SOCIAL SECURITY: How It Works and How to Fix It Jonathan Barry Forman (“Jon”) Alfred P.
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Transcript SOCIAL SECURITY: How It Works and How to Fix It Jonathan Barry Forman (“Jon”) Alfred P.
SOCIAL SECURITY:
How It Works and How to Fix
It
Jonathan Barry Forman (“Jon”)
Alfred P. Murrah Professor of Law
September 2007
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?
47.7 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 (2005)
3
Who Gets Social Security?
30.0 million retired workers
4.8 million widows and widowers
6.2 million disabled workers
0.8 million adults disabled since
childhood
3.1 million children
National Academy of Social Insurance, Social Security Finances: A Primer (2005)
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How Much Does Social Security Pay?
Type of Beneficiary
Average
Monthly
Benefit
All Retired Workers
$1,044
Aged widow(er), non-disabled
$1,008
Disabled worker
$979
Aged couple-both receiving
$1,713
Widowed mother and two children
$2,167
www.ssa.gov/OACT/COLA/colaeffect.html
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Social Security and Poverty
2007 Poverty Levels
Single individuals – $10,210 ($851/month)
Married couples – $13,690 ($1,141/month)
With Social Security only 9% were poor
in 2000
Without it, 48% would have been poor
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Financing Social Security
Workers and their employers pay with
Social Security taxes
Workers pay
6.2% of their earning 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
Social Security tax base is $97,500 in 2007
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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
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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
Result is called Primary Insurance
Amount (PIA)
Paid at full retirement age
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Full Retirement Age
Year of Birth
1937 or earlier
Full Retirement Age
65
1938 - 1942
plus 2 months per year
1942 – 1954
66
1955 - 1959
plus 2 months per year
1960 and later
http://www.ssa.gov/retire2/retirechart.htm
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Primary Insurance Amount
(PIA)
For a worker turning 62 in 2007,
PIA = 90% of first $680 of AIME
+ 32% of AIME from $680 to $4,110 (if any)
+ 15% of AIME over $4,110 (if any)
$680 and $4,110 are called bend points
PIA indexed by cost of living after 62
Provides higher benefits relative to earnings
for lower paid
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Primary Insurance Amount (PIA) formula
for persons turning age 62 in 2007
$2 ,2 0 0
Primary Insurance Amount
$2 ,0 0 0
Seco nd
Bend Po int
$4 ,110
$1,8 0 0
$1,6 0 0
$1,4 0 0
$1,2 0 0
Firs t
Bend Po int
$6 8 0
PIA
$1,0 0 0
$8 0 0
$6 0 0
$4 0 0
$2 0 0
$0
$0
$1,0 0 0
$2 ,0 0 0
$3 ,0 0 0
$4 ,0 0 0
$5,0 0 0
$6 ,0 0 0
Average Indexed Monthly Earnings
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How do benefits compare to earnings?
Retired worker age 65, 2005
$90,000
$80,000
Past Wages
Benefits
$60,000
$55,400
$40,000
$35,300
35%
$20,000
42%
25%
$22,500
$19,600
$15,800
57%
$14,800
$9,000
$0
"low"
"medium"
Earnings Amount
"high"
"maximum"
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Worker Benefits:
Increases and Decreases
Indexed for inflation
Actuarial decrease for early retirement
Example: average-wage worker, 62 in 2006
Will get $1,332.80 per month at her full
retirement age of 66
or $999 per month at 62
Actuarial increase for later retirement
8 percent per year
Retirement Earnings Test
In 2007, early retirees lose $1 of benefits for
each $2 of earnings over $12,960
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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
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
National Academy of Social Insurance, Social Security Finances: A Primer (2005)
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Most elderly don’t receive pensions
Percent with Employer-Sponsored
Pensions
All age 65+
Couples
Unmarried men
Unmarried women
41%
51%
39%
32%
National Academy of Social Insurance, Social Security Finances: A Primer (2005)
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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 annuity
Dual entitlement rule limits benefits
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Estimates for 2006 Finances
Trust Fund income = $745 billion (taxes)
Trust Fund outgo = $555 billion (benefits)
Surplus =
$190 billion
By law, surpluses are invested in U.S.
government securities and earn interest
that goes to the trust funds.
Social Security Administration 2007 Trustees’ Report
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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)
National Academy of Social Insurance, Social Security Finances: A Primer (2005)
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Social Security Administration, 2007 Trustees’ Report
21
The Long-Range Forecast
(Best estimate)
In 2017, 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 2041.
In 2041, reserves are projected to be
depleted. Income is forecast to cover
75% of benefits due then.
By 2081, assuming no change in taxes,
benefits or forecasts, revenue would cover
70% of benefits due then.
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Social Security’s Financing Problem
2007 Trustees Report shows
Expenses will exceed payroll tax income in 2017
Trust funds will be out of money in 2041
75-year deficit equals 1.95% of taxable payroll
Immediate payroll tax increase of 1.95% needed to
restore actuarial balance
Alternatively, immediate ~12.8% across-the-board
benefit cut
$4.7 trillion unfunded liability
About 0.7% as a share of the entire economy (GDP)
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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.
National Academy of Social Insurance, Social Security Finances: A Primer (2005)
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What is that non-taxable
income?
Income not subject to Social Security
taxes includes:
earnings above the tax cap ($97,500 in
2007);
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.
National Academy of Social Insurance, Social Security Finances: A Primer (2005)
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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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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 Eliminated
104%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of
Actuaries (2004).
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 Eliminated
28%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of
Actuaries (2004).
41%
32%
21%
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Options: Increase Investment
Returns
OPTION
% of Deficit Eliminated
Investments in equities
36% - 50%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of
Actuaries (2004).
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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
2007 Poverty Levels
Single individuals – $10,210 ($851/month)
Married couples – $13,690 ($1,141/month)
Would replace SSI and redistribution
within the current SS system
Pay for with general revenues
31
Second Tier: Earnings-related
Benefit
Individual accounts
Hypothetical (“cash balance”) accounts
Invested by professionals
Pay for with reduced payroll taxes
Pay out lifetime annuities
Inflation-adjusted annuities
32
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
33
Conclusions
$4.7 Trillion Unfunded Liability
Oldest baby-boomers are 60
Social Security should provide
adequate incomes throughout
retirement
Reform is needed
34
Sources
American Academy of Actuaries, Social Security Reform: Solutions Inside
the Box: Proposals Not Including Individual Accounts (2004), available at
http://www.actuary.org/pdf/socialsecurity/briefing_041604.pdf.
Jon Forman, Reforming Social Security, 76 (9) Oklahoma Bar Journal 657661 (March 12, 2005), available at http://jay.law.ou.edu/faculty/jforman/SSOBJ-2005.pdf.
National Academy of Social Insurance, Social Security Finances: A Primer
(April 2005), available at
http://www.nasi.org/usr_doc/Financing_Social_Security.ppt.
National Academy of Social Insurance, Options to Balance Social Security
Over the Next 25 Years (Social Security Brief No. 18, February 2005),
available at http://www.nasi.org/usr_doc/SS_Brief_18.pdf.
Social Security and Medicare Boards of Trustees, 2007 Annual Report of the
Board of Trustees of the Federal Old-Age and Survivors Insurance and
Disability Insurance Trust Funds (2007), available at
http://ssa.gov/OACT/TR/TR07/tr07.pdf.
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About the Author
Jonathan Barry Forman (“Jon”) is the Alfred P.
Murrah Professor of Law at the University of Oklahoma
College of Law, where he teaches courses on tax,
pension, and elder law.
Professor Forman is also Vice Chair of the Board of
Trustees of the Oklahoma Public Employees Retirement
System (OPERS) 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 he also
has master’s degrees in economics and psychology.
Jon can be reached at [email protected] or (405) 3254779. His web page is
www.law.ou.edu/faculty/forman.shtml.
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