The Future of Social Security
Amy Rehder Harris
Tax Research and Program Analysis Section Iowa Department of Revenue (formerly of the Long Term Modeling Group, Congressional Budget Office, Washington, D.C)
History of Social Security
Social Security (OASDI) is mandatory public insurance to alleviate poverty in old-age
Old-Age Insurance established 1935 Expanded to include Survivors and Spouses in 1939 Disability Insurance introduced 1956 Hospital Insurance (Medicare) began 1965
Old-Age Eligibility
Must work at least 10 years While working, pay 6.2% (12.4%) payroll tax on earnings up to taxable maximum
$102,000 in 2008 AIME: highest 35 years of earnings (indexed for inflation) PIA: progressive formula – higher replacement for lower lifetime income NRA: rising from 65 to 67 for birth years 1960+ Age at claim (Claim at EEA of 62 = 30% reduction; Claim at 70 with DRC = 24% increase)
Upon retirement, benefits a function of
Primary Insurance Amount
$30,000 15 percent replacement up to maximum $25,000 $25,000 32 percent replacement through $51,456 $30,000
Annual Benefit at NRA
$20,000
$20,000
$15,000
$15,000
$10,000
$10,000
$5,000 90 percent replacement up to $8,532 $0 $0 $12,000 $24,000 $36,000 $48,000 $60,000 $72,000 $84,000
$5,000
$0
Average Annual Earnings
Old-Age Benefits
Retired Workers
31.5 million beneficiaries in 2007
Average annual benefit was $12,500 in 2006 Auxiliary Beneficiaries
Spouses: 2.4 million Survivors: 4.6 million Children: 2.4 million Also mother/father or parents
Spouse Benefits
Established in era of one-earner household
Married to a worker at retirement Married for 10 years or more if divorced Receive benefit equal to 50 percent of PIA Reduced based on claim age of spouse
Average annual benefit was $6,200 in 2006 For two-earner household, spouse with lower earnings could receive no additional benefit even though paid tax of 12.4% on every dollar earned
Survivor Benefits
Established in era of one-earner household
Married to a worker at death Married to deceased worker for 10 years or more if divorced Receive benefit equal to 100 percent of worker benefit Reduced based on claim age of survivor
Average annual benefit was $12,100 in 2006 Survivor in retired household faces up to 1/3 benefit reduction at death of spouse
Disability Insurance
Eligible if worked 5 of previous 10 years
Benefit is function of earnings divided by years worked prior to disability (minus lowest 5 years)
6.8 million beneficiaries in 2006 with average annual benefit of $11,700 Auxiliary beneficiaries: 1.8 million Large growth in beneficiaries
Recent expansion to mental illness and back pain Concerns about incentives to claim DI rather than OAI when nearing EEA (no benefit reduction)
Iowa’s Aging Population
Population Pyramid or Tower?
Population Pyramids of Iowa with Row Headers in Column b and Column Headers in Rows 23 to 25
Figure 2. Iowa Population Pyramids, 2003 and Projected 2030
Percent of Total Population Male 2003 Female
85+ 80 - 84 75 - 79 70 - 74 65 - 69 60 - 64 55 - 59 50 - 54 45 - 49 40 - 44 35 - 39 30 - 34 25 - 29 20 - 24 15 - 19 10 - 14 5-9 0-4 5 4 3 2 1 0 1 2 3 4 5
5 4
Male
2030
Female
3
2
1
0
1
2
3
4
5
Source: U.S. Census Bureau, Population Division, Interim State Population Projections, 2005
Impact of Aging Population
Rising Worker-Beneficiary Ratio
Iowa and US: 3.3 falling to 2.0
OASDI: Wages Income Taxes: Pensions and investment earnings often receive preferential tax treatment, additional exempt earnings by age
Deteriorating Tax Bases
Taxation of Social Security
“Contributions” taxed as income when earned by federal and state governments Benefits paid at retirement non-taxable until 1983
If other income above $32,000/$25,000, up to 50% taxable Revenue to OASDI Trust Fund Attempting to improve system finances in preparation for baby boomers 1993 up to 85%, money to Medicare
Taxation of Social Security in Iowa
Followed federal rules by taxing 50% of benefits for seniors with other income Fear that encouraging high-income elderly to move out of state at retirement 2006 change – phase-out of taxation on benefits by 2014 (43% of taxable benefits exempt in 2009) Evidence suggests elderly move to warmer climates, not non-tax states
Social Security Long Run Finances
Social Security currently running surpluses – saved in OASDI Trust Fund
Taxes > Benefits
Projections show future will have large deficits How are those projections made? What can Congress do to prevent the system from going broke?
CBO Projected Outlays and Revenues 1985-2082
10 9 8 7 Outlays 10 9 8 7 6 5 4 Revenues 3 2 1 0 1995 2005 2015 2025 2035 2045 2055 2065 2075
Share of GDP
6 5 4 3 2 1 0 1985
Social Security Administration
Social Security is administered by SSA, an executive branch agency SSA produces an Annual Trustees report about the future of the system
Short-run (10 years) Long-run (75 years) http://www.ssa.gov/OACT/TR/TR08/index.html
CBO began long-run analysis in 2004
http://www.cbo.gov/ftpdocs/96xx/doc9649/0820-SocialSecurityUpdate.pdf
Long-Run Projections
Taxest = Tax Ratet * Average Waget * Number Workerst Benefitst = Average Benefitt * Number Beneficiariest Trust Fundt = Trust Fundt-1 + Interestt + Taxest – Benefitst
Projecting Taxes
Taxest = Tax Ratet * Average Waget * Number Workerst Average Wage depends on productivity (real wage growth), inflation, and wages as a share of compensation (growth of cash versus benefits)
Projecting Taxes
Taxest = Tax Ratet * Average Waget * Number Workerst Average Wage depends on productivity (real wage growth), inflation, and wages as a share of compensation (growth of cash versus benefits)
Number Workers depends on fertility, immigration and unemployment
Projecting Benefits
Benefitst = Average Benefitt * Number Beneficiariest Average Benefit depends on past wages and inflation (along with all of the policy rules)
Projecting Benefits
Benefitst = Average Benefitt * Number Beneficiariest Average Benefit depends on past wages and inflation (along with all of the policy rules) Number Beneficiaries depends on fertility (60 years earlier), mortality, and disability rates
Projecting Trust Fund Balances
Trust Fundt = Trust Fundt-1 + Interestt + Taxest – Benefitst
Interest rates on government bonds (IOU’s to ourselves)
Ten Key Assumptions
Five Economics Assumptions:
Future earnings
(1) (2) (3) (4) Real wage growth Inflation Unemployment Wage as a Share of Compensation
Future benefits paid to retirees, the disabled, spouses and survivors Earnings on the existing Trust Fund
(5) Interest rate
Ten Key Assumptions (cont)
Five Demographics Assumptions:
How many people will be paying taxes and receiving benefits
(6) Mortality (7) Fertility (8) Immigration (9 & 10) Disability Incidence and Termination
Recent changes to immigration forecast led to improved finances (8% more workers by 2060 with more, younger immigrants assumed)
SSA Projections
Intermediate assumptions
“Best guess”
Uncertainty about 75 years into the future - Range on assumptions
Low-cost High-cost Unlikely No measured probability of actually happening
Problems with scenario analysis
CBO Projections
Stochastic projections (500 runs)
Median
Uncertainty about 75 years into the future - Range on outcomes
90th percentile 10th percentile
Actuarial Balance
75-Year Actuarial Balance
Present value of taxes minus present value of benefits over present value of payroll The size of the tax increase needed today to fund the system for the next 75 years SSA projects -1.70 (from -1.95 last year) CBO projects range -2.7 to 0.1
Income and Cost Rates
Income Rate/Revenues
Payroll taxes as percent of GDP 2007: 4.9 2082: 4.2-5.1
Benefits as percent of GDP 2007: 4.3 2082: 4.6-7.7
Cost Rate/Outlays
Trust Fund Ratio
Trust fund assets over annual expenditures
Measures if the system can pay benefits Currently large surplus Source of touted “Exhaustion Date” SSA projects the system will “go broke” in 2040 CBO projects between 2034 to beyond 2082
CBO Projected Trust Fund Ratio, 1985-2082
10
Ratio of Trust Fund Balance to Annual Outlays
10
5
5
0
0
-5
-5
-10
-10
-15
-15
-20
-20
-25 1985
-25 1995 2005 2015 2025 2035 2045 2055 2065 2075
Hope under Current Law?
Taxest = Tax Ratet * Average Waget * Number Workerst Benefitst = Average Benefitt * Number Beneficiariest Trust Fundt = Trust Fundt-1 + Interestt + Taxest – Benefitst
Hope under Current Law?
Taxest = Tax Ratet * Average Waget * Number Workerst Benefitst = Average Benefitt * Number Beneficiariest Trust Fundt = Trust Fundt-1 + Interestt + Taxest – Benefitst
Changes to Current Law?
Increase taxes above current 6.2%
Regressive tax Raise taxable maximum with no benefit increase? Risk of doing nothing – required tax increases Future workers pay
Required Tax Rate Increases
25% 25%
20%
20%
Employee Tax Increase
Tax Rate
15%
15%
10%
10%
5%
5%
0% 2003
0% 2013 2023 2033 2043 2053 2063 2073 2083 2093
Year
Notes: Results are based on 100 stochastic simulations. Percentiles are derived by ranking each stochastic outcome from worst to best regarding system finances.
Changes to Current Law?
Increase taxes above current 6.2% Reduce benefits paid to current or future beneficiaries
Raise NRA further? Risk of doing nothing – about 2040 when system no longer takes in enough resources not all of promised benefits can be paid Across-the-board benefit cuts? Future beneficiaries pay
Required Benefit Cuts
70% 70%
60%
60%
Share of Current Benefit
50%
Benefit Cut
50%
40%
40%
30%
30%
20%
20%
10%
10%
0% 1941
0% 1951 1961 1971 1981 1991 2001 2011 2021 2031
Age 62 Birth Cohort
Notes: Results are based on 100 stochastic simulations. Percentiles are derived by ranking each stochastic outcome from worst to best regarding system finances.
Changes to Current Law?
Increase taxes above current 6.2% Reduce benefits paid to current or future beneficiaries Raise the interest earned by the Trust Funds through investing in more risky assets, either the government or individual workers
Current credit market problems make most wary
Risks of Government Investing
Bad stock returns could harm new retirees (35% of the time – lose money)
Only 5% chance better off in all years over next 75
Public control over private assets creates conflicts
“Social Investing”
Individual Accounts
Allow individuals to take part of payroll tax and invest in higher returns paid by the stock market Trade-off is must accept higher risks
Stock market is NOT a sure thing
Obama’s Plan
Opposes any “privatization” Proposes to improve finances by applying payroll taxes on high incomes
Proposed a 2% to 4% payroll tax on earnings above $250,000 starting roughly 10 years from now Preliminary analysis suggests this could address 15% of long-run problem
McCain’s Plan
Believes can meet benefit promises to current and future retirees without raising taxes
No specific plan to make changes
Supports personal accounts for current workers as a supplement
(Lead economic advisor is former CBO director during my tenure there – very aware of the future problems and supportive of individual accounts that were analyzed during my tenure)
Nonpartisan Social Security Reform Plan (Three Economists)
Raise EEA from 62 to 65 Raise NRA to 68 for 1955 and later Reduce PIA replacement factors
Lowers benefits but more progressive formula
Raise taxable maximum (no benefits credit) Low-earner benefit Reduce spouse benefit Individual Accounts – 1.5% carve-out and 1.5% add-on
Your future retirement?
Social Security benefits are uncertain for your generation if reforms not instituted soon Still not a great method of “saving” for retirement Three-legged stool
Public pension (Social Security) Private pension (401k) Personal saving (Roth IRA)
Economics informs us - solution is political
Even Bigger Mess: Medicare
Congressional efforts for Social Security reform ended with 2006 election CBO shifted focus to Medicare
Much bigger financial problem Part of health care “crisis” in America Same concerns about aging with little control on benefit costs
Last action expanded the program!
Medicare defined
Medicare is publicly-provided health insurance for the elderly
Medicaid is publicly-provided health insurance for low income uninsured
Four parts
Part A: Hospital Insurance (HI) Part B: Supplemental Medical Insurance (SMI) Part C: Medicare Advantage is alternative to A&B Part D: Prescription Drugs
Who is covered?
Elderly, 65+ (85% of beneficiaries)
Everyone automatically covered by HI, must sign up for SMI (95% do) 36.9 million beneficiaries in 2007
Disabled eligible after two years receiving DI benefits
7.2 million beneficiaries
End stage renal disease (kidney dialysis)
What is covered?
HI covers inpatient hospital care, skilled nursing facilities, home health services, and hospice care SMI covers doctor visits, lab tests, and outpatient hospital care Part D covers prescription drugs (w limits) Does NOT cover nursing homes
How is Medicare financed?
HI financed through payroll taxes
1.45% (3.9%) on all earnings (HI Trust Fund)
SMI and Part D financed through monthly premiums (25%) and general revenues
SMI $96.40-238.40 (2008) each month, Part D varies by plan - deducted from Social Security checks Also co-pays and deductibles
Medicare in financial trouble
Dramatic growth in the program
1980: $37 Billion 2007: $432 Billion
Similar to Social Security, Medicare has a bleak financial future
Baby boomers start to retire in next 5 years People living longer Health costs rising faster than economy as a whole
Excess Cost Growth
Growth in spending per beneficiary that exceeds growth in per capita GDP
3.0 percent over 1970-2005 2.1 percent over 1990-2005
Captures both policy changes and “residual” growth Assumption going forward dramatically alters projections of program growth Same issues for Medicaid (program for poor jointly funded by the states)
Medicare and Medicaid Spending as Share of GDP: Excess Cost Growth??
40 Percent 40 35 35
30
30
25
Excess Cost Growth of 2.5 percent
CBO Forecast
25
20
20
15
15
10
Excess Cost Growth 10 of 1 percent No Excess Cost Growth
1995 2005 2015 2025 2035 2045 2055 2065 2075 5
5
0 1985
0
…so federal budget in trouble
HI Trust Fund, currently in surplus, is projected to be exhausted in 2019 as costs rise (between $980 billion and $1.4 trillion) SMI will squeeze other federal spending as the Part B costs rise – 75% from current taxpayers Part D cheaper so far, but cries to expand coverage may raise costs
Estimated to cost $400 B over 10 years
Your future retirement?
Health care diminishing as private retirement benefit Reliance on Medicare also uncertain Economics informs us – solution is political