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SOCIAL SECURITY: How It Works and How to Fix It

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Title: SOCIAL SECURITY: How It Works and How to Fix It


1
SOCIAL SECURITYHow It Works and How to Fix It
  • Jonathan Barry Forman (Jon)
  • Alfred P. Murrah Professor of Law
  • September 2007

2
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

3
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)
4
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)
5
How Much Does Social Security Pay?
www.ssa.gov/OACT/COLA/colaeffect.html
6
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

7
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

8
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)

9
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

10
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

11
Full Retirement Age
http//www.ssa.gov/retire2/retirechart.htm
12
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

13
(No Transcript)
14
How do benefits compare to earnings?
Retired worker age 65, 2005
15
Worker BenefitsIncreases 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

16
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)
17
Most elderly dont receive pensions
  • Percent with Employer-Sponsored Pensions
  • All age 65 41
  • Couples 51
  • Unmarried men 39
  • Unmarried women 32

National Academy of Social Insurance, Social
Security Finances A Primer (2005)
18
Family Benefits
  • Spouses, dependents, and survivors
  • Husband or wife gets 50 of workers PIA
  • Together, couple gets 150
  • Widow or widower gets 100 of workers PIA
  • A joint and two-thirds annuity
  • Dual entitlement rule limits benefits

19
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
20
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)
21
Social Security Administration, 2007 Trustees
Report
22
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.

23
Social Securitys 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)

24
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)
25
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)
26
Only 3 Ways to Fix Social Security
  • Raise Taxes
  • Cut Benefits
  • Increase Investment Returns
  • Private investment
  • Either government or individual

27
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
  • 93
  • 40
  • 10
  • 20

National Academy of Social Insurance, Social
Security Brief No. 18 (2005) American Academy of
Actuaries (2004).
28
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
  • 41
  • 32
  • 21

National Academy of Social Insurance, Social
Security Brief No. 18 (2005) American Academy of
Actuaries (2004).
29
Options Increase Investment Returns
  • OPTION
  • Investments in equities
  • of Deficit Eliminated
  • 36 - 50

National Academy of Social Insurance, Social
Security Brief No. 18 (2005) American Academy of
Actuaries (2004).
30
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

31
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

32
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

33
Earnings Sharing
  • Credit each spouse with one-half of couples
    combined earnings during marriage
  • At retirement, each spouses benefit would be
    based on her half of the couples earnings, plus
    her prior earnings
  • Would replace spousal benefits

34
Conclusions
  • 4.7 Trillion Unfunded Liability
  • Oldest baby-boomers are 60
  • Social Security should provide adequate incomes
    throughout retirement
  • Reform is needed

35
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/brief
    ing_041604.pdf.
  • Jon Forman, Reforming Social Security, 76 (9)
    Oklahoma Bar Journal 657-661 (March 12, 2005),
    available at http//jay.law.ou.edu/faculty/jforman
    /SS-OBJ-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.

36
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 masters
    degrees in economics and psychology.
  • Jon can be reached at jforman_at_ou.edu or (405)
    325-4779. His web page is www.law.ou.edu/faculty/f
    orman.shtml.
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