considered
in the simulation
analysis. Table VI-12 shows the average
family income from various sources derived from these simulation
results. The results are somewhat
startling.
The Social Security benefit reductions
for the youngest cohort, on an annual average basis,
are two to three times those from the alternative
simulation
that
considered
raising both normal and early retirement
ages. At first
glance, the size of the Social Security benefit reductions
would seem
to imply greater reductions
in average total family income than those
shown in the table. The increased
prevalence
of earnings, however,
causes the average total family income to fall significantly
less than
Social Security benefits.
The changes in earnings
among the three cohorts are interesting.
For the oldest cohort, average earnings decline by 7.7 percent, but 3
192
percent more families are simulated
as having earnings
at the reference age. The reason that average earnings
decline relates to the
structure
of the retirement
decision inherent in the model. A person's
retirement
decision is affected not only bv Social Security eligibility
but by pension eligibility
as well. A person who is eligible for a pension, given current
program
characteristics,
will be less sensitive
to
rising Social Security
retirement
ages than will a person who is not
eligible for a pension. Furthermore,
it is lower-wage
workers who are
less likely to be covered by a pension, in the labor market as we know
it today and in the PRISM simulation.
As the later retirement
ages
are phased in, it will be lower-wage
workers who are more likely to
extend their working careers, unless employers
modify their pension
plans in accordance
with changes in Social Security retirement-age
provisions.
While it is impossible
to estimate
whether and how employers might react to higher Social Securitv retirement
ages there
is evidence
to suggest that many employers
would not change the
retirement-age
provisions
in their pension plans at this time. _
A second interesting
facet of the earnings
data included
in table
VI-12 is that the increased prevalence of the receipt of earnings reaches
its peak for the middle cohort in the three age groupings.
The transition to this option would be completed
about midwav through the
cohort's
attainment
of age sixty-two.
The increased
prevalence
of
pension
benefits and IRA annuities
in the simulation
significantly
diminishes
the effect of keeping
lower-wage
workers in the labor
force. The further growth
of IRA annuities
and receipt of pension
benefits
in combination
with the reassertion
of the long-term
trend
toward earlier
retirement
in the simulation
reduces
the marginal
growth in earnings
for the youngest cohort in comparison
with the
middle group in the simulation.
Average earnings
actually
increase
slightly under the increased
normal retirement
age simulation.
Assuming
that increased
earnings
will make up for most of the
declines
in Social Security
benefits,
in the aggregate,
ignores
the
distributional
question that is central to the Social Security adequacy
issue. In none of the three cohorts simulated
does the prevalence
of
family earnings rise above 34 percent. Those families with the largest
reductions
in Social Security benefits under this policy option would
be the least likelv to have significant
earnings
at normal retirement
ages.
_David
Sheinerman,
"Attitudes
Towards
Raising Social Security's
Normal
Retirement Age--A
Survey of Connecticut
General
Pension
Plan Clients,"
(Washington,
D.C.: EBRI, 1982).
193
Although the average benefits are characterized
as reductions
relative to the current policy scenario,
these benefits represent
continuous growth
in average benefits in real terms. Between
the oldest
and youngest
cohort in table VI-12, the average simulated
family
benefits at age sixty-eight grew by 21 percent. In addition, this policy
option would continue to allow people to retire at age sixty-two. Given
the wide variations
in workers' health characteristics
and job opportunities
as they reach their sixties, the value of this early retirement option may outweigh
the benefit reductions.
Comparing
the Alternatives
Any retirement
age in a national program
the magnitude
of Social
Security is somewhat
arbitrary.
The establishment
of age sixty-five
in 1935 as Social Security's
retirement
age was basically a normative
decision. The same can be said about the other facets of the program
as well, from the benefit structure
to the financing
provisions.
The
prospect
facing Congress now is a new set of normative
options, all
of which somewhat
change the course from the accumulation
of past
decisions.
It is possible that if Congress were presented
with a clean
slate, it might design a program
significantly
different from the one
now known as Social Security. But Congress does not have a clean
slate; there is a defined structure
with an inherent set of obligations.
Congress
faces the choice between making a set of incremental
adjustments
or more radically
restructuring
the existing system.
In focusing on the incremental
approach,
this chapter has discussed
a series of specific options. Thus far the discussion
has centered
on
the effects of the option on benefits at various points in the simulated
persons'
lives. Another way to look at the effects of these various
policy options is to compare the effects on lifetime benefits at some
common
age. PRISM adds an interesting
dimension
for comparing
expected lifetime benefits under the various options because PRISM
simulates
a date of death for each sample person.
In the PRISM project we compared
the effects of all the options by
calculating
the present value of Social Security
benefits, based on
the simulated
life beyond age sixty-two,
under each of the options.
We calculated
the stream of annual benefits paid each year that a
person lived beyond age sixty-two; this calculation
included not only
worker benefits but spouse and survivor benefits as well. Each benefit
was attributed
to the person to whom it would be paid; that is, a
spouse benefit was attributed
to the spouse, not to the primary
beneficiary on whose benefit the spouse benefit was based. Annual ben194
efits were calculated
in 1982 dollars and discounted
bv a 2 percent
real rate of return back to age sixty-two
to give the value of lifetime
benefits that would be paid to all persons who reached early retirement age under current policy for each of the policy options that was
simulated.
The value of benefits under each of the alternative
policy
options was then compared with the value under the current policy
option, and the percentage
change in benefits was calculated.
Table
VI-13 shows the results of these calculations
for all individuals
in the
cohort of workers aged twenty-five
to thirty-four in 1979. To limit
the complexity
of the analysis, only one cohort is shown. This cohort
was chosen because these people would feel the maximum
effect of
each of the options simulated.
From a lifetime-benefits
perspective,
the distributional
effects of
the various options are quite different. The bend-point options tend
to cluster the benefit reductions,
relative to current policy, below 15
percent. Under the price indexing of earnings options, benefit reductions for the majority would also be less than 15 percent. Under each
of these options there is a clear modal group with narrowly distributed benefit reductions being spread across a wide range of the population. Under these options, almost everybody
ends up in roughly
the same boat, so to speak. The variations
in the distributions
that
exist from the alternative
formula adjustments
stem from variations
in work and earnings patterns in the simulations.
Under the scenario for raising both the normal retirement and early
retirement ages, about 34 percent of the people had benefit reductions
of less than 5 percent. In fact some people with long lives beyond age
sixty-eight,
who worked to normal retirement
age under both simulations,
would receive higher lifetime benefits under the higherretirement-ages
scenario. This occurs because their benefits would
be calculated
on the basis of a PIA formula whose bend points had
been indexed three additional
years. About 23 percent of the people
at the upper end of the distribution
would experience benefit reductions of 25 percent or more under this option, while 10 percent would
lose benefits altogether.
This wider distribution,
compared with the
distribution
under the other options, stems from later retirement ages
in combination
with age at death. Even though average life expectancy increases over the simulation
period, some people still die between the ages of sixty-two
and sixty-five
and sixty-five
and sixtyeight. People who do not live to age sixty-five or who live only a few
years into retirement
would receive benefits for a shorter period under this option. Obviously,
their benefits would be reduced significantly.
t
195
196
The option that raises normal
retirement
age but maintains
the
current
early retirement
age would lead to somewhat
larger benefit
reductions
on average
than any of the other options.
This occurs
because people are expected to choose to retire at an age close to the
retirement
age under current policy, at the expense of larger actuarial
reductions
in their benefits. If older workers were to extend their
careers in the future, however,
this phenomenon
might be less extensive than the simulation
suggests. The size of the baby-boom
cohort and the prospects
of the mass exodus of these people from the
work force might result in significant
wage growth among the members of this cohort as they begin to retire. To some extent, this phenomenon
is captured
in the simulation,
but possibly not sufficiently.
If the wages of this cohort were to rise appreciably
as the group
approached
retirement,
the labor-force
participation
of the elderly
could be expected to rise and the Social Security benefit reductions
would be less pronounced
than the simulation
results shown in table
VI- 13 suggest.
The Social Securitv
modifications
discussed
also will have somewhat different
effects on men and women. These differences
occur
because of variations
in male and female earnings
patterns
and life
expectancy.
Table VI-14 compares
the results of the simulations
for
three of the options discussed
on the basis of sex. The options that
would modify the benefit formula would reduce lifetime benefits for
men on average slightly more than for women. For example, the 75
percent
wage-indexation
option would reduce benefits for about 38
percent of the women by 10 percent or less. For another 60 percent
of the women, the benefit reductions
would range between 10 and 15
percent. In contrast,
about 19 percent of men would experience
benefit reductions
of less than 10 percent, while about 81 percent would
have reductions
ranging between
10 and 15 percent.
Raising both the early and normal retirement
ages in Social Security would provide somewhat
smaller changes in lifetime benefits
for people who live well beyond retirement
age, so women would
benefit more than men. Under the option for-raising both retirement
ages, the simulated
lifetime
benefits
for 41 percent of the women
were less than 5 percent below the current policy results, while only
26 percent of men had benefit reductions
in this range. In contrast,
about 37 percent of the men had cuts of 5 to 10 percent in lifetime
benefits, while only 20 percent of women fell in this interval.
Men
were also slightly more likely than women to have cuts of 10 percent
or more in lifetime benefits.
197
TABLE
VI-14
Distribution
of Relative Change in the Present Value of
Lifetime Social Security Benefits for Men and Women
at Age 62 Under Alternate Policy Scenarios Compared
to Current Policy for Individuals Ages 25 to 34 in 1979
Relative
Reduction in
Lifetime
Benefits
Compared with
Current
Policy
Less than 5
_ercent
5 to 9.99
_ercent
10 to 14.99
_ercent
15 to 19.99
_ercent
20 to 24.99
9ercent
25 to 99.99
_ercent
100 percent
Total _
Policy Option
Raising Normal
Raising Early and
Retirement Age and
75 Percent BendNormal Retirement
Adjusting Actuarial
Point Indexation
Ages
Factors
Men
Women
Men
Women
Men
Women
(Percents of persons in each category)
0.9
3.3
26.1
41 .l
1.4
12.1
18.5
34.3
36.5
19.9
2.3
11.2
80.5
60.0
7.7
7.2
6.5
17.6
0.1
1.4
5.5
5.5
56.9
41.0
0.0
0.5
2.3
2.6
26.0
12.9
0.0
0.0
!00.0
0.6
0.0
100.1
11.4
10.3
99.8
14.0
9.6
99.9
5.0
1.8
99.9
3.8
1.3
99.9
Source: Tabulation of PRISM simulation results.
_Totals may not add to exactly 100 percent because of rounding.
The option
that would
raise normal
retirement
age to sixty-eight
and adjust
the actuarial
factors
back to sixty-two
has a substantially
greater
effect on men than women.
A larger
portion
of women
than
men would
have benefit
reductions
of less than
15 percent,
while
a
larger
share
of the men fall into the reduction
categories
15 percent
and above.
Selecting
Options
No clear decision
rule for
rived from this analysis.
The
the various
options
showed
each approach.
Adjustments
198
selecting
a particular
option
can be defirst part of the chapter
that described
the savings
that can be garnered
from
can be made
to each of the options
to
get more or less savings, but roughly
gained by either reducing initial benefit
ages.
comparable
savings can bc
growth or raising retirement
The latter part of the chapter
that described
the distributional
effects of the options showed somewhat
more pronounced
differences
in the options. Before Congress
chooses one of these options, or a
similar variant, it must ultimately
decide how it wishes to distribute
the benefit adjustments.
Modifying the benefit formula
will give a
narrow range of benefit adjustments,
but the adjustments
will affect
almost everyone.
Modifying the retirement
age, though, will give a
much broader range of adjustments.
If both normal and early retirement ages were raised, many future beneficiaries
would be better off
than they would bc under the formula
modification
options, while
many others would be worse off.
None of the options considered
in the simulations
would by itself
resolve the long-term
financial
imbalance
in the OASDI program, so
other adjustments
will also have to be considered.
In the PRISM
project, we simulated
the implications
of taxing 50 percent of Socia_
Security
benefits in combination
with 75 percent wage indexing of
bend points. The results of that simulation,
discussed earlier, suggest
that this combination
of policy change would not radically
redistribute the income accruing to the elderlv in the future. In fact, it appears /
that this course would come closer to maintaining
the elderlv's
income distribution
than any single option considered
bv itself. This !
combination
of modifying the benefit formula and the tax treatment
of Social Security benefits would probably
still fall short of closing
the long-term
financing deficit, however.
Raising the early and normal retirement
ages in Social Security
might seem particularly
harsh because this action would completely
eliminate
benefits to some people who would, under current policy,
receive benefits. The selection of any eligibility
criterion
for retirement age, however,
has the effect of excluding
some people from
benefits. This is true of current
policy, which does not provide retirement
benefits
prior to age sixty-two.
The relevant
question
is
whether raising Social Security retirement
ages would exclude more
people from benefits than current policy does. If retirement
ages were
increased,
the Social Security
Disability
Insurance
program
would
be called upon to a greater extent to deal with the greater prevalence
of disability
and health problems
among older workers than is now
the case. Considering
the inherent
response
of the DI program
to a
policy of increased
retirement
ages, such a policy should not result
199
in greater
benefit exclusions
(because
of death before entitlement)
than have occurred
over the life of the Social Security program.
Certain combinations
of benefit formula adjustments
and changing
retirement
ages might be considered.
But combining
options just to
get to financial
balance could be devastating.
A combination
of benefit formula modifications
with increasing
retirement
age would lead
to greater benefit adjustment
than any discussed
here. Such a combination would accentuate
the distribution
of the adjustments
as well.
Rather than considering
such combinations,
Congress may wish to
consider other alternatives
that would help resolve the financing deficits in the long term. The next two chapters are devoted to a further
discussion
of such alternatives.
200
VII.
Universal
Coverage
Social Security
and the Alternatives*
In the proccss of developing the 1977 Social Security amendments,
the House Ways and Means Committee reported out a bill that would
have mandated
universal
coverage.
Had Social Security coverage
been extended
to all employment
in the United States effective Januarv 1, 1978, the program
would have no short-term
financing problem today. In the long-term,
the financing
deficit would have been
reduced bv 0.5 percent of payroll--slightly
more than one-quarter
of
the financing
deficit projected
under the 1982 Trustees Report Alternative II-B assumptions.
Coverage was not expanded
by the 1977
amendments.
In fact, since that time, a number
of employers
who
had the option have withdrawn
from the system.
When the Social Securitv program
was established
in 1935, participation
in it was compulsory
for all private-sector
workers in commerce and industrv
who were not vet sixty-five
years old. At that
time, somewhat
more than half of all U.S. workers
were covered.
Some categories
of workers, such as federal civilian employees,
were
excluded because most of these people were protected
under the Civil
Service Retirement
System (CSRS). State and local employees
were
excluded because it was believed that the Constitution
might prevent
their participation.
Since 1935, both Social Security
coverage
and
benefits have been greatly expanded.
Today, more than 90 percent of the nation's workers have Social
Security coverage.
Of workers not now covered bv Social Security,
2.5 million are federal civilian employees,
3 million are state and
local government
employees,
and 500,000 to 1,000,000 are employees
of private, nonprofit
organizations.
Most of these employees
participate
in their employers'
retirement,
survivor,
and disability
insurance
systems. Other persons without
Social Security coverage include "quasi-workers,"
such as newspaper
carriers and other casual laborers who do not earn enough in a year
to meet the coverage
criteria.
Conscientious
objectors,
such as the
Amish, are also not covered on the basis of self-employment.
":An earlier version of this chapter was presented
at the American Enterprise
Conference
on Controlling
Social Security
Costs, June 26, 1981.
lnstitute's
201
Problems
with
the Status
Quo
Although the Social Security program now covers almost all American workers,
certain
inequities
and inadequacies
result from the
existing pattern
of exemptions
from the program.
There are three
major problems:
(1) inadequate
protection
for persons not covered;
(2) inequities
inherent
in exemption
from participation
in a mandatory redistributive
program;
and (3) subsidized
benefits afforded
partial participants
in Social Security.
Inadequate
Protection [br Persons Not Covered--Most
workers not
covered by Social Security are covered by pension plans sponsored
by their employers.
Both Social Security and the typical pension plan
require a period of employment
under the system before the worker
is eligible for insurance
protection.
As a result, workers who have
noncovered
jobs or who shift between covered and noncovered
employment
may experience
periods
without
disability
and survivor
I
coverage.
Public pension plans usually require at least five years of service
before the worker receives disability
protection.
Many employees
in
the initial five years of service are young people holding their first
major jobs who have no other pension protection.
Although disability
is unlikely for most young workers, it does occur and the worker is
often without insurance
or assets.
Workers who leave federal employment
without CSRS annuity status, for example, are the least likely to have Social Security coverage
and are the most likely to need it. Of workers who left federal employment
between
1973 and 1977, an average of 39 percent of the
men and 63 percent of the women were not insured against disability.
Even the most vigorous opponents
of mandatory
Social Security coverage acknowledge
that these insurance
gaps warrant
modifying the
current system.
Workers in employment
not covered by Social Security
also experience
gaps in benefits. These gaps arise because many of the alternative
pension
systems do not provide
disability
and survivor
benefits comparable
to those provided by Social Security. A twentyone-year-old
worker can acquire Social Security disability
protection
with credited
earnings
for six quarters
of work in covered employment; in fact, these credits can be earned with as little as one month
_The term "noncovered"
used in this chapter
refers to Social Security coverage.
The
overwhelming
majority o[ "noncovered
workers"
in this context are actually
covered
by a pension other than Social Security.
2O2
of covered employment
in two consecutive
vears. To become insured
under CSRS, the same person would have to work five vears for the
federal government.
Many noncovered
state and local systems require
even longer periods
of coverage
to qualify for disability
benefits. 2
Furthermore,
the benefits provided by these other pensions are often
inferior, especially
for young workers with families.
The partial gaps in coverage extend bevond disability
and survivor
protection.
A comparison
of covered and noncovered
state and local
pension plans shows that the combined
benefits (i.e., Social Security
plus pension) of covered systems generally
exceeded
the benefits of
noncovered
systems by 20 to 60 percent in 1976. Given the fact that
Social Security
benefits are not currentlv
taxable,
the disparity
between the annuities
of covered and noncovered
plans is even more
marked. 3
In addition,
dependent
benefits are usually more generous under
Social Security than they are under noncovered
plans. Social Security
provides better spouse, survivor, and disability
benefits and medical
protection
than virtually any noncovered
system. Social Security benefits are fully indexed to changes in the cost of living, whereas
the
benefits of most noncovered
plans are not. These differences
in coverage and benefit levels make all noncovered
workers and their families more vulnerable
than covered workers.
Inequities
Inherent in Exemption
[rom Participation
in a Mandatory
Redistributive
Program--Career
noncovered workers are exempted from
paying into an income-redistributive
program
that provides proportionately
more generous
benefits
to low-wage
than to high-wage
workers. Part of the payroll tax contributions
of high-wage
covered
workers
is used to provide more generous
benefits
to retirees
with
low average lifetime earnings
than they would otherwise
receive if
Social Security
were not tilted to favor low-income
workers.
The
highly paid noncovered
worker does not share this burden. There is
nothing inherently
different in the employment
of noncovered
workers that differentiates
their work from that of covered workers. There
are accountants,
lawyers, economists,
actuaries,
blue-collar
workers,
clerks, and secretaries
in both the covered and the noncovered
sectors.
2For example,
the Louisiana
State Public Employee
Retirement
Svstem requires five
years of service for survivor
protection
and ten years for disability
protection.
3Final report of the Universal
Social Security
Coverage
Study Group, The Desirability
and Feasibility
o[ Social Security Coverage [br Employees
of Federal, State and Local
Government
and Private, Nonproiit
Organizations
(Washington,
D.C., 1980), p. 27, hereafter cited as Universal Coverage Study.
203
The only distinction
is that some workers
are employed
by employers
who do not participate
in the system.
It should
be kept in mind,
laowever,
that some
noncovered
employees
are low-paid
workers
who would
actually
benefit
from expanded
coverage.
Women,
for example,
would
benefit
from wider
Social
Security
coverage.
Approximately
28 percent
of women
employed
by the federal
government
in April 1978 had annual
salaries
below $10,000,
whereas
only 7 percent
of the federally
employed
men
did. Only
8 percent
of the federally
employed
women
had salaries
above $20,000
in 1978, whereas
31 percent
of the men did. Similarly,
members
of minority
groups
would
benefit
from the redistributive
aspects
of Social Security.
Only 12.9 percent
of the whites
employed
by the federal government
had annual
salaries
below $10,000
in April
1978, but 19.4 percent
of minority
group employees
did. In comparison, 11.6 percent
of minority
federal
workers
had salaries
exceeding
$20,000
per year,
while
37.5 percent
of white
federal
workers
had
such salaries
in April 1978. 4
It is the redistributive
aspect
of Social
Security
to the third
set of problems
which
many
people
the most important
inequity
resulting
from the
Social
Security
exemptions.
that also gives rise
believe
constitutes
current
pattern
of
Benefits
Af]orded
Partial
Participants
in Social
Security--Workers
with periods
of noncovered
employment
who qualify
for Social
Security
benefits
receive
higher
benefits
in proportion
to their contributions
to Social
Security
than
do workers
with
only
covered
employment.
It is important
to understand
that although
this difference is quantifiable,
the issue is still highly
emotional
and controversial.
Language
must
be selected
carefully
so that the issues
are
not obscured
by rhetoric.
4This analysis is based on a six-year, 1 percent longitudinal sample of the |edera]
government's Central Personnel Data File (CPDF). This file represents approximately
2.7 million [ederal workers in each vear and approximately 4.2 million workers for
the total period. This sample excludes about 10 percent of federal employees covered
under CSRS whose records are not maintained in the CPDF: legislative employees,
employees of the District of Columbia, foreign nationals, agricultural extension employees, and several other relatively small groups of workers. In each year, roughly
10 percent of the workers in the sample were covered under Social Security through
their federal employment. These workers were excluded from the analysis where
appropriate. The CPDF data were linked with Social Security Administration records
that provide detailed information on the extent of earnings of those workers who
were covered by Social Security and a longitudinal record of their insurance status.
These, in turn, were linked with the CSRS annuity file, which provided detailed
retirement income data on federal workers who retired during the six-year period.
204
Frequently,
people who have a favorable
ratio of benefits to contributions from Social Security because of periods of noncovered employment are characterized
as "double dippers."
The attribution
is
misleading
and brings a pejorative
tone to the discussion.
Both the
description
and the policy solutions that have been put forward
to
solve the "double dipper" problem reflect a lack of understanding
of
the problem or of potential effective solutions.
"Double dipping" suggests receiving dual compensation
or benefits
based on one period of service. For people who work in noncovered
employment,
there is little double attribution
of service both to a
noncovered
pension system and to Social Security. Dual beneficiary
status occurs because recipients have complied with mandatory
provisions under both covered and noncovered employment.
While working in noncovered employment
they contributed
to their pension plan
and became eligible for benefits. While working in covered employment they contributed
to Social Security and met the eligibility
requirements
for a Social Security benefit as well. Many of those who
receive preferential
treatment
from Social Security because of noncovered employment
receive absolutely
no retirement
benefits from
the noncovered
employer's
pension plan. 5
A more appropriate
description
widely used in the literature
characterizes
the relatively generous payments
to people with periods of
noncovered
employment
as "windfall
benefits."
The Universal Coverage Study characterized
the windfalls
as "unintended
subsidies."
The Fund to Assure Independent
Retirement
(FAIR), a coalition
of
federal unions that has amassed several million dollars to lobby against
universal
coverage,
has taken the position that neither the windfall
nor the unintended
subsidy characterization
is fair, as stated here:
•
FAIR finds it inconsistent
who receive
"windfall"
•
It is an
discount
•
but not amusing
that
benefits
are criticized,
retired
while
public employees
others
are not.
established
[act that self-employed
persons
receive
a 25 percent
on the total contribution
to the Social
Security
trust fund. When
viewed
against
others
who receive
benefits
from
the fund, the self-employed
clearly
receive
benefits
in excess
of the standard
contribution
rate. Yet nobody
complains
that
they are ripping
off the taxpayers.
Similarly,
individuals
who use "non-earned"
income,
such as dividends
on investments
and capital
gains
from business
transactions,
[or part of
their
working
lifetime
do not pay a Social
Security
tax on such non-
SThe term "noncovered
employer"
does not provide
Social Security.
throughout
this discussion
means the employer
It does not mean that a pension is not provided.
205
earned income.
falls" acquired
No argument
has been advanced
to suggest
in this manner
should be eliminated.
6
that
"wind-
To place
FAIR's
position
in perspective,
it should
be noted
that
Congress
has explicitly
decided
to give preferential
treatment
to earnings of the self-employed
and to unearned
income.
The equity
of the
special
treatments
of these kinds of income
can be debated,
but the
intent
of Congress
cannot.
The Social
Security
program
is financed
by a payroll
tax on wage or salary
income--not
by a tax on capital.
Congress
has clearly
legislated
lower payroll
tax rates from the selfemployed
than for hired workers.
Any subsidies
that result
from these
policies
are clearly
the "intent"
of Congress.
At the same time, it should
be noted
that universal
coverage
has
not been the intent
of Congress
thus far, either.
The concern
about
unintended
subsidies
is substantiated,
however,
by the House of Representatives'
Report
on the Social Security
Act Amendments
of 1939:
An average wage formula will also have the effect of raising
the level of benefits payable in the early years of the system,
but it will reduce future costs by eliminating
unwarranted
bonuses payable
under the present formula
to workers in
insured employment
only a few years. These bonuses result
from the greater
weight now given to the first $3,000 of
accumulated
wages. They are justified,
if a total wage formula is used, in the case of older and low-paid workers who
retire in the early years of the system and have not had time
in which to build up substantial
benefit rights. In the long
run, however,
such bonuses are unwise and endanger
the
solvency of the system by permitting
disproportionately
large
benefits
to workers
who migrate
between
uninsured
and
insured
employment
and accumulate
only small earnings
in insured employment
.7
Providing
a Perspective
on the
Bonuses
The Social Security
bonuses
to noncovered
workers
result from two
factors:
(1) the benefit
formula
provides
a deliberate
subsidy
intended
for workers
with relatively
low lifetime
wages;
and (2) the benefit
calculation
does not distinguish
between
truly low-wage
earners
and
those whose
average
lifetime
covered
earnings
are low because
they
work primarily
in noncovered
employment.
The underlying
premise
6"FAIR Facts No. 3," in Tlle National Rural Letter Carrier, vol. 79, no. 46 (December 31,
1980), pp. 863-864.
7House of Representatives, 76th Congress, First Session, Report no. 728, SocialSecurity
Act Amendments o[ 1939 (June 2, 1939), p. 10.
206
in the unwarranted
bonus concept is that Social Security should treat
workers with comparable
earnings
patterns
comparably.
To demonstrate
this premise, let us consider the beginning
salary level and
annual
wage increases
for each of the three hypothetical
workers
shown in table VII-I.
The favorable
benefit-contribution
ratio that results from periods
of noncovered
employment
is reflected in table VII-2. The table shows
the value of employee
taxes paid at retirement
assuming
2 percent
real interest
on contributions,
compounded
annually.
Each worker
is assumed
to work continuously
between
the age of twenty-two,
attained
in 1981, until the age of sixty-two,
which occurs in 2021.
The calculations
assume
that currently
legislated
payroll tax rates
will apply, that there will be no inflation, and that average real wages
will increase
1 percent per year. The value of expected total benefits
at retirement
age sixtv-two
is 80 percent
of the primary
insurance
amount
based on current
life expectancy
tables (slightly more than
eighteen years) discounted
at a rate of 2 percent per year.
Table VII-2 shows the effects of exempting
periods of employment
from Social Security
coverage. Such exemptions
result in far more
rapid declines in contributions
than in benefits. With only thirtv-five
years of covered employment,
the hypothetical
workers pay only 86
to 90 percent of the full-career
tax liability; vet they receive virtually
full benefits. Thc workers with thirty vears of coverage
make 72 to
78 percent of full-career
contributions
but receive 88 to 94 percent
of a full benefit. For twenty years of coverage the workers make roughly
half the whole-life contribution,
but receive three-fourths
of the full
benefit. For ten vears of coverage,
workcrs
contribute
about onefourth and receive about half of the full benefit.
TABLE
Wage
Assumptions
Worker
Salary
Level
(Dollars)
VII-I
for Three
l
Hypothetical
Worker
Annual
Increase
(Percent)
Salary
Level
(Dollars)
2
Workers
Worker
Annual
Increase
(Percent)
3
Salary
Level
(Dollars)
Annual
Increase
(Percent)
Year
Age
1981
22
8,529
3
14,348
5
19,655
5
1990
31
11,129
1
22,258
1
30,491
3
2000
41
12,293
1
24,586
1
40,977
1
2010
51
13,579
1
27,159
1
45,264
1
2020
61
15,000
Source:
Universal Coverage Study,
Study Group, (Washington,
30,000
report of the Universal
Social
D.C., March 1980), p. 52.
50,000
Security
Coverage
207
TABLE
VII-2
Percentage
of Total Employee Social Security Taxes
Paid and Primary Benefits Accrued for Three
Hypothetical
Forty-Year Workers in Covered
Employment,
by Final Salary
$15,000
Final Salary
$30,000
$50,000
Taxes
Benefits
Taxes
Benefits
Taxes
Benefits
$53,391
$81,210
$104,668
$117,601
$150,191
$141,801
Value at retirement
|0r f0rty-year
coveredcareer
Percentage
Years o/Career Covered
(35 years total)
6-40 years
88
1-5,
11 40
87
- 10, 16-40
86
- 15, 21-40
87
-20, 26 40
87
-25, 31-40
88
-30, 36 40
89
-35
89
Years o[ Career Covered
(30 years total)
11-40 years
75
1-10, 21-40
73
i-20, 31-40
75
1-30
78
of Total Taxes Paid and Benefits
Less than Forty Years Worked
Accrued
for
100
99
99
99
99
99
99
99
89
87
86
86
87
88
88
89
100
99
98
98
98
98
98
98
90
87
86
86
87
87
88
89
100
99
98
98
98
98
98
98
90
88
88
88
76
72
75
77
94
92
92
92
77
72
74
77
93
90
90
90
Years o[Career Covered
(20 years total)
21 40 years
47
11-30
52
1-20
53
69
68
68
48
53
52
76
76
72
49
54
51
77
77
73
Years o] Career Covered
(10 years total)
31-40 years
22
21-30
25
11-20
27
1-10
25
49
47
47
47
23
25
28
24
48
48
48
43
23
26
28
23
5I
51
43
43
Source:
Note:
2O8
U_iversal Coverage Study, report ol the Universal Social Security Coverage
Study Group, (Washington, D.C., March 1980), p. 36.
All dollar amounts are in 1980 dollars. Although the effects of inl]ation have
been eliminated, the computations assume I percent increases in productivity
for each year between 1981 and 2020.
The concern about this problem typically focuses only on persons
who derive benefits from pension plans of noncovered
employers
at
the same time that they receive Social Securitv benefits. Yet workers
with verv short periods of exempted
employment
also receive preferential
treatment
from Social Security, whether or not they receive
a pension from noncovered
employment.
During the development
of
the Universal Coverage Study, there was a considerable
debate about
the precise definition
of the "unintended
subsidies."
The concept of
windfalls
for dual beneficiaries
had been discussed and was generally
accepted
by serious students of Social Security.
The concept of the
"contribution
gaps" for workers
with short periods of noncovered
service was developed
and refined by the coverage studv staff and
was accepted
more slowly.
One of the arguments
against the idea of the contribution
gaps was
that it assumed
that workers were somehow
responsible
for paying
for their own benefits. The argument
focused on the relation of benefits to contributions
inherent
in table VII-2. Table VII-2 is not based
on the assumption,
however,
that there is necessarily
any dollar
equivalence
between full lifetime contributions
and an expected full
retirement
benefit for any particular
worker. The underlying
premise
is simply that workers will contribute
while employed
and will benefit while retired. Workers who do not participate
fully on the contribution
side of the program
should not expect to receive the full
protection
of the benefit side. Congress recognized
this principle
in
1939 when it cautioned
against
"unwarranted
bonuses
to workers
who migrate
between uninsured
and insured employment.
''s
Measuring
the Cost
to Social
Security
of the Bonuses
The Universal Coverage Study also attempted
to quantify the cost
of the unwarranted
bonuses from Social Security.
Because of limitations in the available data, the subsidies to dual beneficiaries
and
to workers with short periods of noncovered
service were estimated
separately.
The windfalls
were estimated
as
unwarranted
bonuses paid. For workers with short periods of noncovered service, the windfalls were estimated
as foregone contributions not reflected in proportionate
benefit reductions
under current
policy.
Estimates
of windfalls
were based on the
assumption
that
workers
with
periods
of noncovered
employment
81bid.
209
would not receive a higher replacement
rate on their covered earnings
than workers whose total earnings wcrc in covered employment.
Calculating
the "correct"
replacement
rate [br workers with noncovered
employment
required
the derivation
of phantom
average
indexed
monthly earnings
and primary
insurance
amounts;
that is, total career earnings
were treated as though they were covered. These phantom values were used to derive the intended or "correct"
replacement
rate, which was then multiplied
by the AIME from covered employment to derive an intended or "correct"
PIA. The adjusted
PIA was
then used to obtain the benefit that the annuitant
was intended
to
receive under the Social Security program.
The difference
between
this intended
benefit and the benefit under the current
law was the
measure
bonus.
of the windfall
used to derive
an estimate
of the aggregate
As an illustration,
consider
three hypothetical
workers shown in
table VII-3 who retired
in 1980 with identical
wage streams
and
$12,000 in annual lifetime average indexed earnings.
For worker A
retiring
at age sixty-five with a full career in covered employment,
Social Security
replaced
43.26 percent of the AIME. For workers B
and C, the replacement
rates under current law were 55 and 77 percent of AIME, respectively.
The windfall
calculation
assumed
that
workers who had idcntical
earnings
histories should have the same
replacement
of AIME. The actual replacement
rate for the fully covered worker was assumed
to bc the target replacement
rate for workers with noncovered
earnings. Using that target replacement
rate to
calculate
the benefits defines the "intended"
benefit for workers with
periods of noncovcred
employment.
An estimate
of windfalls
was derived from 1 percent of the annuitants who began receiving
CSRS benefits between
1973 and 1978,
had attained
the age of sixty-two by April 1978, and were eligible to
receive a Social Security
benefit by that date. An average windfall
was calculated
that accounted
for actuarial
reductions
based on age
at receipt of Social Security.
The calculation
also accounted
for a
proportionate
assignment
of spouses and Medicare Part A benefits as
windfalls.
On the basis of average windfalls
to this cohort of annuitants, extrapolations
were made to the remaining
CSRS annuitant
population
and noncovered
state and local pension annuitants.
The
Social Security windfalls
were estimated
to be
$840 million in 1980. 9
9See the
vation.
210
U_ziversal Coverage
Stuclv,
chapter
3, tot a detailed
description
of this deri-
TABLE
VII-3
Earnings Credits, Present Low Benefits, and Estimated
Windfalls
for Three Hypothetical
Workers with
Identical Wage Streams
Earnings
Credits
Covered
Not covered
Total
AIME
Present
PIA _
Worker A
Worker B
Worker C
$12,000
$12,000
1,000
$ 6,000
6000
$12,000
500
$ 3,000
9_000
$12,000
250
$432.60
$272.60
$192.60
0
Law
Replacement
rate
43%
Target Bene[its
Replacement
rate
PIA
43%
$432.60
55e/_
43_
$216.30
77c_
43cA
$108.15
Windfall Be_te[its
Actual PIA less
target PIA
0
$ 56.30
$ 84.45
Source: Calculated bv author.
"PIAs are computed using tile assumption that each benefit calculation procedure was
fully e|'|;ective and using the 1980 benefit formula. Earnings credits "_veredivided bv
12 as if the', had been average
indexed monthlycarnings.
There
are
several
reasons
to believe
that
this
is a conservative
es-
timate.
First,
only primary
beneficiaries
were considered,
although
survivor
benefits
would
also include
some windfall
component.
Second, windfalls
were calculated
at the point of entitlement,
but were
not indexed
to account
for cost-of-living
incrcascs,
which would apply"
to the windlall
portion
of total benefits.
Third,
the calculation
did
not account
for the fact that
treatment
of five years
of noncovcred
earnings
reduces
as "drop-out"
contributions
years
in calculating
relatively
more
than
Social
Security
benefits
it reduces
benefits.
Fi-
nally,
the dual beneficiary
rates for state and local annuitants
were
considered
to occur
to the same extent
as among
CSRS annuitants,
although
the limited
evidence
available
suggested
that they may be
more prevalent.
This is especially'
the case for teachers,
whose
summer vacations
offer the opportunity
t0r secondary'
.jobs, and for police
and fire fighters,
for whom dual careers
are the norm because
of earh"
retirement
provisions.
In future years, the total magnitude
of the windfalls
will be affected
bv recent
legislation
that covers
federal
workers
under
Medicare,
211
beginning
in 1983. In the immediate
future, the effect will be to increase the windfalls,
because
even shorter-than-normal
periods of
coverage will provide Medicare eligibility.
Although the regulations
have not yet been released, early indications
are that as little as one
month's
coverage
will result in benefit entitlement.
For a regular
worker retiring in 1983 at age sixty-two, thirty-two
quarters
of coverage would be required. Federal workers eligible for retirement
without the required
quarters
of coverage, it appears,
will have to work
only through
January
1983 to become entitled at age sixty-five. In
the long-term,
the measure will reduce Medicare windfalls for federal
annuitants,
but it does not apply to other noncovered
groups.
Estimates
of contribution
gaps for workers with short periods of
noncovered
service who do not qualify for noncovered
pensions were
obtained
by calculating
the part of noncovered
earnings
that would
have to be covered
to establish
parity between
contributions
and
benefits under Social Security.
For workers who spend fewer than
five years in noncovered
employment,
virtually all earnings
would
have to be covered because of the "drop-out"
years in the benefit
calculation.
If a worker spends fewer than five years in noncovered
employment,
there would be little effect on ultimate
benefits, but
lifetime contributions
would be reduced by 10 percent or more. For
workers with more than five years of noncovcred
employment,
only
that portion of exempted earnings has to be counted that would insure
parity between the portion of total lifetime payroll taxes contributed
and the benefits received.
The estimate
of the contribution
gaps for the federal work force
was $576 million, or 1.1 percent of payroll covered by CSRS in 1980.
This same payroll percentage
was attributed
to noncovered
state and
local salaries,
raising the estimate
another $500 million, for a total
loss of $1.1 billion to Social Security in 1980. As the combined
tax
rates rise to 15.3 percent of payroll in 1990, this figure will climb to
$1.4 billion in 1980 dollars. I°
Estimates
of total bonuses suggest that the combined
windfalls
to
dual beneficiaries
and contribution
gaps for current
workers will
exceed $2 billion in 1982. These are costs incurred by Social Security
and borne by the taxpayers
who contribute
to the program.
Options
There
outlined
_°lbid.,
212
for Resolution
of the
Problems
is a wide range of alternatives
for resolving
the problems
above. Some analysts have argued that expanded
coverage
p. 44.
should be encouraged
by means of added incentives.
Voluntary
coverage of workers now exempted
would be encouraged
if Social Securitv revenues were raised whollv or in part through general revenues,
a value-added
tax, or a windfall profit tax on oil companies.
Each of
these options has been suggested
as a potential
source of Social Security funding.
Because
people in noncovered
employment
would
share the burden of these taxes, the incentives
for their voluntary
participation
would be increased.
Although
alternative
sources of
funding
for Old-Age, Survivor,
Disability,
and Hospital
Insurance
have been suggested,
they have been widely opposed to date.
At the state and local levels, revenue-sharing
funds could be made
contingent
on voluntary
Social Security
coverage.
Because retirement systems are not always coterminous
with units of government
eligible to receive such funds, administering
this incentive would be
difficult. Anothcr approach
would be to require that all employment
subsidized
by federal grants-in-aid
be covered. The ultimate
effects,
howevcr,
might be felt not bv state and local employees,
but bv the
people the grant programs
are designed to assist.
The problem
of unintended
benefits could be more directly eliminated bv revising the basic structure
benefit
formula. Because such changes could affect the benefits of almost all
future recipients
of Social Security, however, it is hard to justify them
solely on the basis of reduction
in windfall benefits. Given that such
radical modifications
would be like the tail wagging
unlikely that the desire to reducc windfall benefits
be sufficient
justification
for completely
changing
Social Security.
the dog, it seems
would, by itself,
the structure
of
There are more limited options that deal directly with the Social
Securitv
benefits of persons now exempted
from the program.
These
options leave other aspects of the program
intact and modit\' only
the relationship
of Social Security to workers exempted under current
law. This set of alternatives
ranges from options to eliminate
windfall
benefits, to universal
coverage.
Although there arc several ways to address the problems
that arise
because coverage
is not universal,
the discussion
here will focus on
three sets of alternatives:
(1) mandatory
universal
Social Security
coverage: (2) modification
of the benefit calculation
to eliminate
the
unintended
subsidies;
and (3) proposals
that would reduce Social
Securitv benefits on the basis of the receipt ofa noncovered
employer
pension.
213
Universal Social Security Coverage--Universal
coverage could theoretically
be legislated
and implemented
for the remaining
noncovered segments of the work force. Certain legal or constitutional
questions
would have to be resolved for state, local, and nonprofit groups. Legal
opinion cuts both ways, and legislation
mandating
coverage
would
probably
be tested in the Supreme
Court if it encompassed
these
groups, i i
If a decision were made to mandate
coverage,
certain decisions
would have to be made to determine
the specific groups of workers
to be included.
Coverage could be mandated
for all workers as of a
specific date, or coverage might affect only groups of workers. Workers already participating
in a noncovered
employer pension plan, for
example, might continue to receive their coverage exemptions
as long
as they remained
active participants
in that plan. An intermediate
set of options exists, of course, that could allow continued
exemptions
based on age or service, or a combination
of both at the time coverage
was mandated.
An alternative
would be to have continued
exemptions
based on the time until eligibility
for retirement.
Workers within ten
years of normal retirement
age, for example, might not have adequate
working years left to earn a Social Security entitlement.
The question of equity is the overriding
issue that has given rise
to consideration
of mandating
universal
Social Securitv
coverage.
The financing implications
of coverage were significant
enough, however, that universal
coverage was included in the House Wavs and
Means Committee
version of the 1977 Social Security
Act amendments that was sent to the full House of Representatives,
as discussed
at the beginning of this chapter. The short-term
effects would be more
dramatic
than the long-term
implications.
The short-term
effects of expanded
mandatory
coverage relate almost entirely to the revenue side of the program. Bringing in cohorts
of new workers would not generate new cohorts of retirees for several
years. Bringing in cohorts of current noncovered workers who already
have some years of coverage would increase benefits for workers retiring in the first few years after implementation
but it would also
reduce windfalls.
For such workers who would otherwise
receive a
Social Security benefit, each additional
year of coverage reduces the
amount
of the bonus. Table VII-4 shows estimates
of the increased
outlays that would result
the Actuary of the Social
from expanded
coverage
Security Administration
that the Office of
developed
for the
UniversalCoverageStudy includes a separate legal brief on the issues that would
he raised by mandating coverage for I_ederalworkers, state and local governments,
and nonprofit entities.
liThe
214
,e %
Z_
_'_
_
_=
-
_
_._
_._
_
_.__
__
"_
"_,e_
_=
"-o-_
'_
_ _ _ _ t_ oo _. ""
215
I
U_liversal Coverage Study. The estimates were developed in 1979, and
reflect assumptions
being used at that time for Social Security cost
projections.
More current
assumptions
would change the precise estimate but not their order of magnitude.
Most important,
it is apparent
that expanded
coverage
would result in less than $1 billion
in increased
benefits during the first lour years after implementation.
Table VII-5 shows more recent estimates
of the additional
revenues
that would flow into the trust funds if expanded
coverage were mandated. Coverage of current workers would result in a massive infusion
of new revenues,
beginning
in the first year of implementation
and
continuing
on into the future. Coverage of new workers only would
result in much slower growth in the level of new revenues in the short
term. Implementation
of mandatory
coverage
in 1984 for new entrants into currently
noncovered jobs would result in new revenue of
$700 million for Social Security in the first year and $21 billion during
the first five years. In the context of the total Social Security budget,
these numbers are not overwhelming,
but they begin to add up quickly.
As the late Senator
Everett Dirksen used to say: "A billion here and
a billion there and after a while you are talking about real money."
More rapid implementation
of coverage
and inclusion of current
workers could play a significant
role in the resolution
of the shortterm financing
problems
of Social Security.
There is no practical
reason, for example,
why large portions of the current
federal work
force could not be covered as early as January
1, 1984. Virtually, all
the workers who would be affected already have account numbers.
Most already
have a record of covered earnings
under the Social
Security program. Social Security could certainly
post the additional
earnings
data without any modification
of existing operations.
The
federal government
could provide the needed information
to Social
Security without any major modifications
of its own payroll systems.
In fact, the needed inlormation
is already being provided
to Social
Security but is not being posted.
At the federal level, the only major practical roadblock
to coverage
is the redesign of the CSRS and other federal systems in coordination
with Social Security coverage. The Universal Coverage Study includes
a series of pension plan options coordinated
with Social Security
coverage
that would maintain
the average benefits of the current
CSRS. Because of Social Security's
redistributive
aspect, these options would mean slightly higher benefits
for lower-wage
workers
and slightly reduced benefits for higher-wage
workers. 12Because cov12Universal
216
Coverage
Study,
chapter
5.
_
_
_-_i _¢'_ _ -
L_. _
_
_
_
--
--
,_
_-_ _"
_{_ P_
_
.................
217
erage would mean
warranted
bonuses,
benefits.
the elimination
of unintended
subsidies
or unthere would be some decline in total retirement
At the state and local levels, the time required to implement
mandatory coverage would be somewhat
longer than at the federal level.
A timetable
would have to be developed
for state and local jurisdictions to implement
coverage and to modify existing plans. After enactment
of federal legislation,
the affected jurisdiction
would need
some time to consider and develop a plan for coordination
with Social
Security.
The legislative
bodies would need time to implement
the
new plan designs or to modify existing ones. These modifications
would have to be implemented
within each jurisdiction's
budget cycle. Pension provisions
that are contractual
agreements
would have
to be modified.
For nonprofit
organizations,
there are already
legislative
and fiduciary requirements
that are applicable
to pension plan design, although the extent to which the Employee Retirement
Income Security
Act and Internal
Revenue Service regulations
apply to this sector is
not completely
clear. Many of the employers
that would be affected
in this sector do not now provide
any pension protection
for their
workers, so Social Security coverage would provide such protection
for the first time. No problems
would arise in designing coordinated
pension systems where no systems exist to be coordinated.
Because of differences
in the implications
of mandatory
coverage,
Congress might decide to mandate
coverage only for federal workers
or to mandate
coverage for them before doing so for remaining
noncovered workers. Congress also might choose to cover some existing
federal employees
while mandating
coverage
for new entrants
only
in other affected systems. The infusion of new revenues into Social
Security would still be significant in the short term. Table VII-5 shows,
for example,
that mandatory
coverage of all federal workers on January 1, 1984, would generate
new OASDI tax revenues of more than
$44 billion by 1988. Continuing
the exemption
for federal workers
within ten years of retirement
might reduce that amount by as much
as 30 percent but would still generate
more than $30 billion in the
first five years of mandatory
coverage. Coverage
of state and local
government
and nonprofit
new entrants
in 1985 would add another
$8 billion to $10 billion by 1988. Added Social Security benefits under
such a scenario would be less than $1 billion between 1984 and 1988.
At first glance, the long-term
implications
of mandatory
coverage
may appear less impressive
than the short-term
impact, but careful
examination
indicates
otherwise.
Table VII-6 shows the long-term
218
impact on the Social Security program of the two extreme mandatory
coverage options. The table shows the amount by which payroll taxes
resulting
from mandatory
coverage would exceed new benefits. The
assumed implementation
date is January 1, 1984. Coverage of current
workers would have a significantly
greater positive effect between
now and the end of the century than would phasing in coverage for
new-entrants
only. After the turn of the century, the effect would shift
and the new entrant option would provide a more advantageous
balance. In both cases, however, the seventy-five-year
average excess of
taxes over expenditures
is estimated
to be 0.53 percent of total payroll
for the OASDI program.
The 0.53 percent
may seem insignificant,
but applied to taxable payroll in excess of $1 trillion in 1982, it would
generate
more than $5 billion in added revenues in excess of expenditures.
Mandatory
expansion
of Social Security
coverage
would have a
significant
positive effect on the financing of the program. The shortterm versus long-term
implications
would depend on the inclusion
of workers not currently
covered. Although these results are impressive, it should be understood
that any new revenues accruing to Social
Security have to come from somewhere.
Before considering
the possible sources, we examine two alternatives
to universal coverage.
Modification
o[ the Bene[i't Computation--Modifying
the benefit
computation
lot workers with noncovered
earnings
could eliminate
the unintended
benefits now paid bv the Social Securitv program.
Basically
two options have received serious consideration--the
"average-replacement-rate"
formula,
and the "proportional
earnings"
formula.
The average-replacement-rate
formula corresponds
to the method
for estimating
windfalls
previously
discussed.
Under this modification,
workers with noncovered employment
would
not receive a higher replacement
rate on their covered earnings than
workers whose total earnings
were in covered employment.
Calculating the benefit under this method would require the derivation
of
a phantom
AIME and PIA. In this calculation,
total career earnings
would be tested as though thev were covered. These phantom
values
would be used to derive the intended or "correct"
replacement
rate,
which would then be multiplied
bv the actual AIME to derive the
intended
PIA. The PIA would be adjusted
bv actuarial
reductions
to
obtain the benefit that the annuitant
was intended
to receive under
the Social
Security
program
as designed.
219
TABLE
VII-6
Estimated
Amount by Which OASDI Taxes Exceed
Expenditures, a as a Percentage of Total Taxable
Payroll, after Extension of Coverage Effective on
January 1, 1984, for Selected Calendar Years
1984-2060
Calendar
Year
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
22O
Employees
Pre_nt and Futu_
(Percent)
.88
.87
.87
.86
.85
.84
.83
.83
.81
.80
.79
.77
.76
.74
.73
.71
.69
.68
.67
.65
.64
.63
.62
.61
.61
.60
.56
.48
.40
.33
.29
.27
.26
.26
Affected
Futu_ Hires
(Percent)
.04
.13
.19
.24
.27
.33
.39
.43
.48
.52
.55
.57
.59
.61
.62
.63
.65
.66
.67
.67
.68
.69
.69
.73
.79
.81
.78
.66
.53
.41
.34
.30
.27
.26
Calendar
Year
TABLE VII-6 (Continued)
Employees Affected
Present and Future
Future Hires
(Percent)
(Percent)
25- Year A _,erages
1982-2006
2007-2031
2032-2056
.70
.58
.32
.45
.76
.38
75-Year Average
1982 2056
.53
.53
Source: Social Security Administration, Office of the Actuary.
Note:
The group affected includes federal civil servants and employees of state and
local governments and nonprofit institutions.
qncludes only OASDI portion ot the payroll tax.
This proposal
would reduce the windfalls
provided bv Social Security to workers with periods of noncovered
employment.
Because
it could not be implemented
retrospectively,
it would allow for a slow
phase-in
of the reductions
in benefits from Social Security.
It would
partially
meet the goals of expanded
coverage
and might actually
serve to encourage
coverage of all public and nonprofit
workers not
now covered.
This option would not, however,
completely
eliminate
all future
windfall
benefits
for workers with only short periods of service in
noncovered
employment.
For workers with less than five years of
noncovered
earnings,
the proposal
might provide virtually the same
Social Security benefit as the current formula, but such workers would
continue
to be exempt from paying Social Security
taxes on their
noncovered
earnings. This feature would continue the current pattern
of high Social Security benefits in relation to contributions
for workers with short periods of noncovered
employment.
The effect of this option on Social Security
administrative
procedures would be substantial.
Information
on noncovered
wages is not
recorded on any of the program
record files maintained
bv the Social
Security Administration.
Developing procedures
to include, post, and
verit_v this information
would substantially
add to current workloads.
Such procedures
would also complicate
the benefit calculation
process at the field level. The indexing computations
would be required
for each case in which noncovered
earnings
were included.
This increase in processing
would double the resources required for benefit
calculations
for the cases affected, and might also result in a larger
number of manually
handled
cases.
221
The proportional
earnings
formula t3 is a modification
of the average-replacement-rate
formula
that also attempts
to eliminate
the
contribution
gap resulting from short periods of noncovered
employment. For workers with total work careers of thirty-five years or less
after 1990, this alternative
would result in the same benefit as the
average replacement
rate formula discussed
above. For workers with
more than thirty-five
years of earnings, this option would result in a
smaller Social Security
benefit than the average replacement
alternative.
With a proportional
earnings
formula,
a phantom
PIA would be
calculated
on the basis of total earnings,
consisting
of all covered
earnings
plus all noncovered
earnings
up to the Social Security
maximum
for each year after the effective
date. This phantom
PIA
would be reduced
by multiplying
it bv the ratio of total covered
earnings
to the sum of the total covered and noncovered
earnings
up to the Social
Security
maximum
for each year. The product
would be the actual
PIA on which Social Security
benefits
would
be based. The effect of this alternative
would be to provide workers
with noncovered
earnings
with the same ratio of expected
Social
Security
benefits to covered indexed earnings
that they would have
received
had their full career earnings
streams
been covered.
Like
the average-replacement-formula,
this option would result in a slow
phasing
in of the reductions
in Social Security
benefits, because
it
could only be implemented
on a prospective
basis. This option
would be more effective
than the average-replacement-formula
in
eliminating
the contribution
gaps. It would reduce the benefits
of
a worker
with fewer than five years of noncovered
employment.
There would be no effect on the benefits
of workers with only covered employment,
but the administration
program
would become considerably
more complex.
There have been no estimates
of the effects of either of these modifications
of the Social Security formula
on system costs. If the estimates of the windfalls
to dual beneficiaries
are in the right order
of magnitude,
the average replacement
formula should save the system at least 0.1 percent of payroll in the long term. Likewise, if the
estimates
of the total unintended
benefits are close to being correct,
the proportional
earnings formula could save as much as 0.2 percent
of payroll. If the estimates are as conservative
as the previous section
of the paper suggests,
the proportional
earnings
formula might ul)3This is the proposal
advocated
Social Security,
Social Security
191-192.
222
in the final report of the National
in America's
Future (Washington,
Commission
on
D.C., 1981), pp.
timatelv save as much as 0.3 percent of payroll. These would be longterm savings, though. The early-year
savings would be minimal because Social Security cannot obtain noncovered
earnings before 1978.
Although
Social Security now receives such data annually,
noncovered earnings
are not being posted to administrative
records. More
important,
the contribution
gaps are caused bv worker mobility, most
of which occurs among young workers early in their careers. These
proposals
cannot capture the foregone contributions
until retirement
benefits commence,
many years in the future. In contrast, mandatory
coverage of new entrants
only, would close most of the contribution
gaps very quickly, because the majority of current workers who will
leave noncovered
employment
without being entitled
to a pension
will do so in the next five years.
O_setting the No_zcovered Pension Benefit--In
May 1981, the Reagan
administration's
Social Security
proposals
aimed at reducing
the
unwarranted
bonuses included a public pension offset. This strategy
would involve determination
of whether a person eligible for Social
Security
benefits is also eligible for a retirement
benefit from noncovered employment.
If so, the Social Security benefit would be reduced. During 1981, the Social Security benefit formula provided 90
percent replacement
of the first $211 of the AIME, 32 percent of the
next $1,063 of AIME and 15 percent of AIME in excess of $1,274. The
administration's
proposal called for reducing Social Security benefits
for beneficiaries
of these pensions bv providing
only 32 percent of
the first $211 of AIME subject to the benefit reduction
not to exceed
50 percent of the pension amount. The difference
between 90 and 32
percent replacement
of $211 of AIME is $122.38 monthly.
Under this
proposal,
the offset would be computed
on the amount of the monthly
pension at the time the worker becomes concurrently
entitled
to a
Social Security
benefit and a pension based on noncovered
employment. If the pension benefit exceeded $245, the full offset would apply.
If it were less, the offset would be half the monthly pension benefit.
Dependents
benefits, maximum
family benefits,
reductions
due to
age, and other calculations
would be based on the new PIA after the
reduction
due to the offset. This recommendation
has a precedent
in
that the Social Security
benefit for a man receiving
a benefit as a
spouse is now reduced dollar for dollar if he is also receiving a public
pension for noncovered
employment.
After December
1982, this provision will also apply to women.
Unlike many of the windfall reduction
proposals
that call for direct
modification
benefit formula,
pension offset
223
plans would not require a long phase-in period. Because the reductions could be implemented
immediately,
however,
there could be
larger benefit differences
for persons becoming
entitled
at slightly
different
points in time, even though they had similar career and
earnings
patterns.
A public pension offset could be viewed as introducing a means test into the determination
of Social Security benefits. Persons with comparable
covered earnings would receive different
Social Security benefits according
to the amount of their noncovered
pension, and pension amounts
paid by different public employment
retirement
systems on a given earnings
history could vary significantly, depending
on their benefit computation
rules.
A public pension offset would have no effect on the Social Security
benefits of workers who do not become entitled to a noncovered
pension. This feature would perpetuate
the advantageous
treatment
of
workers with short periods of noncovered
employment
who benefit
from the contribution
gap. This particular
pension offset proposal
would not address the windfall
benefits of annuitants
who receive
small public pension amounts because of short periods of noncovered
employment.
Administratively,
a public pension offset would be simpler
than
the average-replacement-rate
or proportional
earnings formula modifications.
The biggest problem would be the verification
of the pension amount
by the noncovered
employer.
The IRS tax form W-2P
contains
the worker's Social Security number
and the pension paid
and is provided
to the Social Security Administration.
A system interface could be developed
that would match W-2P reporting
information with Social Security's
master
beneficiary
record system to
allow the computation
of the appropriate
offset. For this interface
to
work, IRS would have to require reporting
of all public pension income on the W-2P form, which it does not now do, and would need
to add some indication
of whether the pension was based on earnings
not covered by Social Security.
The short-term
effect on Social Security
financing
would be negligible because the proposal would affect only persons who retire after
the implementation
date. The Social Security Administration
estimates the long-term
effect on financing at 0.1 percent of payroll.
The Effect
Recipients
of Eliminating
the Unintended
The options for reducing
the unintended
all have a positive effect on Social Security
224
Benefits
on
Social Security benefits
financing.
In the short-
term, the pension offset and formula modifications
would have little
effect. The tull effect of the pension offset on specific individuals
could
be immediate,
but it would be years before all existing dual beneficiaries would be replaced by retirees affected bv the proposal. Phasing
in the formula modifications
would occur even more slowly. Because
historical
data on noncovered
earnings
are not available,
it would
take years before specific individuals
would feel the full effects of the
proposals.
This fact, in conjunction
with the fact that the proposal
would apply only to future retirees, suggests that the impact on shortterm financing
issues would be insignificant.
Coverage, of course, has
the largest effect on the short-term
financing
situation.
Coverage of
currently
exempted
workers has the most significant
and immediate
effect. Even covering
new entrants
onlv is far more effective from a
short-term
Social Security
financing
perspective
than the alternatives to expanded
coverage.
The major problem with the options that have been discussed
thus
far is that each has certain costs that someone must bear. Reducing
the Social Security
benefits to account for noncovered
earnings
or
pension benefits would place the costs of windfall elimination
directly
on the worker alone. For persons receiving
benefits
from pensions
resulting
from noncovered
employment,
reductions
in Social Security
benefits would probably
not result in offsetting increases
in pension
benefits. For persons withdrawing
completely from such pension plans,
these options would either reduce ultimate retirement
income or have
no effect on the unwarranted
bonuses. Adjustments
of Social Security
benefit levels would not resolve the problems
of gaps in insurance
protection
that now exist in systems that do not provide Social Security coverage. But, Social Securitv coverage would probably result
in some redistribution
of retirement
benefits and might affect the
magnitude
and incidence
of retirement
costs.
It is clear which persons will bear the burden of benefit reductions
if windfalls
are to be reduced or eliminated.
The costs of expanded
coverage
warrant
closer examination
because, the issues varv with
the groups of workers being considered.
The
Cost
of Coverage
for Federal
Workers
Advocates of mandatory
Social Security coverage of federal workers often focus on the beneficial effects for Social Securitv. Critics of
mandatory
coverage, in contrast, argue that covering federal workers
will raise the cost of federal civilian retirement
programs and threaten
the viability of their retirement
trust funds. This section analyzes the
225
potential effect that Social Security coverage of federal workers would
have on the cost of the federal Civil Service Retirement
System and
the federal budgetary
effect of such a measure.
In order for a discussion of this sort to be meaningful,
it has to be concrete. This analysis
focuses on an option--IV-A--discussed
in a recent report issued by
the Congressional
Research
Service. 14 Option IV-A was chosen because it closely parallels
the plan included
in legislation
recently
introduced
by Senator Ted Stevens.
The analysis assumes that all workers hired for federal civilian jobs
after January
l, 1983, would be covered by Social Security and by a
plan that would be financed solely by employer
contributions.
This plan would provide contributions
of 9 percent on
the first $20,000 of salary and 16 percent above that. The $20,000
would be indexed
by increases
in the general wage schedule
over
time. In addition
to the basic benefit, a supplemental
thrift plan
would also be available
for workers covered under the new plan. This
plan would allow the employee to contribute
up to 6 percent of salary
into the plan and would be fully matched by the employer.
The Stevens bill would fully match employee contributions
up to 3 percent
of salary. This element
of the Stevens bill would reduce the cost
estimates
presented.
However,
the Stevens bill would also provide
contributions
based on military service, raising costs compared
with
the option considered
here. The option discussed here and the Stevens
bill would also modify the federal employee sick leave and disability
program
to coordinate
The cost of CSRS can be considered
from different perspectives.
One common
way to estimate
the cost of a retirement
program is to
use what actuaries
call the "entry age normal cost method."
This
method estimates
the percentage
of a worker's salary that would have
to be set aside each year to fully fund benefit entitlements
by retirement. Aggregating
the normal cost of all workers provides an estimate
of the employer's
total normal cost. As with most estimates,
the normal cost estimate is sensitive to the assumptions
on which it is based.
Table VII-7 uses two different sets of economic assumptions
to estimate the normal cost of the current
CSRS program.
The greatest
variance in assumptions
for the two estimates
is in inflation, although
the inflation/interest
differential
is most significant
in explaining
the
variance in the normal cost estimates.
The real interest rate, or return
14Congressional Research Service, Restructuring the Civil Sen,ice Retirement System:
Analysis of Options to Control Costs and Mamtai_zRetirement hlcome Security (Washington, D.C.: U.S. Government Printing Office, 1982).
226
TABLE VII-7
Effect of Economic Assumptions
on Civil Service
Retirement System Cost Estimates
CSRS Board of
Actuaries
Social Security 1981,
II-B
Interest
Rate
(Percent)
Wage
Growth
(Percent)
Inflation
Rate
(Percent)
Normal
Cost
(Percent)
6.0
5.5
5.0
36.46
6.1
5.5
4.0
31.23
Source: Congressional Research Service, Restructuring the Civil ServiceRetirement Svstern: Analysis o[ Options to Control Costs and Maintain Retirement Income
Security (Washington, D.C.: U.S. Government Printing Office, 1982), p. 50.
on assets under the 1981 Trustees Report II-B assumptions,
is twice
that under the Board of Actuaries'
assumptions.
Higher interest rates
raise investment
income over time and increase the degree to which
the trust fund supports benefits.
Since employees
covered by CSRS contribute
7 percent of salary
to the retirement
program,
the cost of the program
to the employer
(i.e., the government)
cost is 29.46 or 24.23 percent of payroll, depending on which set of assumptions
is used. Since this discussion
is focusing
on Social Security
coverage
costs, the Social Security
assumptions
are used for the remainder
of the discussion.
The normal cost measure is a useful concept because it gives a good
perspective
on the generosity
of the retirement
program
in comparison with pensions
established
by other employers.
For example, in
the private sector, employer
normal costs for retirement
programs
generally
run about 7 to 12 percent of payroll on top of Social Security. The normal cost is also useful because it is indicative
of the
portion of lifetime benefits paid to workers in the form of deferred
retirement
income. The projected
employer
cost of the defined contribution
plan analyzed
here is 14.50 percent of payroll. 15 By comparison, the projected
employer cost of the Stevens proposal is 14.49
percent of payroll. Including
the employer OASDHI contributions
at
the ultimate
rate of 7.65 percent
now legislated
would raise total
employer
cost for the modified federal retirement
program
to 22.15
percent
of payroll--substantially
less than the cost of the current
system.
_Slbid.,p. 53.
227
An alternative
way to evaluate
the cost of CSRS is to look at the
cost on a budget basis. This is useful because it reflects the relative
cost of federal retirement
for taxpayers
and participants.
Figure VIII pictorially
represents
the operation
of the CSRS during fiscal 1980.
The budget box represents
the total federal budget components
of
the CSRS. It includes the off-budget
Postal Service. The first inner
box represents
the unified budget. The arrows represent
the budgetary flows relevant to CSRS. All transactions
that cross the outermost
box affect the total cost of CSRS. Transactions
crossing the largest
interior box affect the unified budget.
FIGURE VII-I
Flow of Funds
Related to the Civil Service
System, 1980
Employee
Postal
Contributions
Retirement
Contributions
($3.60 Billion)
($1.49 Billion)
UNIFIED
BUDGET
\
GeneraI Revem_e._
Agency
"_
CSRS
F.nd
CoMributions
($2.85 Billion)
Direct
Appropriations/
Transfers
Interest
($11.23
Billion)
on Investments
($4.9 Billion)
Annuities,
Refunds.
($14,78 Billion)
Source:
228
Budget
flows
1982, appendix
taken
from
p.l-V118.
Budget
o[
the
United
States
Government
Expenses
Fiscal
Year
The implication
of this depiction
is that most of the funding of
CSRS is internal
to the unified budget. Even the Postal Service contributions
fall conceptually
within the unified budget framework.
If
the United States Postal Service (USPS) increased
its contributions,
higher postage
rates or general revenue support
of that off-budget
account could result. In either case the cost would be borne by the
public. In terms of total federal outlays in 1980, benefits and refunds
amounted
to $14.78 billion while employee contributions
were $3.60
billion. The 1980 USPS contribution
was split between the normal 7
percent agency contribution
($775 million) and the obligations
($714
million) vis-a-vis unfunded
liabilities.
Since USPS is off budget, its
contributions
do affect the unified budget net costs of the program
but not total outlays from the taxpayers'
perspective.
In short, the
taxpayer
cost of CSRS is equal to total benefits plus contribution
refunds minus employee contributions.
In 1980 this was $11.18 billion
($14.78 billion minus $3.60 billion).
The example also raises another important
point in regard to funding CSRS liabilities.
Much concern has been voiced over the unfunded
liabilities
of CSRS. The total liabilities
of the system exist because
of the statutes
that define the program.
To the extent the system
holds government
securities as its funding instruments,
it has a contractual
promise from the government
(IOUs) that certain resources
will be available
to meet benefit payments
as required.
The unfunded
liabilities,
in contrast,
arc statutory
promises
that have arisen because benefits
accrued under the law have not been matched
by a
comparable
pool of assets (i.e., government
IOUs). Converting
statutory liabilities
into contractual
obligations
would not affect benefit
levels because they are separately
defined by statute. The important
point is that there be a funding mechanism
available
to meet these
benefit obligations,
as they come due. Even though the current system
has sizable unfunded
liabilities,
the current funding method assures
benefits for the foreseeable
future.
The budgetary
process would allow more rapid funding of CSRS
liabilities
than now occurs without having an adverse effect on taxpayers. Although an added annual contribution,
say $20 billion, would
be an increase
in general
revenue
expenditures,
that contribution
would be exactly offset by an increase
in CSRS income. The U.S.
government
would increase
its bond issues (i.e., the debt level) by
$20 billion, but these would be offset by a $20 billion increase
in
CSRS funds. In the future, the interest on the additional
debt would
have to be paid to the trust fund, but current
law requires
interest
229
payment
on the unfunded
liabilities.
There would be no practical
impact on the taxpayers.
This is not to suggest that CSRS should be funded instantaneously,
or that the unfunded
liability should be ignored. The presence
of a
fully funded system could well lead to pressure for benefit increases,
which would, in turn, increase the taxpayers'
cost. Yet the unfunded
liability
is a real cost that will eventually
have to be covered. The
important
variable to consider
is what it would cost to modify the
current
system. The foregoing discussion
suggests that CSRS budgetary effects could be described
by the following formula:
(I) CSRS Budgetary
Cost = benefits plus refunds minus
employee contributions.
Table VII-8 shows the long-term
projected
budgetary
costs of the
current
CSRS if the program
is not modified. 16
The budget
is also affected by Social Security
windfall
benefits
paid to persons covered by CSRS. The annual magnitude
of these
windfalls
for federal workers and annuitants
was estimated
earlier
in this chapter to have been roughly $1 billion in 1980. Because the
current
system gives rise to these Social Security
windfalls,
they
should be considered
as raising the cost of the current system. While
the costs of these windfalls
should be considered
as part of the total,
they are not included
in the estimates
of the current system's
cost
for comparisons
with the modified
system. They are not included
because
the Stevens bill does not provide for explicit windfall
reductions.
The Stevens bill would, however, gradually
eliminate
the
windfall phenomenon
for federal workers and result in real savings
to taxpayers.
The particular
method for modifying
the system analyzed
by the
Congressional
Research
Service and included
in Senator
Stevens's
bill calls for Social Security coverage
coordinated
with a modified
federal pension for new federal employees
beginning
in 1983. That
means that the ongoing costs of the total system have to be estimated
separately
for the closed system that applies to old hires, and for the
new system covering
future employees.
The budgetary
costs of the
separate
systems can be aggregated
to get the combined
systems cost.
The total budgetary
impact of modifying CSRS would be different
from the effect on the various accounts
taken separately.
Both CSRS
I_See Sylvester
J. Schieber,
Sen, ice Retirement
System
of the derivation
of these
230
The Cost and Funding Implications
o['Modif_ving the Civil
(Washington,
D.C.: EBR1, 1982) for a complete
discussion
estimates.
TABLE
VII-8
Federal Agency and General Revenue Expenditure
Projections for the Current Civil Service Retirement
System and Modified System in Conjunction with
Newly Hired Workers Under Social Security, Selected
Years, 1983-2050
Current System
(Billions)
Modified System
(Billions)
$ 17.9
20.0
22.4
24.3
26.3
28.4
30.3
32.3
34.2
42.4
54.5
70.8
93.2
122.4
161.8
212.6
277.7
360.0
465.7
604.1
786.7
$ 17.7
19.2
22.2
24.1
26.1
28.1
30.1
31.7
33.7
41.7
54.7
68.1
86.1
102.9
130.8
167.3
211.8
273.6
360.3
499.2
683.6
1983
1984
1985
1986
1987
1988
1989
1990
1991
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
Source:
and
Net Savings
(Billions)
$
0.2
0.1
0.2
0.2
0.2
0.3
0.3
0.6
0.5
0.8
- 0.2
2.7
7.1
19.5
31.0
45.3
65.9
86.4
105.4
104.9
103.1
Svh'ester J. Schieber, "The Cost and Funding Implications of Modifying the
Cixil Service Retirement System," (Washington, D.C.: EBRI, August 19, 1982),
tables 2, 6, and 8.
Social
Security
arc
now
within
proposal
analyzed
here would
costs for the various
accounts
(2) Closed
CSRS
(3) New CSRS
(4) Social
Costs
Costs
Security
-
the
unified
budget.
Because
the
segregate
the old and new systems,
can be considered
as follows:
the
benefits (old) plus refunds
employee
contributions.
= benefits (new) plus refunds
employee contribulions.
Costs
- benefits (SS) ittim_s
contributions.
mi_uLs
minus
employee
231
(5) Total Budget Cost - old CSRS cost plus new CSRS cost
plus Social Security cost. _7
Equation
(2) is essentially
the same as equation
(1) discussed
earlier, which applies to the current system. The difference is that equation (2) applies only to those workers on the payroll or persons entitled
to CSRS benefits
(receiving
or deferred)
on the assumed
date the
modified
system would be put into operation.
Equation
(1), in contrast, assumed that future new workers would continue to be covered
under the current system. Equation
(3) represents
the budgetary
cost
of the new federal retirement
program.
Equation
(4) shows the budgetary
effects of Social Security coverage of new hires. The budgetary
effect is different
from the effect
on the OASDHI accounts,
in that the specific account would be credited for both employer and employee contributions.
Since Social Security is in the unified budget, the employer contribution
would show
up as an expense in the agencies'
budget and as equal trust fund
income in the Social Security accounts.
The two would cancel each
other out.
If Social Security is taken out of the unified budget it would change
the analysis conceptually
without affecting the practical
result. For
example,
if Social Security were an off-budget account, the employer
contribution
would show up as a real budget expense. The contribution would show up as income to an off-budget account. The budgetary and off-budget accounts
would both still be federal accounts,
however.
While taking Social Security off budget would change the
bookkeeping,
it would not change the overall fiscal position of the
federal government
if coverage were extended
to federal workers.
The total budgetary
costs, modifying CSRS as considered
here, can
be calculated
according
to equation
(5) and compared
with the cost
of the current system derived on the basis of equation (1). Table VII8 shows the projected
budgetary
cost of the current
system and the
proposed
modified system and the net differences.
Based on the projections,
moving to the modified
system on January
1, 1983, would
reduce the budgetary
costs of federal retirement
by $1 billion over
the first five years. While the cost savings during the early years would
be moderate
in relative terms, the actual numbers
that would show
up in the unified budget might be affected by moving accounts
in or
out of the budget. This would not affect taxpayer
costs for federal
retirement,
however.
17SeeSylvester J. Schieber. Tile Cost and Fmldml¢ Implication,s olModil),i_l_ the Civil
Sera,iceRetirement System (Washington, D.C.:EBRI, 1982)10r the detailed proiections
of the component eiements of each o1 these equations.
232
The Stevens legislation
would cover newly hired workers mandatorily and offer incentives
for current
workers to move to the new
system. The savings from modifying
CSRS in accordance
with this
proposal would grow significantly
after the turn of the century as the
federal work force becomes predominantly
covered bv the new system. Ultimately,
the savings would grow to nearly one-quarter
of the
current
system's
cost if it were to be perpetuated.
The net savings
estimates
of moving to the modified system do not include any savings
that could be realized if a Social Security windfall reduction
provision for old hires were implemented.
For example, Congressman
J. J.
Pickle, Chairman
of the Social Security Subcommittee
of the House
Ways and Means Committee,
has suggested
legislation
that would
reduce future windfalls
for persons
not covered by Social Security
for some portion of their career. His proposal would reduce the benefit
derived under the current formula to that percentage
of total lifetime
earnings
in covered
employment.
If such a proposal
were implemented
in 1983, the total savings would be small. However,
if one
assumed
that windfalls
were reduced at a rate of 2 percent per year,
additional
savings could be as much as $100 million by the mid 1980s
and rise to more than $1 billion by the turn of the century. The Social
Security
actuaries
have estimated
similar savings. They estimated
the Pickle proposal would save $100 million in both 1985 and 1986,
and average 0.05 percent of total Social Security covered payroll over
the next seventy-five
years.
The net cost increase
in the proposed
system around the turn of
the century,
shown in table VII-8, is the result of modification
to
vesting provisions under the new plan. By that time, significant
numbers of terminating
workers will be rolling their vested benefits into
alternative
retirement
vehicles as they leave federal service. If the
proposed
modification
of the new system were made in conjunction
with a windfall reduction
proposal,
the cost savings that would result
from modifications
to the CSRS would be significantly
greater than
those shown in table VII-8.
In sum, modifying the CSRS along the lines of the option analyzed
here, or the Stevens proposal,
would result in significant
budgetary
savings over both the short and long term. Coverage
of new hires
under Social Security
would maintain
the level of employee
contributions for retirement
purposes. In a budgetary
sense then, any proposal coupled
with Social Security
coverage that just maintains
or
does not increase
total federal retirement
benefits cannot cost the
taxpayers
more
than the current
system.
233
The Stevens bill includes a "grandfathering"
provision which seeks
to maintain
the "implied contract"
between the employer and current
employees.
This provision would continue to cover all current workers under the current
CSRS unless they voluntarily
joined the new
system. The Supreme
Court has held that the current
system is not
a legal obligation
but a gratuity.
Congress has repeatedly
modified
the system over the years. The question that Congress will have to
face in the future is whether
the "implied
contract"
with its own
workers who are only twenty, thirty, or even forty years of age is not
subject to change during a period when the "implied
Social Security
contract"
is being changed for the general populace.
The CSRS could be closed for substantial
numbers of current federal workers.
Their earnings
replacement
accruals
to date could be
frozen and applied against their final average salaries when they are
eligible to retire. Their future accruals
would accumulate
under the
new plan, thus making the transition
to the modified system far more
gradual
than under the Stevens proposal.
Although the federal retirement
program
would still be comparatively generous, the costs of federal pensions would not rise as a result
of Social Security coverage unless retirement
benefits rose. The elimination of the unintended
benefits now provided
by Social Security
would provide a net savings to the taxpayers
who support the federal
retirement
programs.
Analysis by the actuary of the Office of Personnel Management,
provided
to the Universal
Coverage Study group,
indicated
that existing CSRS financing measures
would keep the federal retirement
program
solvent through a transition
to Social Security coverage. Solvency could be achieved if coverage were extended
either to current workers or only new hires for any of the coordination
models they considered.
The Stevens proposal has explicit transition
provisions
to do so.
The Cost
The state
of Coverage
for State
and local situation
and
Local
is different
Workers
from
the federal
case in
several respects. To identify the implications
of mandatory coverage,
the Universal Coverage Study group commissioned
an actuarial analysis of several state and local plans. A constant-benefit
concept was
posited at this level as a reasonable constraint
in designing modified
pension plans in coordination
with Social Security coverage.
The
concept was that initial benefits at retirement provided by the current
system should be matched by the modified system. There was a major
problem in putting this concept into operation, because the state and
234
local plans do not index benefits at levels near recent increases
in
the consumer
price index, as Social Security and CSRS do. The typical state or local plan provides a capped cost-of-living
adjustment
of as much as 3 percent per year, and more generous
plans provide
5 percent
increases if the CPI exceeds that level.
When the Universal Coverage Study group specified the dimensions
for their constant-benefit
plans, they stipulated
that the modified
plans coordinated
with Social Security should provide benefits equal
to the current
plan in the first years of retirement
for the average
retiree. Because Social Security would provide a more fully indexed
benefit than the portion of the pension benefit that it was replacing,
the coordinated
retirement
program
would significantly
increase lifetime benefits if this approach
were used in actual plan design. This
effect can be seen in table VII-9, which shows the present values of
benefits
at retirement
for a typical worker under a set of existing
plans. The table also shows the value of benefits for a set of coordinated plans using the first-year constant-benefit
design concept.
In
both cases the value of benefits are shown under two inflation assumptions.
Employee
turnover
rates are also important
in determining
the
potential
effects of Social Security coverage on pension costs for systems that are not covered. One high-turnover
plan discussed
in the
Universal Coverage Study, for example,
had a normal cost of 10.9 percent of payroll. If turnover,
except for death, disability,
and retirement, were eliminated
from this plan, the normal cost would be 18.8
percent
of payroll. In contrast,
a plan with very low turnover
had a
normal cost of 19.1 percent of payroll, which rose to only 21.1 under
the assumption
that all employees
stayed to draw a benefit.
The
system's
costs, in short, are reduced
as a result of turnover.
Social
Security
tax payments,
of course, are not refundable.
Part of the
savings that noncovered
systems now experience
as a result of turnover would be eliminated
if coverage were mandated.
The Universal
Coverage Study estimated
that this added cost would range from 0.3
percent of payroll for low-turnover
plans to 3.9 percent of payroll for
high-turnover
plans. _
The Universal Coverage Study also found that some noncovered
public systems pay the Part A Medicare premiums
for their annuitants
who have not acquired
Medicare
coverage
on the basis of covered
I_Universal Coverage Study, pp. 210-211.
This is the reason
are withdrawing
from Social Security
and substituting
ported to be as generous
but at a much lower cost.
that some
retirement
employers
programs
today
pur-
235
mmbm_b__m
U
_
N
=
236
_ s E
--__
__.-
_---__
_
_
_._
,
m_
237
employment.
Their evidence showed, however, that most noncovered
state and local employees
do become eligible for Medicare, although
they contribute
nothing to the program
from their noncovered
earnings. For this reason, coverage would add more than 1 percent to the
payroll costs of many of the affected employers,
who would get negligible increments
in benefits in return. Iv
Social Security coverage would also result in higher survivor benefits than those provided by many noncovered
state and local systems.
Surviving spouse's benefits after retirement
are often available
if the
annuitant
takes a reduced annuity with the survivor option, but many
systems simply refund the employee's
contribution
to the heirs of any
worker who dies before retirement.
2°
Each of these considerations
suggests that mandatory
Social Security coverage
for noncovered
state and local governments
would
raise retirement
program costs. The Universal Coverage Study group
undertook
two independent
efforts to estimate
the costs of coverage
for noncovered
plans. The first was a study conducted
by the Actuarial
Education
and Research Fund (AERF), which had actuaries for twentyfive noncovered
employer
plans estimate
the costs of coverage. The
second was conducted
through an interagency
study sponsored
by
the Department
of Housing and Urban Development,
which had provided a grant to the Urban Institute to analyze several facets of public
pension policy. The Urban Institute
contracted
with Howard Winklevoss and Associates of Philadelphia
for an analysis of the implications of coverage
for twenty-one
large noncovered
state and local
pension plans.
Both studies showed
that the total pension costs of noncovered
systems would increase significantly
if Social Security coverage were
extended
to these systems. 21 The AERF estimates
for large plans suggested greater increases
than the Winklevoss
estimates.
The reason
is that the latter study designed coordinated
plan benefits that would
replicate
first-year
retirement
benefits
for an average retiree. The
AERF study, in contrast, attempted
to replicate first-year benefits for
the modal group of annuitants.
The result was that benefits were
being matched
for workers with salaries significantly
above mean or
median
levels. 22 In both cases, the matching
of first-year
benefits
would lead to significantly
higher lifetime benefits under a coordiIgUniversalCoverageStudy, p. 21 I.
2°UniversalCoveragestudy, p. 188.
2_The summary results of the AERF analysis are shown in table VII-lO; summary
estimates from the Winklevoss analysis are in table VII-11.
22UniversalCoverageStudy, p. 214.
238
nated system
benefits.
because
of the greater
indexation
of Social
Security
The Universal Coverage Study concluded
that the net effect of coverage on combined
employee-employer
pension costs under the constant-benefit
formulas would range from 5 to 10 percent of payroll.
The summary
results of these cost estimates
are shown in tables VII10 and VII-1 i. It is hard to project how these cost increases might be
shared on a nominal basis. Employee contributions
are more common
to public defined-benefit
pension plans than to their private-sector
counterparts.
Among public plans that already have Social Security
coverage, the norm for employee contributions
is 4 percent of salary
to the pension in addition to the employee share of the Social Security
payroll tax) 3
A fundamental
question pertinent
to this issue is whether state and
local jurisdictions
would modify their plans in response
to Social
Security coverage in the way hypothesized
in the report. The answer
is that they probably would not. They might attempt to "grandfather"
current
workers who were affected bv a coverage
measure,
but it is
highly unlikely that pension plans would be redesigned
to provide
more generous
retirement
benefits for workers who have not vet been
hired. If anything,
recent modifications
to public pension plans have
aimed at reducing benefits. Specific recent cases where such redesigns
have taken place include the Indianapolis,
New York City, San Francisco, and Maryland
State retirement
systems. In three of the four
cases, the plans allowed current
workers to opt into the new, less
generous
plan by providing
financial
incentives.
Maryland,
for example, changed from a contributory
to a noncontributory
(but less
expensive)
plan. To encourage
workers to transfer credits from the
old plan to the new, rebates of employee contributions
under the old
plan plus interest were offered in exchange for new service credits.
The transition
issue might also cause particular
problems
for some
state and local systems. The budgetary
issues discussed for a coverage
transition
for federal workers also apply to state and local systems.
At the federal level, however, pension financing
occurs at the same
level of government
as Social Security financing.
If benefits were the
same after coverage as before, there would be no budgetary
effect. At
the state and local levels, the pension benefit stream would not be
immediately
reduced
because
of mandated
coverage.
The affected
jurisdiction
would have to continue meeting pension payments
while
simultaneously
forfeiting
revenue
from employee
contributions,
in
23Ibid.. p. XV.
239
TABLE
VII-10
Normal Cost of Current Plan Compared with Normal
Cost of Constant Benefit Step-Rate Plus Social Security
Payroll Taxes
Current
Plan
(Percent)
Plan a
Large Plans (1,000 or more
Constant Benefit
Plan
(Percent)
Combined Benefit
Plan
Plus 15.3
Combined
Social Security
Payroll Taxes
(Percent)
members)
H 1- t
11.89
(1)
5.21
(2)
20.51
H2
H3
H4
H5
H6
14.83
16.81
16.27
12.72
18.92
8.95
8.84
5.84
6.61
9.26
24.25
24.04 b
21.14
10.95 h
24.56
7.82
14.39
15.68
5.34
6.75
7.93
20.64
20.95 b
23.23
12.98
11.08
6.06
10.19
10.86
9.80
10.11
18.60
28.28
26.38
21.36
25.49
23.52 b
25.00 t'
25.41
33.90
19.20
34.50
11.04
8.10
17.33
8.89
23.78
25.24
26.34
23.40
32.63
24.19
39.08
40.54
18.59
33.89
-
p,f
g,t,p,f
g
g
t
LI - g
L3 - g
L6 - g
Medium-Size
M1 - p
M2 - g,p,f
M3 - p,f
M4 - p
M5 - g,p,f
M6 - g,p,f
M7 - f
M8 - f
Plans ( 100-999 members)
20.91
19.87
12.11
19.15
19.68
19.73
16.09
30.06
M9 - p,f
Small
Sl
S2
$5
$6
T!
T3
-
Plans (Less than
p
p,f
p
p
p
f
T4 - p,f
Source:
23.13
100 members)
17.87
13.66
22.72
17.51
31.58
38.50
23.90
Universal Coverage Study, report of the Universal Social Security Coverage
Study Group (Washington, D.C., March 1980), table 6-23, p. 194.
_'ln this coding, f = Fire Fighter plans, g = general public employee plan, p = police
plan, and t - teacher plan.
_'Combincd Social Securitv taxes arc somewhat below 15.30 percent of salaries above
the wage base.
240
TABLE
VII-I 1
Normal Cost Versus Constant-Benefit
Plan
Plus Social Security Taxes for Selected
Employee Retirement Systems as a Percentage
of Payroll
Current
Present Plan's
Normal Cost
(Percent)
Assumptions a
Constant-Benefit
Plan's
Normal Cost Plus
Social Security Taxes
(Percent)
Employees'
Plan No.
80
120
140
260
620
675
685
735
830
980
995
17.1
12.4
10.9
12.0
13.5
13.6
12.2
15.3
10.5
12.2
17.5
23.6
20.5
20.0
19.6
23.9
20.1
19.5
22.5
15.6
20.4
22.1
Fighters' Plan No.
560
600
760
975
990
17.8
16.2
31.2
18.1
33.8
26.7
27.8
33.7
29.0
43.3
16.3
9.9
15.0
9.1
15.5
21.6
25.0
18.1
24.5
17.5
24.0
24.2
400
440
490
500
510
970
Coverage Study, report of the Universal Social Security Coverage
(Washington, D.C., March 1980), table 6-26, p. 197.
taxes include 15.30 percent combined employer and employee
Estimates reflect plan actuarial assumptions. Plans shown arc
Social Security.
Income Security Act forty-year amortization of untunded liaboth cases.
241
many cases, and meeting employer
payroll tax liabilities.
Where the
old system is fully funded, this problem may not be serious because
(1)current
benefits
would be paid out of the pension
fund and
(2) contributions
to the pension fund could be reduced because liabilities would accrue less rapidly under a plan modified
in coordination with Social Security coverage. Where the plan is financed on
a pay-as-you-go
basis, the implications
would he substantial.
The
jurisdiction
would have to finance current
benefits from its current
budget while also paying any payroll tax liabilities that would result
from coverage.
From a strictly fiscal perspective,
a set of financial incentives
could
be devised to encourage
state and local jurisdictions
to cover current
workers. If newly covered state and local jurisdictions
were mandated
to cover current
workers, for example,
it would be possible to give
the employer a break on the payroll tax for some period to help meet
the transition
costs to coverage. Table VII-12 shows the effects of
covering
all state and local workers beginning
in 1985 if the full
payroll tax is collected. The table also shows the effect if newly covered employers
were given a five-year holiday from paying their share
of the payroll tax. It is clear from the table that it would be to Social
Security's
advantage
to cover current state and local workers, while
giving the newly covered employers
a temporary
financial
break on
the payroll tax to help meet the costs of transition
from noncoverage
to coverage.
In fact, it would be possible to go even further and,
starting
in 1990, phase in the employer
portion of the payroll tax.
The employer
could be required,
for example,
to pay 1 percent
of
payroll in 1990, 2 percent in 1991, and so forth until the full payroll
tax burden was met. Such financial incentives
would result in greater
added revenues for Social Security in the short term than the revenues
that would result from covering
new employees
only. Such a plan
would also make the prospects
of coverage
more palatable
for the
affected jurisdictions.
The major potential
problem with this approach
is that jurisdictions that were already covered might complain
that they were not
offered similar incentives.
However,
considering
the relatively
low
levels of the payroll
tax that prevailed
when most of these plans
entered
the Social Security system it might be argued that earlier
entrants
had received a comparable
advantage.
The new costs associated
with mandatory
coverage would not be
distributed
uniformly.
Those states with substantial
numbers of noncovered workers in the public sector would bear more new costs than
states in which many localities
or state agencies already participate
242
TABLE
VII-12
Effects of Expanded Coverage for State and Local
Workers on Social Security Revenues for 1985 and 1990
Under II-B Assumptions,
1985-1990
Year
1985
1986
1987
1988
1989
1990
Sources:
Benefit
Increases
(Millions)
Full Contribution
Net Revenue
Collection
Gain
(Millions)
(Millions)
$
0
$ 7,500
40
8,1 O0
1O0
8,800
200
9,500
300
10,200
500
11,800
Benefit increase estimated
derived trom table VII-5.
Employee Contribution Only
Net Revenue
Collection
Gain
(Millions)
(Millions)
$ 7,500
$ 3,750
$ 3,750
8,060
4,050
4,010
8,700
4,400
4,300
9,300
4,750
4,550
9,900
5,1 O0
4,800
11,300
5,900
5,400
bv the author from table VII-4. Collections were
in Social
Security.
Specifically,
Colorado,
Louisiana,
Massachusetts,
Nevada,
and Ohio would
experience
the largest
increases
in total
pension
costs.
In addition,
California,
Maine,
Missouri,
Illinois,
and
Texas have substantial
numbers
of public
cmployees
who would
be
affected.
Sevcral
noncovered
local .jurisdictions
within
states
that are
largely
covered
also would
have higher
costs
if coverage
were expanded.
Total
pension
costs
in the affected
jurisdiction,
however,
would
generally
not be higher
than in localities
alreadv
covered
by
Social
Security.
Mandatory
Organizations
Social
Security
Coverage
of Nonprofit
The issues for employers
of nonprofit
organizations
are less clearly
defined
than for public-sector
workers.
Mandatory
coverage
would
improve
the retirement
income
protection
of most noncovered
workers. Because
much
employment
in this sector
is sporadic,
however,
and because
much nonprofit
activity
occurs
without
any contact
with
government,
it would
be hard to enforce
mandatory
coverage
for all
nonprofit
enterprises.
For employers
who do not have any retirement
plan, Social Security
coverage
would
increase
the cost of doing business. For employers
who do have plans,
the issues are similar
to those
discussed
tor state and local employers.
243
Other Issues
Coverage
Associated
with
Mandatory
Social
Security
The Fund to Assure Independent
Retirement
makes several
in opposition
to universal
Social Security coverage:
points
FAIR research indicates that in the end, merger would cost
the taxpayers more, not less. Today's contributor becomes
tomorrow's liability to Social Security. And if government
were to provide supplementary
retirement, as is the case
with "company" plans, taxpayers would have to absorb the
cost of the additional plan.
Public employees who are exempted from Social Securitv
coverage actually pay more taxes than persons with corresponding incomes who are covered by Social Security.
While working, both are taxed on their income, including
the dollars paid either to Social Security or their retirement
plan. But after retirement, ex-public employees from every
level of government continue to pay taxes-- to evem, level o/
government--on their annuities. Social Security benefits are
tax-free.
The independent actuarial firm of Edward H. Friend and
Company, engaged by FAIR, has determined that retired
public workers pay approximately
ten percent of their annuities in Federal income taxes. Taking Federal income retirees alone, this means that on the basis of disbursements
in 1979, Federal retirees paid an estimated $1.26 billion in
Federal income taxes. 24
This statement
must be analyzed carefully since opponents
of universal Social Security
coverage widely subscribe
to the underlying
premises. The first misconception
is that noncovered
pension systems
would be "merged"
No one has ever talked
about merging systems. There would be no expropriation
of existing
funds. The pension systems that would be affected would continue
to be totally independent
of Social Security.
At least 70 percent of
state and local workers are already covered by Social Security, and
the overwhelming
majority are covered by a pension plan in addition
to Social Security.
In 1979, 68.5 percent of nonagricultural
privatesector workers between
the ages of twenty-five
and sixty-four
who
were working at least half-time and had been in their jobs for a year
24"FAIR Facts No. 1," in Tke National
5, 1980), p. 820.
244
R.ral
Letter Carrier,
vol. 79, no. 43 (November
or more were working for an employer
who provided
a pension in
addition
to Social Security. 25 In no instance have any of these plans
been merged with Social Security.
The second point, that there are differences
in tax treatment
of
Social Security and pension income, is partly correct. Public-pension
annuitants
under age sixty-five are eligible for the retirement
income
credit; after age sixty-five thev are eligible for the credit for the elderly. The credit is basically
15 percent of the first $2,500 of pension
income for eligible individuals
and 15 percent of $3,750 for married
couples filing a joint return. These amounts
are reduced bv nontaxable pensions
received, monthly
payments
from matured
U.S. government
life insurance
endowments,
and Railroad
Retirement
and
Social Securitv
benefits. For people under age sixty-two,
there is a
further reduction
for annual earnings over $900. Betwcen ages sixtytwo, and seventy-two,
exempted
income is reduced by 50 percent of
annual earnings
bctween $1,200 and $1,700 and all earnings
above
$1,700. After age seventy-two,
there is no earnings
test.
The estimate
of 10 percent federal tax liability on CSRS annuities
is probably
high. Thc Universal Coverage Study group was provided
a 1 percent
sample
of primary
CSRS annuitants
in mid-1979.
To
estimate
1980 federal income tax liability on CSRS benefits roughly,
the 1979 benefit levels were adjusted for COLA increases through the
end of 1980. Each individual
was treated
as filing a single return.
The standard
deduction
was taken in each instance,
with a double
exemption
provided
to annuitants
over age sixty-five. No credits or
other deductions
were considered.
No provision
was made for the
two years of tax-free annuities
the typical beneficiary
receives until
benefits exceed the employee's
contribution.
On this basis, both the
median
and the average federal income tax rates for 1980 were estimated
to bc almost exactly 10 percent. The sample did not include
any survivors,
who receive onlv 55 percent of the primary
annuitant
benefit, although survivors made up 26 percent of the total annuitants
during
1979. Including
them would have rcduced
both the median
and the mcan tax rates. Had spouses of primary
annuitants
been
considered
in calculating
exemptions,
the average tax rates would
havc been reduced
further.
Finally, the consideration
of available
credits and potential deductions above the standard deductions
would
have resulted
in further
reduced estimates
of federal tax liabilities
on CSRS annuities.
2SSvlvester J. Schieber
and Patricia
M. George, Retirement
Income
Aging America:
Coverage and Benefit Entitlement
(Washington,
chapter
2.
Opporttmities
D.C.: EBRI,
in at_
1981),
245
Even if the 10 percent
average tax rate is considered
correct,
the
implications
of Social Security coverage are negligible for some time.
If one assumes
that workers within ten years of normal retirement
would receive a continued
exemption
from Social Security coverage,
there would be little effect on CSRS benefits for at least ten years.
Then the CSRS benefit reductions
would be gradually
phased in. The
presumption
in the benefit designs developed
by the Universal
Coverage Study group was that any current
workers affected would receive benefits based on a combined
formula: periods of service under
the current formula would be treated under the current formula and
prospective
service, if coverage were extended, would be treated under the new system. The same transition
could be implemented
if the
CSRS was modified
along the lines proposed
by Senator
Stevens.
This would result in a gradual reduction
in CSRS benefits as Social
Security benefits increased
with the length of covered service. Even
after the full maturation
of a coordinated
system, there would be
substantial
benefits paid by the CSR system that would still be subject to federal taxes. The tax code is continuously
changed for a wide
variety of reasons.
It is hard to believe that a potential
loss of $1
billion dollars in annual
federal tax revenues
ten to twenty years
from now is crucial to this issue.
The last point in the FAIR position just cited implies that taxpayers
would have new liabilities
if the federal retirement
plan were coordinated with Social Security coverage. The fact is that taxpayers
now
absorb the liability
of most of the federal retirement
system. The
current
system costs federal workers 7 percent of their salary, and
the taxpayers
30 percent of the federal payroll. The unintended
benefits paid by Social Security cost an additional
2 percent of federal
payroll, which is absorbed
by the full-career
participants
in Social
Security.
A coordinated
system will cost the taxpayers
more only if
employees'
contributions
to the combined
system were less than their
current contribution
or if benefits were raised.
It has been argued that coverage
should not be mandated
at the
state and local levels because such a mandate
would be a further
infringement
of the federal government
on the rights of other governmental
bodies. The prospect
of government
infringement
is certainly a serious issue, but so is the issue of equity for taxpayers
and
workers.
In the case of mandatory
Social Security coverage,
these
issues are at odds with each other, and each should be weighed carefully. State and local retirement
costs may increase if Social Security
coverage is mandated.
Such an increase is serious at a time when the
public wants to reduce the costs of government.
The Social Security
246
"bonuses"
"hidden"
now provided
to workers in these systems, however, are
costs of government
that would become visible to the tax-
payers in the .jurisdictions
affected by coverage
legislation.
The cost
of increases in Social Security coverage would generally' be the result
of increases
in protection
provided
to public workers. The increases
in protection
would be largely directed toward individuals
who now
receive inadequate
protection
from their retirement
plans. Expanded
coverage would eliminate
the windfall problem and thus result in a
considerable
reduction
of Social Securitv costs.
The worker equity issues may be best considered
within the context
of a current
move in the federal government
to determine
benefit
comparability
using the framework
of total compensation.
Within
this framework
roughly 25 percent of workers' compensation
would
be attributed
to the accrual of pension rights. This amount
may be
equitable
for individuals
who will ultimately
receive a pension, but
it is hardly fair for the 25 percent of current federal workers who will
not. They face the prospect of being victimized
in three ways: (1) they
receive no pension protection
for their service (86 percent have more
than five years of covered service and are theoretically
vested under
the plan but will not receive any benefit from it; 62 percent
have
more than ten years of service under CSRS and would be vested under
a private retirement
plan); (2) during their period of federal employment, they would have their disposable
wages reduced for benefits
they will not receive; (3) thev do not have the portability
protection
provided by Social Security to more than 90 percent of the work force
and may ultimately
receive reduced retirement
benefits because of
substantial
periods of noncovered
service.
The argument
has been put forward that mandatory
universal coverage would be a further expansion
of a program
that is already
beyond its limits. This argument
needs clarification.
The 25 percent
of federal workers who terminate
their employment
without entitlement to a pension presumably
take jobs covered bv Social Security.
The Universal Coverage Study cited evidence suggesting
that as many
as 70 percent of federal annuitants
will receive Social Security benefits. 26Because of the prevalence of policemen,
firefighters,
and teachers at the state and local levels, the rates of Social Security entitlement
may be higher among other annuitants
on noncovered
employer pensions. As noted in chapter V, less than 20 percent of the approximately'
6 million workers now in noncovered
employment
will not receive
Social Security
benefits; these workers constitute
only 1 percent of
e_'U_tiversal Coverage
Sttu(v,
p. 41.
247
the current work torce. Although universal coverage would significantly increase the base of covered earnings, it would have little effect
on the number of workers who become covered during their working
caFeeFs.
One other argument against expanding coverage is that most noncovered workers today are already protected by a pension plan and
they do not "need" the protections provided by Social Security. Laying aside the portability and vesting issues already discussed, it might
be recalled this rationale did not hold forth for private sector workers
in 1935. As was discussed in chapter I, the Clark amendment to the
original 1935 Social Security Act, which would have exempted private-sector workers covered by an employer pension, was among the
most debated issues of the original legislation. Neither private-sector
employers with a pension nor their employees were exempted from
Social Security participation
in 1935 and they have never received
such exemptions since.
248
VIII. Other Policy Considerations
Throughout
the discussion
thus far, a series of issues related to the
central Social Security policy debate have been treated tangentially.
Some of these issues have been discussed
for years, while others have
entered the debate more recently. This chapter addresses
five of these
issues.
The first section discusses the facets of the Social Security program
that determine
the distribution
of benefits to dependents
and survivors. The concern in this area relates primarily
to the equity of Social
Security's
treatment
of women.
The second section deals with the earnings
test that reduces or
eliminates
the Social Security
benefits for people who continue
to
work and earn substantial
income beyond the normal retirement
age.
The third section focuses on the prospect of significant
OASDI trust
fund accumulations
during the 1990s, which would complicate
the
resolution
of both the short- and long-term
financing problems.
It is
premature
to be overly concerned
about this potential
problem
in
light of the significant
future financing
deficits in the Hospital
Insurance
program,
but the HI program
is being scrutinized
bv the
current
Social Security
Advisory Council, which will make policy
recommendations
during
1983. Assuming
that the HI problems
are
resolved, the potential OASDI trust fund accumulations
under certain
policy options would be significant
and difficult to manage. A method
of handling
these potential
trust funds, should they arise, is outlined.
The fourth section considers the prospects of using general revenues
to finance Social Security
in the future. At the outset, Franklin
D.
Roosevelt was strongly committed
to financing Social Security through
a payroll tax system. Over the years, Congress has remained
equally
committed.
Yet, some analysts
and policymakers
advocate
general
revenue
infusions as the best wav to deal with Social Security's
financing shortfalls
in both the short and long terms.
The final section evaluates
a set of recommendations
that
would
modify Social Security
more fundamentally
than any of the propositions considered
throughout
the other parts of this book. These
proposals
would change aggregate benefit accumulations,
the method
of financing
them, and the ultimate
benefit distributions.
Horizontal
and Vertical
Equity
in Social
Security
As was noted in the discussion
of the evolution
and its financing
and benefit structure
in chapter
of Social Security
I, the original 1eg249
islation included a benefit structure
that provided relatively
higher
benefits
to low-wage
workers than to people with higher levels of
earnings.
The program
was originally
configured
as a redistributive
retirement
annuity program. The 1939 amendments
changed the fundamental
characteristics
of the program
by providing
survivor and
dependent
benefits.
The architects
of Social Security
over the years have sought to
balance the adequacy
and equity goals of the program. The adequacy
goal is fulfilled through
the program's
redistributive
aspect. It is
accomplished
practically
by the PIA formula,
which provides
relatively lower benefits at progressively
higher levels of lifetime earnings.
For two persons
with the same characteristics
in every regard but
lifetime earnings,
the equity goal is fulfilled through the PIA formula
which provides
higher absolute benefits
to the retiree with higher
earnings
who paid higher taxes.
The equity goal, however, was compounded--some
critics say confounded--by
the 1939 amendment's
introduction
of dependent
benefits. Two sets of equity criteria must be considered:
"vertical"
and
"horizontal"
ones. For the program
to be vertically
equitable,
they
argue, a worker who contributed
more to the program
through the
payroll tax should be paid a higher benefit than one who pays less.
For the program
to be horizontally
equitable,
equal contributions
should result in equal benefits. The introduction
of dependent
and
survivor
benefits,
in combination
with the diversity
of individual
lifestyles
and working patterns,
has meant these two goals are not
simultaneously
attainable.
This situation
has given rise to a series of what are characterized
as "women's
issues" or "family issues." In fact, Social Security treats
female workers exactly the same as male workers. Some would point
out that it treats women better, because it does not actuarially
reduce
their benefits to account for their longer life expectancy.
The changing
role of women in society, however, has raised public "consciousness"
on women's equity issues. In 1940, when Social Security started paying benefits,
about one of four women over age fifteen was in the
labor force. By 1980, more than half of all women of working age and
two-thirds
of those between the ages of twenty and forty-five were in
the labor force.
The equity conflict in Social Security arises because supplemental
benefits are paid to dependents
of "entitled"
or regular beneficiaries.
In the case of spouse benefits,
they are payable to both men and
women but in most cases it is a woman who is eligible to receive
them. This is the case because among most married couples, it is the
250
husband
who has the higher lifetime earnings of the two and the wife
who is more likely to have had significant
periods out of the labor
force. A woman is eligible for 50 percent of her husband's
basic Social
Security
benefit when she reaches age sixty-five. She can take that
benefit as early as age sixty-two if her husband
is receiving benefits.
If she takes the benefit prior to age sixty-five,
it is reduced
on the
basis of the actuarial
tactors used to determine
monthlv benefit levels.
A widow is eligible to receive her husband's
full benefit at age sixtyfive, but can take an actuariallv
reduced benefit as early as age sixty.
A widow can actually
receive the husband's
benefit at much earlier
ages if she is caring for the deceased's
children
under eighteen
years
of age. Any woman who was married to a man for at least ten years
is eligible for benefits based on her late husband's
entire work career.
A woman who is in the labor force and is entitled to Social Security
on the basis of her own contributions
does not receive the full amount
of the spouse's benefits. The benefits are basically determined
in the
following wav: first, her own entitlement
is determined
on the basis
of her earnings
and age at retirement;
second, her benefit as the
spouse of an entitled
beneficiary
is determined
and if that amount is
higher than her own entitlement,
she is paid the additional
amount.
In a practical
sense, she gets the higher of the two benefits, although
in Social Security's
bookkeeping
she gets her own entitlement
plus
the residual
amount that is a spouse benefit.
Under this system, vertical equity and horizontal
equity are both
maintained
for any two families with exactlv the same characteristics
and lifetime earnings
patterns.
When family characteristics
or earnings patterns
vary, the equity criteria break down. Specifically,
they
break down between single and married individuals,
between singleearner and two-earner
couples, and for divorcees. The single-married
inequities
arise on the basis of both survivor and dependent
benefits.
Two workers,
one single and one married,
with exactly the same
earnings
make the same contribution
to Social Security but receive
different protections.
The single person who dies prior to retirement
receives no benefit
from Social Security (other than insurance
protection
against disability while he or she was alive). When a single person dies after
retirement,
all Social Security
benefits
related
to that person end
with his or her death. But when a married
person dies prior to retirement,
Social Security benefits may be paid both to a spouse and
to children.
When a married
man dies after retirement,
a widow's
benefit may be paid.
251
One possible solution to this inequity in benefits available
for single
and married
people is to increase
the tax rate on married
people or
on people with potentially
eligible children.
In the case of children,
however,
it can be argued that the benefits are merely an investment
in a future generation
of taxpayers.
Although workers with children
do place Social Security
at additional
risk, these workers are also
helping to preserve
the future of the program
by providing
the replacement
generation
of workers.
The same cannot be said for the
single worker who has no children.
In the case of a surviving
elderly spouse, the issues are somewhat
different. Here the equity problems relate to benefits provided people
on the basis of labor-force
participation.
Consider, for example, three
households,
each with a total average indexed earnings of $1,000 in
1982. Assume that one consists of a single person, never married, who
is sixty-two in early 1982; the second consists of a couple both reaching age sixty-two
in 1982, one of whom never participated
in the
labor force; and a third consists of a two-earner
couple, both partners
of which had equal earnings
throughout
their lives and where both
also reached age sixty-two in 1982. Further, assume each of the three
"economic
units" had equal earnings in each year since they reached
age twenty-one.
Table VIII-I shows Social Security benefits for the
three households.
In all these cases, the total earnings
and payroll
taxes in each family can be assumed to be equal; yet each family has
a different
level of benefits.
The difference
between
the single person's
benefit and the twoearner couple's arises because of the intended
redistribution
in the
program.
Both wage-earning
partners
in the couple received
lower
earnings
throughout
their careers
than the single person, so each
receive relatively
higher but absolutely
lower benefits. The principle
of vertical equity is maintained,
while the horizontal
is not. Given
the adequacy goal of the program, horizontal equity cannot be achieved
across single versus married households
with the same lifetime earnings. It is presumed
that Congress has knowingly made this decision
and may or may not reevaluate
it on economic,
social, and political
grounds in the future.
A failure of the equity conditions
that has led to somewhat
more
criticism
of the program
is the higher benefit paid to the one-earner
couple than to the two-earner
couple. The two-earner
couple in table
VIII-1 consisting of husband and wife, both of whom had participated
in the labor force throughout
their lives and had paid taxes comparable to those paid by the single earner, receive less than the oneearner couple. Both the vertical and horizontal
equity criteria
are
252
TABLE
Monthly
Individuals
Social Security Benefits for Specified
and Couples Retiring at Age 62 in Early
1982
Individual's
Benefit
Widow's
Benefit
$1,000
$362.70
-
$1,000
$362.70
157.40 _'
$520.10
$374.00 b
$234.70
234.70 _
$469.40
$234.70 b
AIME
Single
Person
One-Earner
Couple
Worker
Homemaker
Total
Two-Earner
Husband
Wife
Total
VIII-I
$1,000
Couple
$
500
500
$1,000
Source: Calculated by the author'.
_'Assumes husband is alive at age sixty-two.
bAssumes husband dies at age sixty-two.
met
if only
the
worker
benefits
are considered.
If familv
benefits
are
considered,
both fail. Furthermore,
in the case of survivor
benefits,
the spouse
who did not participate
in the labor force fares better
than
the one who did. In the example
shown
in table VIII-l,
the death
of
the husband
in the one-earner
couple
will leave the widow
with a
benefit
that is roughly
$140 per month
higher
than the benefit
for
the two-earner
couple
in similar
circumstances.
During
the 1930s and 1940s, when
fewer women
participated
in
the labor
force, this problem
was less noticeable
than
todav
when
the majority
do. There
is a broad
perception
that women
who stay
in the labor force do not get their money's
worth
out of the program.
The question
that is not always
addressed
is, relative
to what?
The
fact is that because
of women's
longer
life expectancy
at retirement,
female
wage earners
actually
get a better
return
from the program
than male wage earners.
It is only relative
to non-wage-earning
spouses
that wage-earning
women
are disadvantaged.
The primary
concern
about
divorce
is the ten-year
marriage
requirement.
The woman
married
only nine years and eleven
months
is not eligible
for spouse
or survivor
benefits,
while
an additional
month
of marriage
would
warrant
such benefits.
The marriage
requirement
was reduced
from twenty
years
to ten in 1978.
253
The proposals
that would resolve these equity problems
cut in two
directions.
One set of proposals
would "level up" the benefits of twoearner couples. To accomplish
this, benefits could be paid to all couples as if only one partner
in the couple had participated
in the labor
force. Alternatively,
retired workers could be guaranteed
some portion of the spouse's benefit.
Another set of proposals
would raise
worker benefits relative to spouse benefits. Each of these proposals
has certain
merits, but in the context of Social Security
financing
deficits they hardly seem appropriate.
Solving one problem by exacerbating
another would lend little credibility
to the solution.
Another set of proposals
would "level down" the benefits paid to
one-earner
couples. This could be accomplished
by decreasing
or even
eliminating
the spouse benefit for retired workers. Another approach
would be to pay all spouse beneficiaries
a flat benefit. The approach
that has probably
received
the most serious consideration
would
"share" (i.e., divide equally) a couple's earnings or average their AIME.
This would place the one-earner
couple in the same position as the
two-earner
couple. A more restricted
version of this option would call
for earnings
sharing only in the case of divorce.
The earnings
sharing on an annual basis or on the basis of AIME
averaging
would equalize the benefits of married couples regardless
of their one- or two-earner
status. Annual earnings sharing could also
resolve the problem relating to benefits for divorcees, which may be
more of a conceptual
than a practical problem at present. The major
limitation
of either of these approaches
is that participation
in Social
Security is not universal.
If one spouse works in noncovered
employment while the other works in covered, earnings sharing would result
in further
distortion
of equity problems
that already
persist. The
problem would be further exacerbated
in cases of divorce. As a practical matter,
only 8.2 percent of all benefits paid to retired workers
and their dependents
in 1970 were spouse benefitsJ
Given the much
greater participation
of women in the labor force today than in the
past, this problem may be even less prevalent
in the future.
The survivor issue is somewhat
more important
because two-thirds
of all survivor benefits go to elderly survivors.
The AIME averaging
or earnings sharing option would reduce the benefit tot a spouse who
did not participate
in the labor force in table VIII-I to the benefit of
the wage-earning
spouse. Alternatively,
the wage-earning
spouse's
benefits could be raised to the higher" level if the widow or widower
_Social Security Bulleti_t
istration,
1981, p. 108.
254
A_mual
Statistical
Suppleme_zl,
1980,
Social
Security
Admin-
could inheril the spouse's earnings
history. Either option would be
complicated
and certain distortions
would result because coverage
is not universal.
A simpler procedure
for reducing
the benefit for a
spouse who had not participated
in the labor force would be to provide that person a lower portion of the spouse's benefit. For raising
the benefits
[or survivors
who
are
themselves
entitled,
it would be
simpler to provide a fiat benefit or to develop a partial offset procedure rather than the full offset that now applies.
There are practical
problems
with resoh, ing this issue in the short
term. Reducing
benefits
of workers close to retirement
can cause
undue hardship.
Raising benefits in the current environment
max: be
unpalatable.
Resolving the problem,
however, would reduce the criticism of the program.
The
Earnings
Test
Ever since the Social Security program began, the old-age benefits
have been characterized
as retirement
benefits. To assure that benefits go to retirees, the program
includes an earnings
test for retirement. The earnings
test reduces Social Security benefits by one dollar
for every two dollars of earnings
over an exempt amount.
In 1982,
the exempt amount
is $4,400 tot persons
under age sixty-five,
and
$6,000 for persons
aged sixty-five
to seventy-one.
All earnings
arc
exempt above age seventy-two
in 1982. Beginning in 1983, all earnings will be exempt tot workers over age seventy. The exempt earnings
amounts
are indexed by the growth in average wages. Advocates of
the earnings
test argue that Social Security is insurance
against the
loss of earnings
because of old age.
Critics of the earnings
test argue that it should be eliminated
on
several grounds.
First, they argue that the insurance
principle
is not
appropriate
tot old-age benefits because many people retire voluntarily. In this context,
Social Security
is not "insuring"
against
a
circumstance
beyond the beneficiaries'
control, but against one these
people bring on thcmselves.
Critics argue further that it is hard to
rationalize
paying benefits to people who have voluntarily
renounced
their wages when people who continue to work lose benefits. It is also
argued
that there is no rational
basis for trcating
a worker at age
sixty-fivc, the Social Securitv normal retirement
age, any differently
from the way someone age seventy-two
is treated. Furthermore,
there
is widespread
agreement
that the earnings
test is a disincentive
to
work beyond normal retirement
age. Six of the thirteen members
of
255
the 1979 Social Security
of the population,
such
Advisory
Council
argued
that with
disincentives
should
be minimized.
the aging
2
From a slightly
different
perspective,
some
people
are concerned
with the equity
of treating
earned
and unearned
income
differently
under
what
is perceived
as a means
test. In the 1979 Report
of the
Social
Security
Advisory
Council,
four members
argued:
There is also the perceived
injustice in permitting
full benefits to be received regardless
of the amount
of unearned
income (dividends,
interest, etc.) and reducing benefits when
earned income is involved.
The answer usually given to a
complaint
on this point is that the benefits are received as
a matter of right and to reduce them because of unearned
income would be equivalent
to use of a means test. But the
present rule seems to apply a means test based on earned
income. If there is any difference
in these two approaches,
it is too subtle to be understood
by the vast majority
of
workers covered by Social Security)
One of the more serious
problems
with eliminating
the earnings
test for beneficiaries
beyond
age sixty-five
is that it would
raise Social
Security
costs.
The program
actuaries
project
that eliminating
the
earnings
that would
increase
the seventy-five-year
average
cost by
0.14 percent
of payroll.
Until there is some agreement
on other program modifications,
raising
the cost of the system
would be perceived
as irresponsible.
If Congress
were
basis,
as discussed
earnings
Trust
test
Fund
might
to consider
in chapters
make
such
taxing Social Security
benefits
V and VI, however,
elimination
a policy
more
on some
of the
palatable.
Accumulations
The prospects
for trust fund accumulations
are
on any actual
modifications
to the Social
Security
end of a decade
of relatively
constant
deterioration
totally
dependent
program.
At the
in Social
Secu-
rity's
financial
status,
potential
trust fund accumulations
may be
perceived
as either
a pipe dream
or a return
to the blissful
opportunities
of the early
1970s. Recent
experience,
however,
has shown
2Gardner Ackley et al., "Supplementary
Statement on Liberalizing the Earnings Test,"
Social Security Financing and Benelits (Washington, D.C.: Report of the 1979 Advisory
Council), p. 231.
3Grace Davis, Mary Falvey, John Porter, and J. W. Van Gorkum, "Supplementary
Statement on the Need to Phase Out the Earnings Test," Social Security Financing
and Benefits (Washington, D.C.: Report of the 1979 Advisory Council), p. 230.
256
that taking advantage
of blissful opportunities
in the short term can
exact a substantial
price in the longer term.
The problem, whether it is merely perceived at this time or becomes
real in the future, is the projected accumulation
of OASDI trust funds
around the turn of the century
under various policy scenarios.
For
example,
in 1980 there was some discussion
of freezing the PIA formula bend points for three years starting in 1981. The Social Security
actuaries
projected
that such a policy would reduce the long-term
financing
deficit by 1.1 percent
of payroll or by about 88 percent
under the intermediate
assumptions
used in the 1980 valuation.
Under these projections,
freezing bend points for three years was projected to result in OASDI trust funds that would be about three times
the annual OASDI benefit payments
bv the year 2000 and 5.3 times
annual benefit payments
by 2015. 4
There are precedents
for trust fund ratios like these, but they predate the maturing
of the program.
A better perspective
on such accumulations
can be gained by comparing
them with current benefit
levels. Under the 1982 Trustees
Report II-B assumptions,
the 1982
OASDI disbursements
are estimated
to be $160.3 billion (see chapter
IV). In the context of current
benefit levels, a trust fund ratio of 3.0
translates
into a trust fund of $481 billion. A ratio of 5.3 would equal
$850 billion. Although trust funds of these magnitudes
mav hardly
seem a problem, there are several issues to consider.
The Social Security
trust funds are held in the form of federal
securities;
they are part of the federal government's
formal debt,
which is now about $1.1 trillion. Assuming
that the government's
formal debt does not grow anv more rapidly
than annual
OASDI
disbursements,
the OASDI trust funds would buy up a large shave of
the federal debt now held by the general public. However,
the government
would be running substantial
surpluses.
If historical
experience is any guide, it is unlikely that the federal government
would
run such surpluses
for any sustained
length of time. A combination
of fiscal, economic,
and political factors would undoubtedly
dictate
against doing this.
There are several things that might be done instead of buying up
the existing debt stock. The trust funds could be issued new debt and
the revenues
would be used to finance other activities
of the federal
government.
Under this scenario,
the federal budget could be balanced by offsetting
increased payroll tax collections
by reductions
in
the income tax. As the baby-boom
generation
reaches retirement
age
4U .S. Senate
Government
Committee
on Finance, Social Security Financing
Printing
Office, 1980), pp. 53 and 55.
(Washington,
D.C.: U.S.
257
and places claims on the svstem in excess of payroll tax collections,
the opposite
phenomenon
w,ould occur. The securities
held by the
trust funds would be liquidated
to pay benefits. The liquidation
of
these securities
would be financed either by increasing general taxes
to reduce the federal debt, or if the budget is running an overall
deficit, by borrowing
in the general credit markets
to refinance
the
trust fund holdings.
Alternatively,
the program's
expenditures
and revenues could be
more closely balanced
over time to keep the system operating
on a
current-cost
basis. For example,
as the trust funds start to grow,
benefits
could be raised. The problem
with this approach
is that
raising one generation's
level of benefits leads to expectations
of increased
benefits
bv subsequent
generations.
In this case, these increased expectations
would mature with the baby-boom
generation's
retirement.
The credibility
of the program
would be strained as longterm projected
costs rise ta,r above current projections.
Similarly,
the system could be kept on a current-cost
basis by reducing payroll taxes as the trust funds accumulate
beyond some required reserve ratio for administering
the program. Robert Myers has
presented
a proposal t0r automatically
adjusting
the OASDI tax rates
to correspond
with changing
cost rates. For purposes
of describing
the option, he assumes that a trust fund ratio of 50 to 55 percent of
prior-year
benefits should be maintained,
although
he notes that a
higher or lower ratio could be maintained.
At the end of each fiscal
year, the size ot the OASDI trust funds as of September
30 would be
compared
with disbursements
for the year. If the fund ratio equaled
or exceeded
60 percent
of the year's disbursements,
the combined
employer-employee
tax rate would be reduced 0.4 percent
lot the
next calendar
vear. If the actual dollars in the trust funds declined
from one year to the next, however, the tax rate would not be reduced,
even if the trust fund ratio exceeded 60 percent. If the ratio fell below
55 percent, the tax rate would be raised 0.4 percent. If the trust fund
ratio fell between 55.0 and 59.9 percent, the tax rate would be mainrained, s
Myers has estimated
the payroll tax variations
that would result
if this proposal were implemented
in 1991. He assumed that the shortterm solution got the OASDI program
through
1990 with approximately a zero trust fund balance, and he assumed
that no modifiSRobert J. Myers, "How
Operate,"
Memorandum
Security
Reform, June
258
a Proposal tor Automatic
Changes in OASDI Tax Rates Would
no. 23 (Washington,
D.C.: National
Commission
on Social
4, 1982), p. 2.
cations to the current
benefits were implemented.
He used the 1982
II-B assumptions
in estimating
the payroll tax variations.
Under this
scenario,
the currently
legislated
combined
OASDI tax rate of 12.4
percent would be stable between
1991 and 1998. After 1998 it would
begin to decline, reaching
10.4 percent in 2003 and stabilizing
for
five vears. In 2008 and beyond, the tax rate would rise automatically
and steadily, with one three-vear
exception,
reaching
17.6 percent in
2029. Beyond 2030, the rate would vary between
15.6 and 17.6 percent. 6 The portion
of the population
reaching
age twenty-one
and
embarking
on a career in 2008 or after will not be born until 1987 or
after. Under this proposal,
in a little over twenty years, the payroll
tax rate could rise nearly 42 percent without Congress having taken
a single vote. Bv 2029 half the work force would have been born after
the passage of the legislation
that raised their OASDI payroll
tax
rates more than 40 percent above the rate now in current
law for
1990, and 63 percent above the 1982 rate. If conditions
turned out
less favorable than those assumed,
the increases would be still higher.
There is some skepticism
about the potential buildup of the OASDI
trust funds. The projected
Medicare shortfalls
are so large that some
analysts
believe that anv OASDI savings resulting
from alternative
policies will be more than used up bv HI financing.
It may be premature,
theretore,
to design and implement
provisions
that would
mean higher retirement
benefits or lower payroll taxes during the
1990s. A newly appointed
Social Security
Advisory Council is only
now beginning
to grapple with Medicare problems.
Until their deliberations
and proposals
and the resulting
congressional
actions are
clear, the OASDI trust fund accumulation
problem will be more perceptual than real. To the extent that excessive trust funds do accumulate, policymakers
should consider making them an effective tool
for use in resolving the long-term
financing
situation.
Given the current structure
of financing Social Security,
it scents
highly, unlikely that there will ever be the capability'
of prefunding
anv significant
portion of the program's
liabilities.
Given the nature
of trust fund holdings and broader fiscal policy, thc historical
arguments against
prcfunding
probably'
will prevail in the future. The
discussion
of funding, which actually dates back to the early days of
the program,
was described
in chapter I. In the past, this debate has
hinged on three basic concerns:
(1) large trust funds would result in
politically
motivated
benefit increases;
(2)the central
government
could not manage a trust fund of the size involved; and (3) the gov"Ibid.
259
ernment
would
act as a severe
fiscal drag
on the overall
economy
during
the period of fund accumulation.
Any proposal
to prefund
Social Security obligations
has to address these concerns.
One aspect of previous
funding discussions
was the presumption
that the funds would have to be accumulated
and managed centrally.
Some of the historical
concerns regarding
prefunding
might be overcome by prefunding
on an individual
rather than an aggregate
basis.
For example, a trigger mechanism
such as the one developed by Myers
for adjusting
the OASDI tax rate could be adapted
to trigger payroll
tax rebates
rather
than tax rate reductions.
The rebates
could be
restricted
to investment
in approved
vehicles similar to individual
retirement
accounts
that could be converted
into an annuity
upon
attaining
Social Security eligibility
status.
If the redistributive
aspect of the program
was to be maintained,
the credits could be weighted towards lower-income
workers or based
on annual hours of covered employment
rather than wages. If it is
politically more expedient to expose the retirement portfolios of higherincome workers to market risk, the rebates could be based on annual
contributions.
At retirement,
the annuities
could be offset against the
computed
Social Security entitlement.
A major advantage
of these special individual
retirement
security
(SIRS) accounts
would be that they could be used to smooth the tax
rate over time. The problems
of large centrally
managed
trust funds
would not arise because the rebates would be held in individual
accounts. Institutional
investors
could be encouraged
to offer pooled
investment
vehicles, so that small investors
could take advantage
of
the efficiencies
and opportunities
open to the wealthy. Rather than
being a fiscal drag on the economy, such a program
would provide
a direct stream of investment
dollars to the capital market. Furthermore, on the benefit side, SIRS would provide a direct claim on the
capital base of the economy, a claim Social Security does not enjoy
as it is now financed.
One concern
that would almost certainly
be raised about such a
program
would be the responsiveness
of SIRS annuities
to inflation.
The program
could be structured
to provide graded annuities
as well
as, or instead
of, flat annuities.
Further
inflation protection,
comparable
to that provided
by Social Security,
could be underwritten
by the federal government.
Such protection
would not be free, but
would be much cheaper than underwriting
the full cost of the SIRS
annuities
and inflation protection
on a current-cost
basis.
This option would not replace Social Security or any of its basic
characteristics,
but would be a way of accumulating
the surplus pay260
roll taxes [hal will be paid as the baby-boom
generation
matures
through the work force. It would help to capture those taxes in a way
that they could be used to provide the baby-boom
cohort with retirement
benefits. The current-cost
structure
appears
to have a limited capacity to accomplish
these goals. Before a program
like SIRS
could be implemented,
it would require more detailed
development
than provided here. Such a program
would not take effect, however,
until adequate
trust funds had developed
in the OASDI program
to
assume Social Security's
continued
smooth operation,
so there would
be ample time to develop program
details. There are, of course, other
alternatives.
General
Revenue
In the course
Financing
of the deliberations
of the National
Commission
on
Social Security Reform, the discussion
has repeatedly
focused on the
relationship
of projected
Social Security benefit levels relative to the
Gross National
Product (GNP). The point is that future Social Securitv costs as a percentage
of GNP will be much more stable than
the costs as a percentage
of covered payroll. Table VIII-2 shows averaging-period
cost projections
on these two bases.
Under the II-B assumptions,
the OASDI benefits are estimated
to
be about 5.16 percent of GNP during 1982. This rate is projected
to
decline steadily until after the turn of the century. The rate will begin
to rise again as the baby-boom
generation
reaches retirement
age
during the second twenty-five-year
averaging
period shown in table
TABLE VIII-2
Estimated
Costs of OASDI System as a Percentage of
Covered Payroll and as a Percentage of GNP Under
1982 Trustees Report II-B Assumptions
Period
Payroll Cost Rate
(Percent)
GN/PCost Rate
(Percent)
25- Yea r Averages
1982-2006
2007-2031
2032 2056
11.37
14.08
16.81
4.75
5.30
5.78
75- Yea r Average
1982-2056
14.09
5.28
Source: 1982 Social Security Trustees Report, pp. 68-69.
261
VIII-2. The rate is projected
to peak in 2030 at 6.10 percent of GNP,
less than one percentage
point more than in 1982.
To put it somewhat
differently,
if the 1982 OASDI cost rate (11.78
percent) as a percentage
of pay is compared
with the II-B-projected
cost rate (16.83 percent)
for 2030, the cost of OASDI will be 42.9
percent higher in 2030 than in 1982. At the same time, OASDI benefits
as a percentage
of GNP are projected
to be only 18.2 percent higher
in 2030 (6.10 percent)
than in 1982 (5.16 percent). The seventy-fiveyear average cost of OASDI as a percentage
of payroll is 19.6 percent
higher than the 1982 cost under the II-B assumptions.
As a percentage
of GNP, the long-range
cost is only 2.3 percent greater than the 1982
level under the same assumptions.
There is a large discrepancy
between the additional
share of payroll
that would be necessary
to finance Social Security
benefits in the
future versus the total share of GNP that would be required.
As a
result some analysts argue that the revenue sources used to finance
benefits should be expanded
beyond the current
payroll tax. There
has always been some strong opposition
to general revenue financing
of the program,
however. As noted in chapter
I, President
Franklin
D. Roosevelt supported
financing
through the payroll tax because it
would be less subject to political manipulation
than one financed bv
other means.
Over the years, the issue of general
revenue financing
has been
raised on several occasions.
In the initial conception
of the program
by the Committee
on Economic Security, Social Security would have
been partially financed through the general tax system. The logic was
that as Social Security expanded,
the role of old-age assistance
would
diminish
and the "freed revenues"
could be diverted
to the old-age
retirement
program.
President
Roosevelt opposed this logic during
the development
of the Social Security Act in 1935. In 1944, however,
the Social Security Act was amended
to authorize
appropriations
to
the OASDI trust fund any "additional
amounts"
required
to finance
benefits. The 1950 amendments
increased
the wage base, scheduled
a series of tax rate increases,
and eliminated
the 1944 provision
authorizing
general appropriations
from the Treasury to the trust fund.
Congress has continued
to favor a self-supporting
system ever since.
For many years, organized
labor supported
payroll tax financing
of Social Security.
According
to Martha Derthick,
labor's commitment was more strategic
than philosophical,
however.
She quotes
Nelson Cruikshank,
who was Director of the Social Security Department of the American Federation
of Labor-Congress
of Industrial
Organizations
(AFL-CIO) for several years, as saying that labor accepted
262
the 1950 payroll tax provisions "as a practical
move to get the benefits
we wanted. ''7 In 1969 the AFL-CIO recommended
adoption of a threetier financing
scheme: one-third
from general revenues
and the remainder
from the equally shared payroll tax on employers
and workers.
The Carter administration
proposed countercyclical
general revenue financing
in 1977; general revenues
were to be infused into the
trust funds when unemployment
reached
6 percent.
This infusion
would make up for revenue losses that occur when workers lose their
jobs and reduce the aggregate
wage base during adverse economic
periods. Congress rejected the Carter proposal and instead raised the
taxable wage base and scheduled
a series of tax increases.
Most opposition
to general revenue financing is based on two premises. The first premise is that opening the financing to general revenues will result in increased pressure to expand benefits. The payroll
tax, it is argued, acts as a political governor on the program, especially
now that the program
is mature. Anv benefit increases that are provided now must be met with corresponding
tax increases. The theorv
holds that this mechanism
constrains
political
largesse that might
otherwise
prevail.
The second premise is that there are no general revenues with which
to finance
the program.
The United States government
has a long
history of federal deficits. Table VIII-3 shows the federal budgetary
flows between 1940 and 1981. In each of the five-year periods between
1940 and 1979, the general fund was in deficit; there were only six
years between
1940 and 1981 inclusive that the general fund ran a
surplus.
If trust fund receipts and outlays are included as part of the
total federal budget there have been only eight years with a surplus.
Given this fairly consistent
fiscal record, opponents of general revenue
financing argue that it would simply mean higher or alternative
taxes
or even larger deficits in the future.
A more recent concern is the magnitude
of expected federal budget
deficits in the near future. The Congressional
Budget Office has recently projected
deficits, including
off-budget
accounts,
of approximately $170 billion for each of the fiscal years 1983 to 1985. Considering
only the unified budget, the projected
deficits range between
$150
and $160 billion in each of the three fiscal years. The CBO has also
estimated
that when the accounting
is completed,
the 1982 total fed-
7Martha Derthick,
Policymaking
Institution,
1979), p. 250.
[or Social
Security
(Washington,
D.C.: The Brookings
263
264
eral deficit will be $130 billion. 8 The escalating
budget deficits, at
levels significantly
above historical levels, are cause for concern across
the political spectrum.
Establishing
even greater claims on the general revenue funds at this time is inappropriate.
Reorienting
the
Social
Security
Program
As the debate about the Social Security
financing
problems
has
widened, some proposals
have been made to modifv the structure
of
Social Security
radically
or to phase out the program
altogether.
Some of these proposals
include detailed
action plans, while others
give only broad outlines. It would be easy to ignore or dismiss these
proposals
out of hand, but the authors, bv virtue of their backgrounds
and current
positions,
appear
to be serious-minded
people whose
ideas should be carefully
examined.
Three of these options will be
briefly discussed
here.
The Family Plan--Peter
Ferrara, currently
a senior staff member
at the White House Office of Policy Development,
has developed
a
proposal
that would gradually
reform Social Security by creating a
new system in its place. 9 He recommends
a preliminary
set of reforms
that would include indexing the entire system bv the lower of wages
or prices. Then he suggests gradually
raising the normal retirement
age for old-age benefits from sixty-five to sixty-eight.
He also proposes
to eliminate
the progressivity
of the benefit formula and to provide
benefits
in strict proportion
to lifetime contributions
through
the
payroll tax. The welfare elements of the current system would be met
through
the SSI program.
Spouse and dependent
benefits would be
eliminated.
Survivor benefits would depend on contributions
rather
than number
of beneficiaries.
The monthly
benefit maximum
and
earnings
test would be eliminated.
Ferrara
suggests that although
these preliminary
reforms "would not reduce benefits or expenditures
in general, they would aid the proposed
basic reform bv making it
easier to compare
Social Security
with private alternatives.
''l° He
goes on to note that the basic reform is not dependent
on the preliminary modifications.
*Congressional
Budget
Office, The Economic
a_zd Budget Outlook: A_t Update (Washington, D.C.: U.S. Government
Printing
Office, September
1982), p. 36.
9Peter J. Ferrara,
Social SecuriO' Re[orm, the Family Plan (Washington,
D.C.: The Heritage Foundation,
1982). Although
Ferrara is a member of the Reagan administration,
his proposal
should not be construed
as an administration
recommendation.
l°Ibid., p. 51.
265
The Family Plan would be phased in in three steps. Beginning
on
January
1, 1986, a worker could defer up to 20 percent of his or her
OASDI contribution
to an IRA and have the employer
defer a comparable
amount.
The IRA provisions
now in law would he modified
so participants
could use part of their IRA money to buy term life
insurance.
Ultimate
OASI benefits would be reduced in relation
to
the portion of taxes deferred into the IRA. The government
would
continue
to meet the Social Security obligations
through
infusions
of general
revenues.
Ferrara
suggests that the infusion of new investment
capital would result in higher tax collections,
because the
return on capital is "partially
taxed through the corporate
income
tax. The increased
wages and new employment
resulting
from this
investment
would result in increases
in both general revenue
and
payroll tax revenues .... Eventually,
these two factors would entirely
eliminate
the net general revenue subsidy needed to pay Social Security benefits."ll
The proportion
of the OASDHI tax deferrable
to IRAs would increase to 40 percent on January
1, 1996, and to 66 percent on January
1,2004. The remaining
34 percent would go to finance the Disability
Insurance
and Hospital Insurance
programs.
At this point, the employees who directed their employers
to contribute
60 percent of the
payroll tax to the IRA and who deferred
40 percent on their own
could then use the remainder
of the additional
26 percent however
they chose. "This would be justified on the grounds that, since the
benefits payable through the private alternative
system would be so
much higher than those through Social Security...
individuals
would
not be required
to save so much. ''12
On January
1, 2020, the DI share of payroll taxes would be deferrable. On January
1, 2014, the HI portion of the tax could be contributed
to the IRA. Finally on January
1, 2016, a modification
on
the corporate
tax would be implemented
that would exempt corporate profits from taxes in proportion
to the share of their stocks held
by IRAs. The same basic rule would also apply to noncorporate
businesses.
Purchases
of life, disability,
and old-age insurance
would be made
tax exempt.
Employee
contributions
to the IRAs would be tax deductible,
but employer
contributions
would be treated
as regular
income. In accordance
with the current
tax treatment
of Social Security
benefits,
IIIbid., pp. 52-53.
121bid., p. 53.
266
IRA distributions
would
not be taxable.
The svslcm would require savings tor retirement
and insurance
purposes.
Fcrrara estimates
that "the new system would require total
savings lot these contingencies
equal to 87 percent of what individuals would be required
to pay in total Social Security taxcs. ''13 This
estimate
is based on lhc assumption
that "the real, full, before-tax
rate of relurn on capital investment
estimated
by economists
at 12
percent or more would prcvail. ''H
Fcrrara's
proposed
modifications
would definitely
change the distribution
of retirement
benefits. Withdrawing
the weighted
benefits
providcd by Social Security and substituting
SSI instead would save
money in cithcr the short or long term only if the withdrawn
benefits
were not replaced
or if participation
rates were much lower in SSI
than in Social Security J0r the low-income
elderly. It is unlikely that
lowcr-incomc
workcn's will evcr bccome sufficicntiv savvy in thc ways
of the financial
markets
to realize rates of return on their IRAs that
exceed inflation by 12 percent. More reasonablc
rates of return would
be in the range of 1 to 3 percent above the inflation rate, and there
max' bc sustained
pcriods when returns fall short of the inflation rate
for many investors.
As Michael Boskin, professor
of economics
at
Stanford
University
and himself a critic of Social Security', recently
stated: "Some, such as Fcrrara, assumed that the returns to the economy from the extra investment
generated
by private capital formation would be so lm'gc as basically to self-finance
in a costlcss manner
this change. I bclieve such estimates
are well out of the reasonable
range based on our historical
experience
and economic reasoning. ''1_
Perso,al
Sec,rilv
Acco,,Is--Prolessors
Michael
Boskin of Stanford
University,
Laurcnce
Kotlikoff of Yale, and John Shoven of Stanford
havc recommended
a fundamental
rcstrucluring
of Social Security
coupled with development
of a program of personal security accounts
(PSAs). They accept the view that there should be a Social Security
svstem of some kind that requires
people to help provide for themselves in view of the uncmtaintics
of life. t_
Kotlikoff has spelled out a set of propositions
as the foundation
of
PSAs. First, contributions
representing
t0rced savings should be treated
on an individual account basis
higher earnings would requirc higher
contributions
and entitle the earner to a larger benefit. Second, larger
qbid., p.
Lqbid., p.
t_Michael
National
p. 8.
'"Ibid., p.
62.
57.
J. Boskin, "Ahcvnativc
Commission
on Social
Social Sccuvitx
Rct0vm Proposals,"
presented
to the
Security
Rclorm, Washington,
D.C., August 20, 1982,
4.
267
benefits, financed through larger contributions,
should be available
to married
persons with spouses who do not participate
in the labor
torce. Third, workers at risk for survivor benefits should be required
to pay lot such insurance
protection.
Fourth, rather than capping
family or child survivor benefits, the plan proposes that added taxes
should be levied on people at risk, to pay ['or benefits. Fifth, benefits
should be paid in old age regardless
of work status, t7
This proposal is based on the premise that people should get benefits only if they pay for them, and pay for them only if thcv receive
them. Kotlikoff argues that the modified program should continue to
be redistributivc,
providing
higher benefits relative to contributions
for lower-wage
workers. In addition
to purchasing
retirement
benefits, the contributions
would be used to purchase
life, disability,
and
health insurance
from the Social Security
Administration.
The program would fully cover individuals
under age thirty-five, and provide
transitional
coverage
for additional
workers under age fifty-five.
The PSA program
aims to improve the horizontal
equity in Social
Security by setting the single person's earnings base at 70 percent of
the combined-earnings
base for married couples. The proposal calls
for complete
contributions
sharing tot" married couples. Spouse survivor benefits would not be payable until agc sixty-two.
Workers under age fifty-five would be given initial benefit credits
equal to combined
employer-employee
taxes paid in their behalf accumulated
at a 2 percent real interest rate. Additional
credits would
be given on the basis of "unaccrued
bcncfits"--bcnefits
promised
under the current
system that exceed the value of benefits purchasable on the basis of contributions.
The additional
credits would be
scaled progressively,
bv age, for workers aged thirty-six
to fiftv-five.
The PSA system would gradually
accumulate
a three-year
cash
reserve balance through
manipulation
of thc rate of return paid to
individuals'
PSA balances.
By using low rates of return, the system
could reduce benefit payments,
thus maintaining
any desired relationship between annual benefits and contributions.
There are two fundamental
differences
between the current structure of Social Security
and the modified
PSA program.
First, the
current Social Security program is a defined-benefit
program, whereas
the PSA program
would be a defined-contribution
type. The authors
of the proposed
PSA program
suggest that low-wage earners could
accumulate
weighted
credits relative
to high-wage
workers under
_7Laurence J. Kotlikoff,
"Reforming
Social Security
lot the Young: A Framework
Consensus,"
AEI Conference
on Controlling
the Cost of Social Security.
June 25
1981, pp. 10-11.
268
lot
26,
their program.
That is, in order to balance
grams, the low-wage earner would receive
the financing
a contribution
of the procredit of
more than one dollar for each dollar of taxes paid on the basis of
their earnings, while high-wage workers would receive credits of less
than one dollar on the basis of their taxes. Alternatively,
the credit
subsidies
for low-wage
workers could be financed
through general
revenues.
In theory, at least, the credit accumulation
could be structured to give roughly comparable
primary
benefit distributions
to
the benefits that result from the current system. If that is the desired
goal, it is not clear that changing
from a defined-benefit
to definedcontribution
program
nets much in the sense of socio-political
or
economic
goals. If there is really a compelling
need for workers to
know the value of their credit accumulations
annually,
it would be
simpler
to accomplish
this with a defined-contribution
plan. It is
unlikely,
however,
that the average forty- or fifty-year
old worker
L
could translate
the account balance into its expected annuity value
at retirement.
In view of the fact that the PSA program
would still
be unfunded,
the annual PSA wealth statements
might even discourage alternative
savings if stated weahh under the modified system
were to exceed perceived
wealth under the current one.
The second fundamental
change inherent
in the PSA proposal relates to modified contribution
rates for survivor and dependent
benefits. For convenience,
let us discuss benefits for children and spouses
separately.
The authors of the PSA proposal argue that a worker with
children
places the Social Security
system at greater
risk than a
worker who does not have children.
Focusing on the pay-as-you-go
nature of Social Security
as an intergenerational
transfer
program,
however, yields a different perspective.
It is the worker with children
who provides replacement
workers to pay benefits to future retirees.
In fact, the declining
birthrates
of recent vears are responsible
for
much of the projected
long-term
problem.
If we assume
an interest
in perpetuation
of the program
on some
basis, it can be argued that people who do not have children
place
the system at considerablv
more risk than those who do. Surviving
parents with children
now make up about 1.6 percent of all OASDI
beneficiaries.
According to the 1982 Trustees Report II-B projections,
this figure will decline to 1.1 percent bv the vear 2000 and 0.6 percent
in 2030. I_ If these benefits are a problem,
they are a small one and
they are one of diminishing
magnitude.
I_The 1982 Annual Report o[the Board o1 Trustees
Insurance
and Disability Insurance
Trust Funds
Administration,
1982), p. 84.
ol the Federal
(Washington,
Old-Age and &m,ivors
269
The inequities
in cntitlcmcnts
for spouses and widows/widowers
that the PSA advocates
are concerned
about are somewhat
more prevalent and possibly more troubling. Although Congress in the past has
treated
homemakers
who have never participated
in the labor torce
in one way, equity' considerations
may dictate alternative
policies in
the future. It is not clear, however, that the PSA approach
is the best
way to make the system more cquitable.
The Freedom Pla_z--A. Haeworth
Robcrtson,
a tormer chief actuary
of the Social Security Administration,
has proposed a basic modification of the existing system that he labels the Freedom Plan. This
proposal
is based on the premise
that some form of national
social
insurance
is required but that it is not necessary to define the system
for today's youth on the basis of a structure
established
nearly fifty
years ago. Hc points out that in mid-1981,65
perccnt of the total U.S.
population
under age sixty-five was less than thirty-five years of age. _
The Freedom Plan would take effect on July 4, 1984, by Robertson's
design, although
other implementation
dates could be selected. The
population
would be bifurcated
on the implementation
date; people
over age forty-five would continue
to be covered under the current
system, while people under this age would be covered under the new
system.
The Freedom Plan would include three elements: ( 1) a demogrant-Senior Citizen Benefit--payable
to all citizens upon attaining
age
seventy; (2)a governmental
investment
vehicle, "Freedom
Bonds,"
for voluntary
retirement
savings; and (3) a cost-of-living
supplement
for private pensions.
The "Senior Citizen Benefit" would be payable to all citizens meeting specified residency requirements
when they became seventy years
old. There would be no earnings
test or means test of any kind. The
eligibility
age is set at seventy on the basis that life expectancy
at
that age, when the system started providing
benefits, would exceed
life expectancy
at age sixty-five
in 1935, when the Social Security
program
began. The monthly benefit would be set at about $250 in
1980 dollars,
which compares
with an average benefit for retired
workers at that time of $295.51 in 1980. 2° For approximately
onethird of retired workers in 1980, the program
would have meant a
benefit increase. Two-thirds
would have received lower benefits, but
in many
instances
the decrease
would
have been more than offset by
P_A.Haeworth Robertson, Tile Comi_l_Revoluti_mi_lS_cial Security (McLean, Va.: The
Security Press, 1981),p. 297.
-'_lbid., p. 311.
27O
an increase
in the spouse benefit for married
couples. 2' The benefit
increases under the program
would go primarily
to persons with low
lifetime earnings.
The "Senior
Citizen Benefit"
would be indexed
for increases
in
average wages, the demogrant
program
would be financed
through
the general tax system, and the payroll tax would be eliminated
for
its participants.
The financing
provisions
would make the program
as redistributive
as the progressive
income tax. The benefits themselves would not be subject to the income tax.
Disability
benefits would be provided
to persons permanently
totally disabled.
There would be recency of work and residency
to qualify, and beneficiaries
rehabilitation
and retraining
and
tests
would have to agree to participate
in a
program.
The monthly
benefit would
be the same as the "Senior Citizen Benefit" and would be similarly
indexed. The disability
benefits would be financed and subject to the
same taxing provisions
as benefits provided to the elderly.
The second element of the program,
"Freedom
Bonds," would be
available
to any persons between the ages of forty-five and seventy
participating
in the Freedom Plan. Any person could purchase bonds
up to l0 percent of prior-year
earnings or l0 percent of average earnings, whichever
is greater. The value of the bonds would be indexed
each year for inflation and provide no additional
return above inflation. Since the bonds would be purchased
with taxable income they
would not be subjected
to any income taxes when redeemed.
The
bonds would be redeemable
by the purchaser
after age sixty or at
the onset of disability,
or payable to the purchaser's
estate at death.
"The purpose of the bonds is to offer a safe and inflation-proof
vehicle
to accumulate
a reasonable
supplemental
retirement
income during
the latter half of one's working life. ''22
The third tier of the Freedom
Plan would provide cost-of-livingadjustment
supplements
to pension plans. This provision would theoretically
extend to IRA accumulations
as well as to formal pensions
meeting the standards
set by the Internal
Revenue Service. Monthly
pension benefits
would be covered for all benefits
payable beyonct
age seventy. These supplemental
benefits would apply to both public
and private plans and would be financed through general revenues
as well.
The Medicare
and Supplementary
Medical
Insurance
programs
would be continued
in basically their current form with the eligibility
21Ibid.,
22Ibid.,
p. 312.
p. 318.
271
age moved to seventy. Persons eligible for disability
benefits would
be covered by the HI and SMI programs
as well, after a twelve-month
waiting period. Benefits would be financed through general revenues
and the payroll tax would be eliminated.
During the transition
to the new program, those persons who continued to be covered by Social Security would still be subject to the
payroll tax. Since the revenues from the diminished
tax base would
not meet the residual obligations
of the OASDHI program,
these obligations
would bc met through revenues from the general fund. In
this way, the tax burden for paying off the current program's
liabilities would be redistributed
toward higher-income
persons.
In the short term, there would be limited savings under the Freedom Plan. The cost of the basic demogrant,
HI, and SMI programs
would range between 25 and 30 percent
below that of the current
OASDHI by the time the baby-boom
generation
retirement
levels had
peaked, according
to Robertson's
actuarial
calculations.
23 If the Freedom Plan were implemented
as proposed, federal debt servicing costs
might actually
fall. Although the proposal calls for inflation protection on the bonds, it does not provide a real return. It is unlikely that
the federal government
could find such favorable
credit conditions
elsewhere
in the financial
markets over a sustained
period. The indexation
of pension benefits would be an entirely new benefit, not
provided by any facet of the current social insurance system. It would
raise the cost, but the amount of the increase would depend on economic conditions.
Estimates
have not been developed
on these potential extra costs.
The Freedom Plan is fundamentally
a "double-decker"
type of retirement program. The bottom deck would be provided entirely through
the federal government
and would grow with wages over time. The
top deck would be the responsibility
of the individual,
but the contents of that deck would be considerably
enhanced and facilitated
by
the government.
Although a double-decker
system of this sort may
be perceived
as something
radically
new or different,
it is not. As
Ahmeyer
notes, during 1940 the Social Security Board and President
Roosevelt
"were giving serious consideration
to recommending
a
'double decker' system providing
a noncontributory,
uniform, universal old-age pension, plus a contributory
variable pension. ''24 The
structural
difference
between
the Freedom
Plan and that plan deZ_Ibid., p. 333.
24Arthur J. Altmeyer, The Formative Yearsof Social Security (Madison: The University
of Wisconsin Press, 1968),p. 259.
272
veloped in the 1940s is that
bccn fcderallv administered.
the second
deck of the latter
would
have
If Congress should decide early in 1983 to move post haste on the
short-term
financing
but defer the long-term
issues for further consideration,
a double-decker
system of some sort mav be a more feasible option than other major modifications.
Should a program such
as the Freedom
Plan be considered,
certain
modifications
mav be
warranted.
At least three are apparent
from an equity perspective.
First, if the government
is going to provide some type of retirement
bonds as a hedge against
inflation,
there should be some provision
for real returns, at least when real returns are provided elsewhere
in
the market. Otherwise,
a policy may develop, either explicit or implicit, that would seek to minimize
federal debt costs at the expense
of individual
retirement
savings. The payout of the real returns could
be treated
as regular
income; tax provisions
could assure that no
undue advantage
was accorded
these vehicles. In addition,
it would
be desirable
to allow investors
to move their resources
into other
sectors of the financial market if they expect better returns elsewhere.
Second, bifurcating
the work force on an age- and date-specific
basis would cause a considerable
notch variation
in the retirement
provisions
accorded
to individuals
who were nearlv the same age. It
would be more reasonable
to allow initial beneficiaries
of the new
program
to become eligible to retire at roughly the same age as the
last cohorts retiring under the program being phased out. This could
be accomplished
bv phasing in higher retirement
ages for the younger
cohorts of the old program
or lower retirement
ages for the older
cohorts under the younger program.
Third, providing
unlimited
COLA increases
for pension beneficiaries might encourage
further expansion
of pension coverage
and
enhancement
of benefit levels, but the distribution
of benefits might
be somewhat
uneven across the income spectrum.
Providing
full indexation of these benefits at public expense might distort other broad
political or fiscal goals. As a result, limited COLA provisions
might
be more rational.
The senior citizen benefit program proposed bv Robertson would be
somewhat
cheaper
than thc current OASDHI program.
The savings
derive
primarily
Dora raising
the retirement
age. Although
the
new program would ahcv thc basic distribution
of benefits, it does not
appear to bc significantly
less generous, in the aggregate, than OASDHI
with comparable
normal retirement
age provisions. Further analysis of
the distributional
implications of this proposal is warranted before such
a change can bc seriously considered or implemented.
273
IX. The Future of Social Security
Discussion in the previous chapters has focused on Social Security
policy issues from a number of perspectives.
The analysis in many
instances was extremely
detailed, in some, perhaps, it was gruesome.
Anyone who has read this far may be disappointed
that a well-defined
list of "optimal"
solutions has not yet been detailed for solving the
"Social Security financing dilemma."
The difficulty in doing that is
that solutions have to evolve in the political arena. This discourse
has been designed to describe the background
and nature of Social
Security;
to define the position of the program in the broader retirement system that is evolving; to explain the nature of the program's
financing problem;
to present the main potential
solutions; and to
analyze their implications.
Based on a substantial
amount of work
reported on here, however, we can offer certain observations.
Recently it has become almost impossible
to get through a single
day without being exposed to a newspaper
or magazine article or a
television or radio news program addressing
the Social Security concerns of this society. Regardless
of the correctness
or appropriateness
of the content, these analyses are a fact of life. The stories tell of
worried old people who fear the monthly green Social Security checks
will not continue
to arrive on time. They tell of workers who are
convinced
the Social Security program
will not be there when they
retire. They tell of widespread
fear, resentment,
and consternation
among the American
people that should be resolved.
Redefining
the Goals
Social Security was established
in an era of economic uncertainty,
and the program
had a fairly specific set of goals. It sought to provide
a basic floor of income protection
for elderly workers at retirement.
It sought to provide
proportionately
higher benefits
to low-wage
workers than their high-wage
counterparts.
At the same time it established
a link between preretirement
earnings and postretirement
benefits. It provided a financing mechanism
tied to wages, partly as
a practical
matter but also on political grounds. President
Roosevelt
believed that payroll tax financing would give people the impression
they were paying for their benefits, and he proved to be correct. He
also believed that "earned"
benefits would be less subject to political
manipulation
than benefits financed through some alternative
mechanism.
275
In some ways Social Security can be characterized
as a conservative
response
to growing demand
for government
protection
of its citizenry, especially
in old age. The Townsend
movement
during
the
1930s was proposing
a monthly benefit of $200 per month for everyone age sixty or over who was not working. Monthly benefits of this
size in the mid- 1930s would be comparable
to paying people over age
sixty today between
$1,400 and $1,500 per month. The Townsend
movement
was a major concern of President
Roosevelt according
to
Ahmeyer
and Witte, two central participants
in the development
of
the Social Security program.
The Social Security program
that was designed by the Committee
on Economic
Security and modified
and implemented
by Congress
was much smaller
than the leading
alternative
of the time. Even
taking into account the additional
benefit categories
that have been
added to Social Security and all the historical growth in benefit levels,
Social Security
is still a smaller program
than the Townsend
plan.
If everyone over age sixty in the United States today were provided
a monthly
benefit of $1,400, the cost of the program in 1982 would
be at least $600 billion.
The Social Security Act has been changed many times as the program has grown to be the single largest central governmental
activity
outside the realm of national defense. At the same time, the social,
demographic,
and economic
characteristics
been changing.
This dynamic adjustment
current state of affairs.
of the U.S. society have
process has led us to the
Generally,
public policy development
is an incremental
process.
Revolutions
or "big-bang"
phenomena
do not regularly
occur in stable societies. People have an inherent resistance
to radical change in
major institutions
because of the disruption
and destabilization
such
change brings to their lives. Over the years the Social Security Act
has been incrementally
adjusted;
coverage was gradually
extended,
benefits
were added, the formula was modified, and tax rates and
the wage base were adjusted
accordingly.
As the Congress convenes
in 1983, it must readdress
the fundamental
issues relating
to Social
Security. Before dealing with the funding problem at hand, Congress
might well stand back and reconsider
several aspects of public retirement
and economic policy in general.
When the Social Security Act was passed in 1935, the basic socioeconomic unit in society was the "nuclear"
family. The nuclear family
then was typically
a husband who worked, a wife who was a homemaker, and several children.
The nuclear family had evolved from
the "extended"
family in which the grandparents
often lived with,
276
or wcre supporled
bv their own children. It was, to some extent, the
decline of the extended
family that gave rise to the development
of
Social Securitv.
Older parents
were no longer living in their adult
children's
homes, yet they still needed support.
Since 1935, the nuclear family itself has changed,
both in composition and behavior.
The prevalence
of single-parent
households
and
two-earner
couples has radically
changed the population
landscape.
Whether the prevalence
of working women has led to lower birthrates
or vice versa is immaterial;
what is important
is that the majority
of women are now earning
their own Social Securitv
entitlements
and that there will be fewer workers in the future than there would
have been if historical
birthrates
had prevailed.
Both phenomena
have implications
for retirement
policy development.
In the case of couples, Congress should consider whether the concept of husband-earner
with a wife-homemaker
is still the appropriate
premise
for the program.
It should consider
the horizontal
equity
issues that arise between single-earner
couples and two-earner
couples (discussed
in chapter VIII). Because of the lower birthrates
that
have prevailed
in recent years, Congress
also must set a modified
course tot the twenty-first
centurv. It should consider the implications
and desirability
of the alternative
options for raising revenues
or
reducing costs. These considerations
should be conducted in a broader
context of general socioeconomic
goals, of which Social Securitv financing is only one part.
When the Social Security Act was passed in 1935, few workers were
participating
in a pension program. There were no tax incentives
to
encourage
people to save for their own retirement
income security.
Prior to the Great Depression,
there were no bank or savings and loan
insurance
programs
to protect against
the failure of financial
institutions. Today the situation
of workers is radically
different.
Social
Security
is by far the largest element of the elderly's retirement
resources in 1982, but its relative position is changing and will be less
significant
in the future. This different
economic
environment
has
implications
for the development
of retirement
policy in general and
for Social Security policy in particular.
During its early years, the Social Security
program
was largely
"managed"
by the Congress. This does not mean that Congress kept
the earnings records or sent out the checks. The term refers to periodic
congressional
review of the benefit structure
and levels and funding
adjustments.
After providing large benefit increases in the late 1960s
and early 1970s, however, Congress significantly
altered its role. Congress sought to move the program to an automatic
adjustment
process
277
so that benefit levels would be maintained
in real terms over time,
but would be less subject to political manipulation.
The problems
that arose from that adjustment
have been detailed earlier, especially
in chapters
IV and V. Even after the adjustments
in the indexing
provisions
made by the 1977 amendments
problems
have persisted.
During the deliberations
of the National
Commission
on Social
Security Reform the potential of further indexing opportunities
have
been explored. Implementation
of provisions for further indexing would
move Social Security even closer to automatic
self-adjustment.
The
members of the Commission
have considered
a variety of options that
would: (1) index the normal retirement
age to account for increased
longevity; (2) index the payroll tax rate to maintain
fund balances;
and (3) index the payroll tax to offset increases
in nonwage benefit
costs not subject to the payroll tax. About the only thing not considered was indexing the birthrate.
The policy issues that must be considered, however,
relate to whether
the Congress
wishes to retake
greater control of this program
or cast it further into the mode of
automatic
adjustment.
Evaluating
Specific
Options
A wide range of options for addressing
these issues has been presented and discussed
in chapters
V through VIII. Various considerations
are important
in determining
which
options
deserve
congressional
review. Certain options seem to be outside the realm
of reason; for example,
eliminating
any form of social insurance
is
in this category. Moving the social insurance
system from an entirely
public system to a more evenly divided public-private
system might
deserve consideration.
Such a change should not be done in an impetuous
short-term
fashion that would drastically
alter the expectations of workers near retirement
or reduce benefits for those already
retired. Nor should it be based on assumptions
of unreasonable
rates
of return
in private
investment
markets
or wildly optimistic
assumptions
about future increases in productivity.
The discussion
financing situation
in chapter
IV indicates
that in the short term there is not much room or time
to maneuver.
The OASI trust fund must borrow from the HI and DI
trust funds in November
1982; it can borrow enough through the end
of December
1982 to meet benefit schedules
beyond July 1983. Even
if interfund
borrowing
authority
is extended,
the three trust funds
would probably
be depleted sometime
in 1984, and certainly
during
1985. These projections
are not meant to frighten anybody;
they are
278
projections
made by the Social Security actuaries
and they indicate
a situation
worthy
of concern,
not panic. The important
point to
understand
is that the short-term
problem is surmountable.
The discussion
in chapter
V describes
Social Security's
financing
mathematics.
Over short-run
cycles, Social Security is susceptible
to
two problems:
(1)under
current benefit indexation
procedures
and
in certain economic
conditions,
the ratio of average benefits to average wages is unstable;
(2) the ratio of the number of beneficiaries
to the number
of workers varies directlv with unemployment.
The
product
of these two ratios defines the tax rate required
to finance
Social Security.
With no significant
trust fund balance,
Social Security has been buffeted by unemployment
that has been higher than
expected
and by faster growth in average benefits than in average
wages in recent years. As a result, the legislated
tax rates have been
insufficient
to meet the benefit obligations.
A degree of stabilitv
can be established
bv adjusting
the benefit
indexation
provisions
so that benefits do not grow more rapidly than
wages in the future. Because the ratio of beneficiaries
to workers will
never be completely
stable, trust fund balances somewhat
larger than
those maintained
in the early stages of the early 1980s should be
maintained
in thc future. Chapter
V discusses
several options for
meeting
the short-term
financing
imbalance.
In resolving the problems associated
with Social Security, Congress
must pursue
four basic policy goals. Two of these, adequacy
and
equity, have been traditional
concerns
of policymakers.
The other
two goals for Social Security policy are solvencv and support.
In the
past, these latter goals have been met without
much concern;
solvency and support just happened.
With the maturing
of the program
and the blossoming
of tax rates and solvency problems,
these goals
will require
much greater
attention
in future policy deliberations.
The combination
of the four goals--adequacy,
equity, solvency, and
support suggests that the burden of adjusting
Social Security should
be widely shared by American societv. The more widely the burden
can be distributed,
the smaller will be the burden on any one segment
of society.
In the long term, the financing
problems
also appear to be surmountable.
The policy options are somewhat
more varied than in the
short term, however. They aim basically at adjusting
the level and
distribution
of benefits to be provided by Social Security in the future.
Some of the commonly
discussed
options would not have any effect
on benefits
for ten to twenty years; others would begin to adjust
benefits almost immediately
but accomplish
the adjustment
over a
279
long, gradual
transition
period. The options break down into two
categories.
One set of proposals
would raise Social Security's
normal
retirement
age. Such a policy might also raise early retirement
ages
but it would not necessarily
have to do so. A second set of proposals
would adjust the benefit formula over a number of years in a method
different from the method now used. Raising retirement
ages or slowing the growth of future benefit entitlements
are both widely characterized
as benefit reductions.
For example,
growth in the
amounts
that
worker when
determine
the
an option
PIA formula
arc applied
that person
basic Social
evaluated
in chapter
VI would slow the
bend points. These bend points are dollar
against the average lifetime earnings
of a
reaches retirement
age; the bend points
Securitv
benefit entitlement
for an indi-
vidual. These bend points are increased
each year by the growth in
average wages. If they were indexed at 75 percent of wage growth
for sixteen years instead of full wage growth, under assumptions
used
by Social Security's actuaries,
the new beneficiaries'
average benefits
relative
to current
law would be reduced
by an average of roughly
10 to 11 percent bv the end of the transition
period. Because expected
wage growth
would still increase
the bend points under this approach,
average new benefits would still have greater purchasing
power for persons who retired at the end of the transition
than current
benefits have.
The simulation
results in chapter III estimated
that average tamily
Social Security benefits at age sixty-five ['or individual
persons aged
twenty-five
to thirty-four
in 1979 would be about 70 percent higher
than benefits at age sixty-five for persons aged fifty-five to sixty-four
in 1979 under current policy. Benefits relative to current policy would
be about 11 percent
lower if the 75 percent bend point indexation
were implemented,
but they would still be about 50 percent higher
than benefits
for the older cohort under current
policy. To characterize such benefit modifications
as a benefit reduction
is to assume
that the current policy benefits are already in the bank. It is no more
realistic
to assume that we can precisely define the retirement
benefits [or workers thirty years old today than to assume that we can
tell these people what a new automobile
will cost at their retirement
age. If a benefit structure
is in place that assures them a benefit, one
that grows in real terms over time as wages grow, then this assurance
will provide a foundation
on which other elements of the retirement
system can be based.
Raising the retirement
age has also been considered
as a way to
adjust Social Security benefits in order to help balance the projected
280
long-term
funding equation.
This approach
is also frequently
characterized
as a benefit reduction.
The simulation
results in chapter
VI, indeed, show such reductions
relative to current policy. The benefit reductions,
in aggregate,
from raising retirement
ages may be
roughly compared
to those accomplished
bv slowing initial benefit
growth,
however.
An important
distinction
between
the two approaches
to reducing
Social Security costs is the difference
in their
distributional
effects. Raising the Social Security
retirement
ages,
both earlv and normal, would completely
eliminate
payments
to some
people who would receive them under current policy. This phenomenon occurs because Social Security benefits are not paid to the deceased and there is no rebate of contributions
on which benefits are
not paid. Raising Social Security's
retirement
age will exclude some
persons from receiving
benefits who would receive them under current policy because
they will die prior to reaching
the higher age.
Others will receive benefits for a shorter period because they will die
soon after retirement
and their period of receipt will be shortened.
Finally, others will retire earlier, relative to Social Security's
normal
retirement
age and receive a benefit that is actuariallv
reduced to a
greater extent than under current policy.
Increasing
life expectancy,
which is accentuating
Social Securitv's
financing
problems,
cannot be ignored, however.
People today are
living longer, on average, beyond age sixty-five than thev did ten or
twenty years ago or in 1935, when Social Security's
normal retirement age was established.
Increases
in life expectancy
are expected
to continue for the foreseeable
future. In the abstract this increase in
life expectancy
would lead directly
to the conclusion
that people
should be able to work longer, but the increased
incidence
of disability and health problems among older workers, in combination
with
the benefit exclusions
that result from early death complicates
this
conclusion.
Nonetheless,
.just as outcomes
from modification
in benefit formuias can be compared
with the current
levels of benefits, the same
analvtical
criteria
can be applied
to options for raising retirement
age. The concerns over exclusion of some potential
beneficiaries
under
higher retirement
ages is equally appropriate
for the current
eligibility criteria. The worker who dies today at age sixty gets no benefits
from Social Security.
He or she mav indirectlv
receive such benefits
through the spouse and survivor provisions, but those provisions would
continue
to apply even if retirement
ages were raised.
The death exclusion
alreadv exists for people who do not meet the
eligibility
criteria
or accept benefits. The question is, what arc the
281
relative rates of exclusions that result because a particular
retirement
age is applicable?
If retirement
age remains
constant
while life expectancy
rises, then the exclusion affects diminishing
shares of each
successive
cohort of workers. If retirement
age rises gradually
as life
expectancy
rises then the death exclusionary
effect could be held
roughly constant over time. Although disability and health problems
would increase as retirement
ages are raised the Social Security Disability Insurance
program
should ameliorate
part of that problem.
If the response
is insufficient
then additional
provisions
might be
required
that would reduce the savings from raising retirement
ages.
Regardless
retirement
age policy the prevailing
decline in birthrates
over the past twenty-five
years may mean that
the economy will require extended working lives. To some extent, the
size of the baby-boom
generation
and the withdrawal
of these people
from the labor market at retirement
will lead to somewhat
higher
wages. Those higher wages will affect the tradeoff between labor and
leisure or work and retirement.
If the financial incentives
for working
increase,
they will naturally
encourage
older workers to stay in the
job market longer. Massive retirements
of the baby-boom
generation,
however,
could still create labor shortages
that would lead to a decline in gross production.
If such declines in gross product occur, they
would coincide with retirees demanding
a larger share of a smaller
total. Will this phenomenon
occur? No one knows for sure. Might it
occur? Yes.
Raising additional
revenues through the payroll tax or alternative
sources would help resolve the projected
problem. To raise reserves
now to the extent required to balance the system over the long term
would cause the trust fund accumulation
problems
discussed
in the
previous chapter.
Unless provisions
are made to handle those trust
funds, raising
taxes might create even more problems.
To merely
schedule
future tax increases sufficient
to meet the long-term
problems would be to levy on today's children and those not yet born, a
burden that current or prior generations
have been unwilling to bear.
Will future taxpayers
be willing to accept that burden?
Maybe they
will; possibly they won't.
There is the distinct possibility
that the adjustment
or alternative
structure
that comes out of this process will result in an overfinanced
system in the future. If that is the case, policy corrections
will be easy
to achieve: either benefits can be raised, or taxes reduced. There is
also the possibility
that the adjustments
will not be sufficient;
the
choice in this case will be much harder.
282
Congress could move toward a system that indexes retirement
age,
taxes, initial benefit entitlements,
and postretirement
benefits,
but
there are problems
with this approach
stemming
from Social Security's role in the broader
economic
structure.
If employer
pensions
do not move in lockstep with the automatic
Social Security adjustments, perverse
benefit distributions
could result. Legislation
could
require employer
programs
to move in unison with Social Security,
but employers
are influenced
by a wide range of physical, economic,
and technological
factors in determining
their work force policies
and pension programs.
To entirely constrict the ability of employers
to adjust their own pension programs
to fit their particular
circumstances could destroy some employers'
economic
viability.
Furthermore, unt'oreseen
periodic
modifications
to their other retirement
programs
to stay in step with an automatically
adjusted
Social Security program
would complicate
the establishment
and funding of
pensions.
Finally, adverse economic
circumstances
or technological
change could place older workers who lack alternate
provisions
in
particularly
precarious
positions.
Furthermore,
there is some merit in requiring
Congress
to vote
periodically
on the relative burden of taxes and level of benefits. The
process of indexing personal
income tax rates through bracket creep
has been one of the most heated political issues of recent years. The
phenomenon
in the case of bracket creep is somewhat
more subtle
than the explicit indexation
of payroll taxes would be. The indexing
of retirement
ages may not be warmly received, either. Telling young
workers that they will be required
to work a couple more years than
their parents
is one thing, but making
them watch their expected
retirement
age creep further and further up the age spectrum
could
be quite another.
The analyses in chapters V through VIII describe a fairly wide range
of options that the Congress could mix and match to restore financial
soundness
to Social Security. The analyses in chapters V and VI present some of the distributional
questions
to which Congress should be
sensitive
in adjusting
the current
system. It should be understood
that random combinations
of options mav result in less savings than
the sum of the separate
savings of each option. Similarly,
certain
combinations
of options could have significantly
greater impact on
benefit levels and distributions
than each option separately.
For example, slowing the growth of initial benefits in combination
with
raising the retirement
age would cause greater changes
in benefit
levels and distributions
than either option taken separately.
In some
283
instances,
combinations
of policy
effects on the elderly of the future.
Maintaining
Incentives
changes
for Private
could
have
devastating
Programs
The simulation
analysis
that has been discussed
throughout
this
report has assumed
that pension and individual
retirement
savings
incentives
will be maintained
in the future. On this basis it was assumed that gradual
growth
and use of these alternate
retirement
vehicles would continue.
These assumptions
are central to the analysis of the effects of Social Security modifications
on the total income
security of the elderly.
Some people advocate
radically
modil_ving the tax treatment
of
private
retirement
programs
for purposes
of general
revenue
enhancement
or Social Security
financing.
Before policymakers
seriously consider such proposals
they should scrutinize
the implications.
If the retirement
income provided
bv vehicles other than Social Security is reduced
for future retirees,
the eflects of Social Security
modifications
will become much more pronounced.
If private provisions were Completely eliminated,
the demands on Social Security
would increase
significantly
beyond those discussed
in chapters
IV
and V.
If private retirement
programs
were eliminated,
or even diminished, pressure to expand Social Securitv in the long term would be
increased.
While the elimination
or curtailment
of private retirement
programs
may appear to be an attractive
idea to some policy analysts,
Social Security's
current
financing
problems
would be dwarted
by
the magnitude
of the problems
that course would entail.
In 1980, Social Security actuaries
analyzed the costs of a National
Pension Plan that would maintain
living standards
during retirement. I First, they estimated
the levels of income replacement
required to meet their adequacy
goals t0r benefits and then compared
these levels of income replacement
with the levels provided by Social
Security.
A pension plan was designed
to provide benefits that corresponded
with those requirements.
The plan would provide benefits
only after age sixty-five. The plan included provisions
for earnings
sharing
and survivor
benefits and other adjustments
to coordinate
Social Security with the overall income targets specified in the plan.
JFor a complete duscription ol this plan and its costs see Dwight K. Bartlcn, Ill,
"National Demographics and Private Pensions," Conterenc¢ of Actuaries in Public
Practice, Cambridge, Mass., October 7 and 8, 1982.
284
The plan was assumed
to cover all workers,
including
those now
exempt from Social Security participation,
and to take effect in Januarv 1982.
The long-term
cost projections
of the current OASDI system based
on the intermediate
assumptions
Report are
shown in table IX-1. The table also shows the cost of the current
svstem projected
at that time assuming
universal
Social Security
coverage. The universal coverage estimates
are shown so the marginal
cost of the National
Pension Plan can be compared
with the cost of
the current system on the same employment
base.
Implementing
a national
pension plan that, in combination
with
Social Security,
would meet the stated benefit goals and be funded
bv payroll
taxes on a pay-as-you-go
basis would raise the seventyfive year average cost of the federal retirement
program by 63 percent.
TABLE
Projected
with
IX-I
Expenditures
of OASDI
Under
1980 Policy,
Universal
Coverage
and with
Hypothetical
National
Pension
Plan
Estimated
Expenditures
Taxable
as a Percentage
Payroll
of
Current
System
Current System
with Universal
Coverage
Hypothetical
National
Pension Plan
1980-2004
2005-2029
10.66
13.57
9.09
11.86
12.50
20.28
2030
16.98
15.18
26.01
13.74
12.05
19.59
25- Yea r Averages
2054
75- Yea r Average
1980-2054
Sources:
Note:
1980 Social Security Trustees Annual Report, p. 75; and Dwight K. Bartlett,
ill, "National
Demographic
and Private Pensions,"
Conference
of Actuaries
in Public Practice,
Cambridge,
Mass., October 7 and 8, 1982, p. 10.
These projections
arc based on the intermediate
(Alternative
II) set of assumptions
appearing
in the 1980 OASDI Trustees Report. Total taxable payroll is adiusted
to take into account the lower tax rates on self-employment
income and on tips as computed
to the employer
rates, and is also adiusted
to take into account the elimination
of the wage base. The Universal
Coverage
OASDI system
is an extension
of the present
OASDI svstern to cover the
earnings
of federal,
state and local government
employees,
and employees
of nonprofit
organizations,
beginning
January
1, 1982. The Hypothetical
National
Pension
Plan is an extension
of the Universal
Coverage
OASDI
system to provide
supplementary'
old-age and disability
pension benefits to
those newly entitled
persons
after January
1, 1982.
285
It would raise these costs by 71 percent during each of the last two
twenty-five-year
periods in the projection
period. The payroll tax now
legislated
beyond 1990 would meet only about half the projected cost
of the system beyond the turn of the century.
Furthermore,
moving away from the current combination
of Social
Security and private provisions may be compared
to "eating the seed
corn" in more than one way. Private pension assets at the end of 1981,
estimated
from Federal Reserve data, amounted
to $520 billion. State
and local pension assets added another $222 billion. The combined
assets in these pension plans amounted
to 12.3 percent of all outstanding
credit extended
to the U.S. credit markets. The figure, up
from 3.0 percent in 1950, represents
a thirty-year
pattern of steady
growth .2
Pension assets are among the most important
sources of capital in
this country
today and their role is growing. The potential
of IRAs
as a source of long-term
savings is only beginning to be realized. Both
pensions
and IRAs will contribute
to capital growth in the future,
which is particularly
important
during a period of reindustrialization
in this country.
Furthermore,
these assets will provide the elderly
with a retirement
income claim on the capital
base of the United
States economy, which Social Security cannot provide under current
financing
arrangements.
Given the uncertainties
of the public's acceptance
of higher taxes, that claim is worth preserving.
Maintaining
Flexibility
This report has been filled with projections
and estimates
from
many sources. The story that these numbers
tell is that the future
may not be as dismal as a narrow focus on Social Security's
current
financing projections
would suggest. While it is impossible
for anyone
to predict the future with great accuracy, some trends can be observed
and their outcomes predicted.
For example, American society is aging,
and it will continue
to do so. In addition,
pensions are growing in
importance
as a source of retirement
income security, and they will
continue
to do so in a favorable
policy environment.
Although
the
aging of society is bound to put extra stress on Social Security,
the
growth of pensions can help to relieve some of that burden.
These two countervailing
trends suggest that Social Security can
adjust in the future to meet the needs of society. The uncertainty
in
2Sophie M. Korczyk, Retireme_tt Opportumties
i_l an Agi_llg America:
Eco_tomy (Washington,
D.C.: EBRI, 1982), p. 46.
286
Pe_tsio_ts and the
the extent of changes in the economy,
productivity,
birthrates,
life
expectancy
and a host of other factors suggests adoption
of a Social
Security
policy that allows some margin for error. This means that
any policy changes made in the current environment
should not promise
more for the future than we are sure we can provide.
One has to assume that future Congresses
will be better equipped
in ten or twenty years hence to assess appropriate
benefit and taxing
provisions
in their respective
times. Policvmakers
then wilt be better
able to judge the relative needs and capabilities
of their society and
economy than anyone in Congress can judge today. If we cannot trust
the future political process in this society, we should be seeking not
to insure ourselves against that process, but to change it fundamentally.
287
Appendix A
Model
Income
Simulation
This appendix
dcscribes
the Pension and Retiremcnt
Income Simulation Model used to simulate
the current
U.S. retirement
system
in chapter Ill. The model is also used to simulate the alternative
longterm Social Securitv
policy options discussed
in chapter
VI. A brief
description
of each of the main components
follows. A more detailed
description
of the model is available
from the Employee
Bcnefit Research Institute
on request.
The
Input
Database
The database
uscd at the beginning
of the simulation,
which was
developed
by ICF Incorporated,
includes a combination
of data gathered from four separate
databases.
Three of these were sets of interview data from the Census Bureau's Current Population
Survey. The
tourth consisted
of administrative
record data from the Social Security Administration.
A schematic
of the component
elements in the
combined
data set is shown in figure A-1.
Because of the sample design used for the CPS, which is a monthly
survey, there is considerable
overlap from month to month of the
people who are interviewed.
In March of each year, the Census Bureau
includes
an extensive
supplement
to the basic interview
which ascertains
detailed
information
on employment
and earnings. The annual March interview gathers this information
for more than 100,000
adults. The March 1978 CPS questionnaire
responses
were matched
to Social Security
administrative
records bv Social Security
numbers, name, and sex.
Each vear half of the March sample overlaps
the sample administered bv the CPS the following
Mav. During May 1979, the CPS
included
a special supplement
that ascertained
pension coverage,
participation,
and vesting information
for persons who had also been
surveved
in the March 1979 CPS. Slightly more than half the people
interviewed
in the March and May 1979 survevs had also been in the
CPS sample in March 1978. In the end, then, there were about 28,000
persons for whom there were data in each of the four separate
databases.
The combined
ployment-wage
database includes pension information
along with emrate, industry, size of firm, age, sex, hourly/salaried
289
290
status, years of service on current job, Social Security coverage, union
status, marital
status, and a host of other information
for 1979. The
database
also includes
employment,
earnings
and income data, by
source, for the years 1977 and 1978. It includes Social Security quarters of coverage earned for the years 1937 to 1977 and annual taxable
earnings
for 1951 to 1977. This combined
information
is available
on
an individual
and family basis; that is, when married
couples are
included,
information
is available
for both spouses.
The
Work
History
Model
In the first stage in the PRISM simulation process, the model takes
the input database as its definition of the population
in 1979. Then,
by using a Monte Carlo simulation
process (described
below), the
model estimates
annual hours worked and earnings level as well as
changes in family and health characteristics
for each year until retirement.
The model simulates a series of discrete events for each person for
each year in the simulation.
One of the events that is simulated
is
the life or death of a person that year; based on age and sex, the
probability
of a person's dying in any given year is known from Social
Security data. For cxample, assume that thc probability
of death for
a fifty-three-year-old
man is 1 percent; the Monte Carlo process simulates the experience of such a man on the basis of drawing a random
number between zero and onc. If the random number actually drawn
falls below 0.01, the person is trcated as if he had died. If the number
drawn falls between 0.01 and 1.00, hc is treated as living through the
year and becoming a year older. Since only 1 percent of the random
number drawn will fall below 0.01 when many such numbers
are
being drawn, only 1 percent of the fifty-three-year-old
simulation
will die each year.
men in the
The work history model estimates the occurrence
of eight separate
events for each person each year until the person dies or reaches age
seventy: (l)whether
the person dies, becomes disabled, or recovers
from a disability;
(2)whcther
the person marries, gets divorced, or
remarries;
(3) whether
a woman gives birth to a child; (4) whether
the person decides to accept a pension or Social Securitv
benefit;
(5) whethcr thc person works, and if so, the number of hours of work;
(6) whether the person changes jobs; (7) if the person changes jobs or
enters the work force, the industry of employment;
and (8) the wage
rate for the person.
291
The simulation
of each of these events is accomplished
abilities estimated
from recent Census Bureau, Bureau
using probof Labor Sta-
tistics, and Social Security Administration
data. A general schematic
of the model is shown in figure A-2. The information
generated
by
the work history simulation
contains
sufficient
information
about
marital
status,
labor-force
participation,
and retirement
program
coverage
to estimate
both Social Security
and pension benefits for
each person.
Each worker's
pension coverage status in the first year is determined directly from the input database.
Coverage of workers changing jobs or entering
the work force is estimated
as a function of the
person's
industry
of employment,
hours worked, age, and indexed
wage rate. This relationship
is based on coverage rates reported
for
job changers
and labor-force
entrants
in the May 1979 CPS. Over
time, pension coverage is provided to some workers who do not change
jobs and who were not previously covered. This, in essence, provides
for pension plan growth with the passage of time. For workers covered
by multiemployer
plans who change jobs but remain in the same
industry,
there is no change in plan coverage.
A pension plan sponsor selected from a representative
sample of
more than 300 employer
retirement
plan sponsors
is randomly
assigned to each covered worker. This representative
database
is stratified bv industry,
including
federal, state, and local employers;
size
of firm; and muhiemployer
and single-employer
plan sponsors. The
database
includes plan provision data for both the primary and supplemental
defined-benefit
and defined-contribution
plans offered by
public- and private-sector
sponsors. The database
includes all relevant plan provisions
for participation,
vesting, hours crediting,
retirement,
death, disability,
joint and survivor
benefits, and Social
Security
integration.
Within an industry, in a firm of a given size in
the multi- or single-employer
category,
the probability
of being assigned to a given plan sponsor is proportional
to the number of persons actually covered by that plan sponsor. The model assigns a specific
plan or set of plans to each person for each period of covered employment.
The assignment
is random from a group of plans matched
to the worker on the basis of industry,
size of firm and employment
characteristics
of the worker.
The
Retirement
Benefit
Model
Retirement
benefits are estimated
for individuals using the simulated work histories and their record of participation
in retirement
292
FIGURE A-2
PRISM Work History
PENSION
AND SOCIAL
Simulation
SECURITY
Model
DATABASE
RECORDS
-- Social Security data and assumptions
1. DEATH AND DISABILITY
Using National Center for Health
Social Security data
2. MARITAL STATUS TRANSITION
--
By age, education,
From longitudinal
3. CHILD BEARING
[
Statistics
hours worked, number
analvsis of CPS data
I
(NCHS)
and
of children
1
-- ACCEPTANCE
From longitudinalOF analysis
of CPS data
4.
RETIREMENT
BENEFITS
[
1
--
By age, sex, marital status, education
From longitudinal
of CPS data
5. HOURS
WORKED analysis
ANNUALLY
6. JOB CHANGE
--
Bv age, hours worked, years of service
From longitudinal
analysis of CPS data
7. INDUSTRY
---
OF EMPLOYMENT
Fox" job changers,
From longitudinal
-From longitudinal
8. WAGE
RATES
labor force entrants
analvsis of CPS data
analysis
ot CPS data
I
I
I-[
REPEAT PROCESS FOR EACH SIMULATION
Source: ICF Incorporated project staff.
YEAR
]
293
programs.
The first step in the benefit simulation
model is the calculation of Social Security
benefits based on the wage history. The
primary
insurance
amount
is determined
on the basis of covered
earnings
used to derive the average indexed
monthly
earnings
as
defined in current
law. The benefit formula and taxable wage base
were assumed to adjust in accordance
with the assumed rate of wage
growth assumed
in current
law. The Social Security benefit level is
calculated
on the basis of the PIA and age at retirement.
Benefits are
also calculated
for survivors
of persons who died during the simulation.
To calculate
the pension
benefit, the model first considers
each
worker's history of covered employment.
The model determines
benefit eligibility
on the basis of annual hours worked, tenure of employment in the covered job, creditable
service, and vesting standards
in the plan. If a person is vested, the model uses the benefit formula
in the plan to determine
benefits based on creditable
service. If the
plan is integrated
with Social Security, the model adjusts the benefit
according
to the plan formula. If there is a supplemental
plan, the
model also calculates
benefits in accordance
with the participation
requirements
and benefit or contribution
standards
in the plan. To
determine
total pension benefits, the model undertakes
this process
for each plan in which the worker vests.
In addition to Social Security and employer pension entitlements,
the model estimates
the level of benefits,
in the form of annuity,
purchasable
through IRA accumulations.
IRA accumulations
are estimated on the basis of the earnings history and family characteristics
generated
by the work history model. The probability
of a worker's
adopting
an IRA in any given year of the work career is based on the
worker's
age and family earnings
levels. These probabilities
were
derived from Internal
Revenue Service data on IRA utilization
and
the May 1979 CPS, which included questions
on IRA usage. After an
IRA is established,
using the Monte Carlo technique,
the model calculates annual contributions
as a function of family earnings.
After estimating
benefits from Social Security, employer-sponsored
plans, and IRAs, the model accumulates
total retirement
benefits for
each person in the simulation.
These benefits can be accumulated
either in the form of an annuity or a lump-sum
value, although
in
this project the model converts all employer-sponsored
plan benefits
to life annuities.
As a result, it is possible to examine
the impact of
changes in the accumulation
of retirement
wealth and in the payment
of these benefits during retirement.
294
Once employment-related
retirement
benefits are estimated,
the
model simulates
benefits from the Supplemental
Security
Income
program
in three steps. The first step determines
an individual's
or
married
couple's SSI eligibility
status; once eligibility
has been determined,
the model calculates
the benefit amount.
Because about
25 percent
of all SSI benefit amounts
are provided
through
state
supplementation,
the model accounts
for increased
benefits
in the
major states providing
such benefits. The state of residence
for this
purpose
is assumed
to be the state in which the individual
resided
during
1979. Finally, based on estimated
participation
rates in the
program,
the model simulates
participation
or nonparticipation
in
the program
for individuals.
Figure A-3 displays the general structure
of PRISM's benefit simulation component.
295
FIGURE A-3
PRISM
Retirement
Benefit
Simulation
Model
!
WORK
HISTORIES
FROM
PRISM
WORK
HISTORY
MODEL
1
I
|
1. SOCIAL SECURITY
BENEFIT
ESTIMATION
-- Simulated
work history data for 1979 to retirement
-- Actual data on Social Security
coverage and taxable
earnings
prior to 1979
2. EMPLOYER
--
Earnings
Model
--
Actual
RETIREMENT
and hours worked
benefit
provisions
1
PLAN BENEFIT
simulated
of plans
ESTIMATION
in the Work History.
to which
assigned
1
3. IRA ADOPTION
----
DETERMINATION
Probability
of adoption of IRA
Estimated
annual contribution
Annual income from IRA when retired
4. SSI INCOME
---
Earnings and retirement
income
Eligibility
and benefit provisions
simulated by model
of program
1
BENEFITS
ACCUMULATED
Source: ICFIncorporated project staff.
296
FROM ALL SOURCES
]
Appendix B
Calculating Social Security Benefits
1977 Social Security Formula
This appendix presents the basic steps required
Security
benefits under the formula established
ments to the Social Security Act.
Wage
Under the
to determine
Social
bv the 1977 amend-
Indexing
The first step in calculating
a Social Securitv
benefit under the
formula established
bv the 1977 amendments
is to calculate the AIME.
The AIME is based on actual covered earnings in each year multiplied
by a wage index. A worker's actual covered earnings
on his or her
Social Security account are indexed up through the second year prior
to the worker's reaching age sixty-two. People reaching age sixty-two
in 1981, {'or example,
had their wages indexed
through
1979. Any
earnings
they receive beyond 1979 are treated at their actual face or
nominal value.
The index used to adjust wage histories is based on historical
average wages. The averages for the period 1951 to 1977 represent
the
average wage level in covered employment.
Beyond 1977, the average
wage is based on growth in total wages in both covered and noncovered employment.
The average wage series for computing
the indexing factors used by the Social Security Administration
are shown in
the second column of table B-1.
The annual indexes are derived bv dividing average wages in the
second year prior to attaining
age sixty-two by the average wage in
each prior year. For example, the earnings
for a worker who turned
sixty-two in 1979 are indexed through
1977 when the average wages
were $9,779. The index to be applied against 1976 earnings
is derived
by dividing
the average wage in 1979 ($9,779) bv the average wage
in 1976 ($9,226). The quotient equals 1.060 and is shown in the fourth
column of table B-I for 1976. Each annual indexing
factor for t979
is derived on the basis of 1977 average earnings
in this fashion.
For people reaching age sixtv-two in 1980, the basic year is 1978,
when average wages were $10,556. The 1980 index is derived by the
same procedure
as the 1979 index, but the higher basis raises the
index for each vear prior to 1978. The indexes increase each year at
the same rate as average wages grew in the basis year.
297
TABLE
B-1
Indexing Average Wage Series, Annual Maximum
Taxable Earnings. and Wage Indexes Used in
Calculating
Social Security AIME, 1979-1982
Year
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
Source:
298
Average
Annual
Wage
Se_es
$ 2,799
2,973
3,139
3,156
3,301
3,532
3,642
3,674
3,856
4,007
4,087
4,291
4,397
4,567
4,659
4,938
5,213
5,572
5,894
6,186
6,497
7,134
7,580
8,031
8,631
9,226
9,779
10,556
11,479
12,513
NA
NA
Annual
Maximum
Taxable
Earnings
1979
$ 3,600
3,600
3,600
3,600
4,200
4,200
4,200
4,200
4,800
4,800
4,800
4,800
4,800
4,800
4,800
6,600
6,600
7,800
7,800
7,800
7,800
9,000
10,800
13,200
14,100
15,300
16,500
17,700
22,900
25,900
29,700
32,400
3.494
3.289
3.115
3.099
2.962
2.769
2.685
2.662
2.536
2.441
2.393
2.279
2.224
2.137
2.099
.980
.876
.755
.659
.581
.505
.371
.290
.218
.133
.060
.000
.000
NA
NA
NA
NA
Social Security Administration.
Annual Wage Indexes
1980
1981
1982
3.771
3.550
3.362
3.345
3.197
2.988
2.899
2.873
2.738
2.634
2.383
2.460
2.401
2.306
2.266
2.137
2.025
1.894
1.791
1.706
1.625
1.480
1.393
1.314
1.223
1.144
1.079
1.000
1.000
NA
NA
NA
4.101
3.861
3.657
3.638
3.477
3.250
3.152
3.125
2.977
2.865
2.809
2.675
2.611
2.508
2.464
2.375
2.202
2.060
1.948
1.856
1.767
1.609
1.514
i.429
1.330
1.244
1.174
1.087
1.000
1.000
NA
NA
4.470
4.209
3.986
3.965
3.790
3.542
3.436
3.406
3.245
3.123
3.062
2.916
2.846
2.736
2.686
2.534
2.400
2.246
2.123
2.023
.926
.754
.651
.558
.450
.356
.279
.185
.000
1.000
1.000
NA
Calculating
the AIME
The number of years considered
in the calculation
of AIME varies
for different persons. The proper number of years is determined
by
the year in which the person reaches age sixty-two. For people who
were at least twenty-one
years old in 1950, the number is equal to
the number of years between
1950 and the year the person reaches
age sixty-two, dies, or is disabled. Thus, for a person who reaches age
sixty-two in 1982, the number of years considered
in calculating
the
benefit is the number of years between, but not including, 1950, and
1982, which is thirty-one
years. For people reaching age twenty-one
after 1950 the number of years elapsing between the year the person
reached
that age and the year they reach age sixty-two,
die, or are
disabled is used in the calculation.
This means a maximum of forty
years will be considered
when the process matures.
Once the number of years to be considered
has been determined,
a number of years can be discarded for purposes of these calculations.
For retirement
and survivor benefits, five years are dropped.
For
disability
cases under age twenty-seven,
no years are dropped.
For
disabled people between the ages of twenty-seven
and thirty-one, one
year is dropped.
The number of dropout years increases in one-year
increments
for each additional five years of age at disability.
Thus it
reaches the five-year maximum
for persons disabled at age fortyseven or later.J
The actual number of years used to compute the AIME is the number of years considered,
less the dropped
years. The computation
takes the highest years of indexed earnings beginning
in 1951 and
ending with the year before actual entitlement.
This can include years
before age twenty-one
and after age sixty-two. If the earnings in the
year of entitlement
would raise the AIME, these earnings can be
substituted
later. Similarly,
if a person returns to work after retirement, the AIME can be recomputed
if it would be higher following
the second retirement.
For people reaching
age sixtv-two
in 1982 the number
of AIME
computation
years is twenty-six
(31 minus 5). This number
will increase by one year each year until 1991, when the maximum
of thirtyfive computation
years will be reached.
For the sixtv-two-vear-olds
_Additional dropout years are provided to certain persons if they were living with a
child under three years of age in years they had no earnings. If child-care vears are
considered, no more than three vears of combined child care and regular years can
be dropped.
299
retiring
in 1982, the AIME equals the sum of the highest twenty-six
years of indexed earnings divided by 312 (26 years times 12 months).
The AIME is used to determine
the basic Social Security entitlement.
Calculating
the
PIA
The primary
insurance
amount,
which is the benefit payable to a
person who retires at age sixty-five and receives no dependent's
benefits, is calculated
by a formula specified in the 1977 amendments.
In the original formula
for persons reaching age sixty-two
in 1979,
the PIA was equal to:
90 percent of the first $180 of AIME
plus
32 percent of the next $905 of AIME
plus
15 percent of AIME over $1,0852
These AIME dollar amounts
multiplied
by the various percentage
factors are often referred to as the bend points in the formula; they
accomplish
the income redistribution
from high-to low-wage workers. To see how this distribution
occurs, consider three persons with
AIMEs of $500, $1,000, and $2,000 using the formula above. Table B2 shows the results. The calculated
PIA increases
as the AIME increases, but the ratio of the PIA to the AIME declines as the AIME
rises. Since the PIA determines
the benefit amount,
Social Security
TABLE
PIAs
and
Replacement
Using
1979
of AIME
in Selected
Benefit
Formula
Case l
AIME
PIA
Formula
Case 2
Cases
Case 3
$500.00
$1,000.00
$2,000.00
162.00
102.40
0.00
$264.40
.53
162.00
262.40
0.00
$ 424.40
.42
162.00
289.60
137.25
$ 588.85
.29
Application
.90 of first $180
+ .32 of next $905
+ .1S of AIME over $1,085
Total PIA
PIA/AIME
Source:
B-2
Calculated
bv the author.
2There was a transitional
guarantee
tor persons reaching age
sixty-two
between
1979 and 1982. This basically
Iroze the old tormula and provided
that retirement
bcncl'its would be tile higher o1' benefits calculated
on PIAs determined
under the transitional
or new formula.
300
will replace a larger share of preretirement
earnings
for lower-wage
workers than for higher-wage
workers, if other things are held constant.
The bend points in the tormula established
bv the 1977 amendments are themselves
indexed bv the rate of wage growth. The bend
points in the 1979 formula were indexed by the growth in average
wages between
1977 and 1978 to derive the bend points for the 1980
formula. The growth resulting
from this benefit formula indexation
is reflected in table B-3. The net effect of this growth is that initial
benefits grow at the same rate as wages grow over time.
Both the annual wage indexes and benefit formulas are linked to
workers attaining
age sixty-two
in the applicable
year. The PIA for
people who continue
to work beyond age sixty-two and retire later,
say, at age sixty-five, is determined
under the formula for the cohort
to which these people belong. But their initial PIA is then augmented
to account
for any general
benefit increases
that they would have
received had they retired at age sixty-two. Thus until age sixty-two,
the PIA grows as wages grow; beyond that age it grows in relation
to prices.
Calculating
Benefits
People who retire at age sixtv-five and disabled people reccive the
PIA as their basic bcncfits. The benefits for people who retire before
age sixty-five
are reduced
five-ninths
of 1 percent
for each month
short of age sixtv-five that they draw benefits. This reduction
is equivalent to a 6.67 percent reduction
for each year prior to age sixty-five
and to a 20 percent reduction
of benefits taken at age sixty-two.
For
people reaching age sixty-five after 1981, the PIA is increased
3 percent for each vcar benefits arc not taken between the ages of sixtyfive and seventy-two.
TABLE B-3
Social
Formula
Security
Benefit
Formula
Selected
Years
Replacement
Rates
1979
.90of
first
.32 of next
$
.15 of AIME in excess of
Source:
Social
Security
180
905
1,085
Bend
1980
$
194
977
1,171
Points
1981
$
211
1,063
1,274
for
1982
$
230
1,158
1,388
Administration.
301
Benefits for dependents
are also calculated
from the worker's PIA,
subject to a family maximum.
A spouse of a retired or disabled beneficiary receives 50 percent if the spouse benefit is taken at age sixtyfive. If taken earlier, the benefit is actuarially
reduced at the rate of
twenty-five-thirty-sixths
(i.e., 25/36) of 1 percent
per month.
Each
child under age eighteen receives 50 percent of the PIA until the family
maximum
is reached.
In the case of survivor
benefits, the spouse
taking care of children under age sixteen and the children below age
eighteen are eligible to receive 75 percent of the PIA, up to the family
maximum.
The maximum
family benefit (MFB) for disability cases is the lower
of 150 percent
of the PIA or 85 percent of the AIME, so long as it is
not less than the PIA. For retirement
and survivor cases, the MFB is
calculated
in a fashion similar to the PIA itself. The year in which a
worker reaches age sixty-two
or dies determines
the MFB formula
for the family. The formula is indexed by wage increases in the same
way as the PIA formula.
The bend points and annual amounts
to
which they apply are shown in table B-4.
TABLE B-4
Maximum
Formula Rates
1.50 of
2.72 of
1.34 of
1.75 of
Source:
302
Family
Benefit
Bend
Years
Points
for Selected
1979
1980
1981
1982
first
$230
next
102
next
101
PIA in excess of
433
Social Security Administration.
$248
110
109
467
$270
120
118
508
$294
131
129
554
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America in Transition:
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Retirement
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Volume//--Income
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1982, $10.00 (ISBN 0-86643014-8)
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Retirement
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A Bibliography
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1981, $25.00 (ISBN 0-86643-022-9)
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1981, $25.00 (ISBN 086643-021-0)
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At their November 1!, !982 meeting, the National Commission on Soda! Security Reform agreed that the Sociai Security
cash benefits programs have serious financing problems. The
Commission determined
that they should seek between $150
and SZ00 bison in Social Security revenue and benefit modifications for the period from 1983 through 1989. For the longterm, seventy-five-year
period, the Commission
agreed to seek
adh.tstrnents equal to !.82 percent of projected covered eamin_. Potential pro_am
adjustments that would produce the
_ancJrv 8 necessary to meet both short-term and long-term
goals have different implications for various groups and
members of society.
This report provides the details for an evaluation of the status
of the United States ret_ernent income security system in general, and the Soc.ia/Security system in particular. The analysis
particularly acldresses the scope and mathematics of the financin 8 imbalances of Social Security, several options for baiancing
the system in both the short and long terms, and implications of
various options for the income security of the elderly. The analy-Msgoes beyond Social Security alone, however, because other
elements of the retirement income security system mod_ffy the
implications of'various policy adjustments in the Social Security
program.
The story that the numbers throughout this book tel1 is that
the future may not be so dismal as a narrow focus on Social
Security's current fi_'tancing projections would suggest_ While no
one can predict the future with great accuracy, some trends can
be obsena_ and their outcomes predicted. The various trends
analyzed throughout this book suggest that Social Security can
adjust in the future to meet the needs of society.
19ZO N Street, NW/Suite
5Z0/Washington,
DC 20036
ISBN 0-80643-O_-8
Price$15.00
i
I

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