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SOCIAL SECURITY:How It Works and How to Fix It
by Jon FormanProfessor in Residence
IRS Office of Chief Counsel, Room 3501&
Alfred P. Murrah Professor of LawUniversity of Oklahoma
Norman, Oklahoma
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Overview How Social Security Works
Financing Social Security How Benefits Are Determined
Financial Troubles How to Fix It
Raise Taxes Cut Benefits Increase Investment Returns
A two-tier System
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How Many People Get Social Security?
52 million people receive Social Security each month
1 in 6 Americans get Social Security benefits
Nearly 1 in 4 households get income from Social Security
National Academy of Social Insurance, Social Security Finances: A Primer 4 (2008).
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Who Gets Social Security? (June 2009 Beneficiary Data)
33 million retired workers 2.9 million dependents 7.6 million disabled workers 1.8 million dependents 6.4 million survivors
Social Security Administration, Social Security Basic Facts (2009), http://www.ssa.gov/pressoffice/factsheets/basicfact-alt.pdf.
How Much Does Social Security Pay?(June 2009 Beneficiary Data)
Retired workers $1,159 average monthly benefit
Disabled workers $1,062 average monthly benefit
Survivors $1,118 average monthly benefit
5Social Security Basic Facts.
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Social Security and Poverty
2009 Poverty Levels Single individuals – $10,830 ($903/month) Married couples – $14,570 ($1,214/month)
With Social Security only 9% were poor (in 2000)
Without it, 48% would have been poor
2009 HHS Poverty Guidelines, http://aspe.hhs.gov/POVERTY/09poverty.shtml; Social Security Administration, Social Security Bulletin: Annual Statistical Supplement: 2001 (2002), at 9.
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Financing Social Security Social Security taxes Workers pay
6.2% of their earnings for Social Security, and 1.45% of their earnings for Hospital Insurance
under Medicare (Part A) Employers pay an equal amount The total is 12.4% for Social Security and
2.9% for HI Tax base is $106,800 in 2009
Unchanged for 2010
Social Security Administration, Contribution and Benefit Base (2009), http://www.socialsecurity.gov/OACT/COLA/cbb.html.
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Worker Benefits
Workers over 62 are eligible If they have worked 10 years
Benefits are based on a workers earnings history Career-average earnings Average Indexed Monthly Earnings (AIME)
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Average Indexed Monthly Earnings (AIME)
Determine how much the worker earned every year through age 60 Determine Benefit Computation Years And Earnings in those years
Index those Earnings for Wage Inflation Up to the year the worker turns 60
Subsequent Work Years Also Count Pick the Highest 35 Years
Drop the rest
Social Security Administration, Benefit Calculation Examples for Workers Retiring in 2010 (2009), http://www.socialsecurity.gov/OACT/ProgData/retirebenefit1.html.
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Average Indexed Monthly Earnings (AIME), continued
Add those highest 35 years of earnings up
Divide by 35; Divide by 12 Result is called Average Indexed
Monthly Earnings (AIME) AIME is then linked by formula to the
basic retirement benefit The Primary Insurance Amount (PIA) Paid at full retirement age
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Full Retirement Age
Social Security Administration, Full Retirement Age, http://www.ssa.gov/retire2/retirechart.htm.
Year of Birth Full Retirement Age
1937 or earlier 65
1938 - 1942 plus 2 months per year
1942 – 1954 66
1955 - 1959 plus 2 months per year
1960 and later 67
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Primary Insurance Amount (PIA)
For a worker turning 62 in 2010,PIA = 90% of first $761 of AIME
+ 32% of AIME from $761 to $4,586 (if any)
+ 15% of AIME over $4,586 (if any)
$761 and $4,586 are called bend points PIA indexed by cost of living after 62 Provides higher benefits relative to
earnings for lower paidSocial Security Administration, Benefit Formula “Bend Points” (2009), http://www.ssa.gov/OACT/COLA/bendpoints.html.
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How do benefits comparte to earnings?Retired worker age 65, 2007
$20,610 $24,000$16,700
$37,200
$58,900
$87,800
$9,400$15,570
$0
$20,000
$40,000
$60,000
$80,000
$100,000
"low" "medium" "high" "maximum"
Earnings Amount
Past Wages Benefits
Social Security Basic Facts; Social Security Finances: A Primer, 7.
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Worker Benefits:Increases and Decreases
Indexed for inflation Actuarial decrease for early retirement Actuarial increase for later retirement
8 percent per year Example: maximum-wage worker, 62 in 2010
Will have AIME of $7,949 Will get $1,820 per month at age 62 Or $2,191 per month at age 65 Or $3,119 per month at age 70
Social Security Administration, Workers with Maximum Taxable Earnings (2009), http://www.ssa.gov/OACT/COLA/examplemax.html.
Retirement Earnings Test
Applies only to people below normal retirement age (NRA), which ranges from age 65 to 67 depending on year of birth.
In 2010, early retirees lose $1 of benefits for each $2 of earnings over $14,160
16Social Security Administration, Exempt Amounts Under the Earnings Test (2009), http://www.ssa.gov/OACT/COLA/rtea.html.
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How many people rely on Social Security for most of their income?
90% of people 65 and older get Social Security
Social Security represents 40% of the income of the elderly
Nearly 2 in 3 (66%) get half or more of their income from Social Security
About 1 in 5 (22%) get all their income from Social Security
Social Security Basic Facts; Social Security Finances: A Primer, 8.
Reliance on Social Security Benefits by Race
Percent of beneficiaries who receive half or more of their income from Social Security 65% of Whites 74% of Blacks 67% of Asians 78% of Hispanics
Percent of Beneficiaries who receive all of their income from Social Security 19% of Whites 40% of Blacks 28% of Asians 43% of Hispanics
18Social Security Finances: A Primer, 9.
Most elderly don’t receive pensions
Percent with Employer-Sponsored Pensions
All age 65+ 41%Couples 51%Unmarried men 42%Unmarried women 34%
19Social Security Finances: A Primer, 10.
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How are Benefits Projected to Change in the Future?
Benefits will grow faster than prices, but slower than wages.
The increase in the full benefit age from 65 to 67 over the next 20 years means that benefits will replace a smaller share of retirees’ past earnings.
Social Security Finances: A Primer, 11.
21
Under Current Law Net Replacement Rates will Decline
An average earner at 65 today gets a benefit that replaces about 39% of earnings after deducting Medicare premiums.
A similar earner age 65 in 2030 will have a benefit that replaces about 32% of earnings Higher age for full benefits lowers wage
replacement at 65 Medicare premiums will take a bigger bite
Virginia P. Reno, Are Social Security Benefits Adequate? 4 (2009), http://www.nasi.org/usr_doc/Virginia_Reno_NASI_Presentation_05_15_2009.pdf.
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Family Benefits Spouses, dependents, and survivors Husband or wife gets 50% of worker’s
PIA Together, couple gets 150%
Widow or widower gets 100% of worker’s PIA
A joint and two-thirds survivor annuity Dual entitlement rule limits benefits
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The Need for Reform
Social Security is in financial trouble and will not be able to meet its future benefit commitments.
Social Security redistributes payroll tax revenues in many ways that are quite simply unfair.
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Estimates for 2009 Finances
Trust Fund income = $819 billion (taxes)Trust Fund outgo = $682 billion (benefits)Surplus = $137 billion
By law, surpluses are invested in U.S. government securities and earn interest that goes to the trust funds.
2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds 41 (2009), http://www.socialsecurity.gov/OACT/TR/2009/tr09.pdf.
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How do actuaries estimate the future?
Review the past: birth rates, death rates, immigration, employment, wages, inflation, productivity, interest rates
Assumptions for the next 75 years Three scenarios: Low cost; High cost;
Intermediate (best estimate)
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The Long-Range Forecast(Best estimate)
In 2016, tax revenues into the trust funds forecasted to be less than benefits due that year. Interest on the reserves and the assets themselves will help pay for benefits until 2037.
In 2037, reserves are projected to be depleted. Income is forecast to cover 76% of benefits due then.
By 2083, assuming no change in taxes, benefits or forecasts, revenue would cover 74% of benefits due then.
2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 9.
2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 10.
2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 12.
2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 13.
302009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 15.
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Social Security’s Financing Problem
2009 Trustees Report shows Expenses will exceed payroll tax income in 2016 Trust funds will be out of money in 2037
75-year deficit equals around 2% of taxable payroll Immediate payroll tax increase of 2% needed to
restore actuarial balance Alternatively, immediate ~13% across-the-board
benefit cut $5.3 trillion unfunded liability (over 75 years) About 0.7% as a share of the entire economy (GDP)
2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 2-3.
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Unfunded Obligations(Present values as of January 1, 2009; trillions of dollars)
Present value
As a % of future payroll
As a % of GDP
Over the next 75 years
5.3 1.9 .7
Over the infinite horizon
$15.1 3.4 1.2
2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 63 (table IV.B6).
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Why is the deficit so much smaller as a share of GDP?
The answer is because Social Security taxable wages are only a relatively small part of GDP. Wages taxed for Social Security are 39
percent of GDP. The other 61 percent of national income
is not taxed to help pay for Social Security.
Social Security Finances: A Primer, 30.
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What is that non-taxable income?
Income not subject to Social Security taxes includes: Earnings above the tax cap ($106,800 in
2009 & 2010) Tax exempt compensation (non-taxable
fringe benefits, tax-deferred accounts, etc) Wages of about one in four state and local
workers who are not covered by Social Security
Income from property – stock dividends, interest, and rental income.
Social Security Finances: A Primer, at 31.
Social Security Shortfall and Other Policy Changes
The Social Security shortfall over the next 75 years is smaller than the lost revenue from making permanent the tax cuts of 2001 and 2003. The Social Security shortfall is about one-third the size of the tax cuts over the next 75 years. Social Security deficit 0.56% of GDP Tax cuts made permanent 1.95% of GDP
35Social Security Finances: A Primer, at 32.
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Only 3 Ways to Fix Social Security
Raise Taxes Cut Benefits Increase Investment Returns
Private investment Either government or individual
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Second problem: Social Security Redistributes Economic Resources
Evaluate the program’s impact over the course of a worker’s lifetime.
Compare Social Security taxes paid by a worker and expected benefits.
Linkage between the Social Security taxes and benefits is loose.
Can vary dramatically depending on such factors as family status, income, and age.
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Social Security favors Early generations of retirees over later
generations, Workers with low career-average earnings
over workers with high career-average earnings,
Married couples over singles individuals, One-earner couples over two-earner couples, Larger families over smaller families, and Elderly retirees over elderly workers.
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Social Security's Transfer of Wealth Among Generations by Each Cohort's Year of Birth (Billions of 2003 dollars)
Congressional Budget Office, How Pension Financing Affects Returns to Different Generations (2004).
OPTIONS Raise Taxes Cut Benefits Increase Investment Returns Sources:
National Academy of Social Insurance, Fixing Social Security: Adequate Benefits, Adequate Financing (2009), http://www.nasi.org/usr_doc/Fixing_Social_Security.pdf.
Craig Copeland, Social Security Reform: How Different Options Might Affect Future Funding, 30(9) ebri.org Notes 13 (2009).
American Academy of Actuaries, Social Security Reform Options (2007), http://www.actuary.org/pdf/socialsecurity/reform_07.pdf
Center for Retirement Research at Boston College, The Social Security Fix-It Book (2007), http://crr.bc.edu/special_projects/the_social_security_fix-it_book.html.
National Academy of Social Insurance, Options to Balance Social Security Over the Next 25 Years (2005), http://www.nasi.org/usr_doc/SS_Brief_18.pdf.
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Options: Raise Taxes
OPTION Increase tax rate by
2% total Tax all earnings Tax 90% of earnings Include new state &
local govt. workers Tax SS benefits like
pensions
% of Deficit Eliminated104%
93%40%10%
20%
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Options: Cut Benefits
OPTION Raise retirement age
(to 67 faster & index) Reduce COLA by ½%
each year Cut benefits by 5% for
those starting to get benefits in 2005
Increase # years in wage avg. to 40
% of Deficit Eliminated28%
41%
32%
21%
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Options: Increase Investment Returns
OPTION Investments in equities
% of Deficit Eliminated36% - 50%
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Long-term Reform
Social Security should ensure that every elderly American has an adequate retirement income
We could redesign the system Two-tier system
First tier: poverty-level benefit Second tier: earnings-related benefit Earnings sharing
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First Tier: Basic Benefit
Government guarantee of poverty-level income
2009 Poverty Levels Single individuals – $10,830 ($903/month) Married couples – $14,570 ($1,214/month)
Would replace SSI and redistribution within the current SS system
Pay for with general revenues
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Second Tier: Earnings-related Benefit
Individual accounts Hypothetical (“cash balance”) accounts Invested by professionals
Pay for with payroll taxes Pay out lifetime annuities
Inflation-adjusted annuities
10% Individual Accounts Workers work every year between ages 22
and 65 Each worker contributes 10% of payroll up
to Social Security taxable maximum 3% annual real return (6% nominal; 3%
inflation Money must remain in the account until age
65 and then must be annuitized In the long run, these accounts would
replace around 45% of final wages
Jonathan Barry Forman, Should We Replace the Current Pension System with a Universal Pension
System, 16(2) Journal of Pension Benefits 48-51 (Winter 2009)
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Earnings Sharing
Credit each spouse with one-half of couple’s combined earnings during marriage
At retirement, each spouse’s benefit would be based on her half of the couple’s earnings, plus her prior earnings
Would replace spousal benefits
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Conclusions
$5.3 Trillion Unfunded Liability Oldest baby-boomers are 62 Social Security should provide
adequate incomes throughout retirement
Reform is needed
About the Author Jonathan Barry Forman (“Jon”) is
the Professor in Residence at the Internal Revenue Service Office of Chief Counsel, Washington, DC, for the 2009-2010 academic year;
the Alfred P. Murrah Professor of Law at the University of Oklahoma College of Law, teaching tax and pension law; and
the author of Making America Work (Washington, DC: Urban Institute Press, 2006).
Prior to entering academia, Professor Forman served in all three branches of the federal government. He has a law degree from the University of Michigan and master’s degrees in both economics and psychology.
Jon can be reached at [email protected], 405-325-4779 Slides, etc. at www.law.ou.edu/faculty/forman.shtml
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