The Social Security Windfall Elimination Provision

1
The Social Security Windfall Elimination Provision

• Prof. Jeffrey Brown, UIUC
• SUAA State Meeting
• October 10, 2007

2
First, a Disclaimer

• The views I am presenting here today are my
  personal views, and do not necessarily reflect
  any official position of the Social Security
  Advisory Board or the Social Security
  Administration

3
Overview

• The WEP / GPO exist for valid reasons
• Legislative efforts to repeal the WEP/GPO are
  likely to fail and may have unintended
  consequences
• Perhaps efforts better focused on a) educating
  participants and b) changing the method for
  calculating these provisions

4
Why Does the WEP Exist?

• Historically, government employees were not
  covered under SS due to concerns about federal
  taxes on state governments this changed in 1983
• California, Colorado, Illinois, Louisiana,
  Massachusetts, Ohio and Texas are only states not
  under SS
• WEP established in 1983 to remove an unintended
  advantage that the weighting in the regular
  Social Security benefit formula would otherwise
  provide for persons who have substantial pensions
  from non-covered employment.
• Testimony of Robert M. Wilson, Deputy
  Commissionerfor Legislation and Congressional
  Affairs, Social Security Administration, Hearing
  before the Subcommittee on Social Security
  Committee on Ways and Means, May 1, 2003

5
Lets Get Technical for a Moment

• The core concept of a Social Security benefit is
  something called the Primary Insurance Amount,
  or PIA
• Normally, if one retires at the normal retirement
  age, ones benefit is equal to the PIA
• The PIA is a non-linear function of ones
  lifetime earnings

6
Calculating Benefits Step 1

• Take each year of annual earnings, and index them
  to average wage growth
• Take average of the 35 highest years of indexed
  earnings, and divide by 12 to get
• Average Indexed Monthly Earnings
• A rough measure of where one falls in the
  lifetime earnings distribution (Rich or Poor?)

7
Calculating Benefits Step 2

• Run AIME (average indexed monthly earnings)
  through a non-linear benefit formula to compute
  the Primary Insurance Amount (PIA)
• Here is what the formula looks like for 2007

8
The Benefit (PIA) Formula (2007)
PIA
1706
.15
2nd bendpoint
.32
612
1st bendpoint
.9
4,100
AIME
680
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Why the Complicated Formula?

• Idea is simple to make the Social Security
  benefit formula more progressive
• To provide a higher income replacement rate for
  lower income individuals
• To provide higher benefit relative to lifetime
  earnings for lower income individuals

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What About SURS Participants?

• Income from SURS-covered employment is not
  covered under Social Security
• No taxes paid on this income
• No benefits received from this income
• Many SURS participants, however, also have part
  of their lifetime income from sources that are
  covered by Social Security
• Former, subsequent, or second jobs
• Consulting income

11
What is the Problem?

• If one simply uses Social Security covered
  earnings, and ignores SURS income, then it
  provides an incorrect picture of ones true
  lifetime earnings
• Ex If only 10 of lifetime income is covered
  under SS, one would look like a lifetime poor,
  when in fact they are not
• The result of blindly applying the formula is
  that SURS employees would get too high a return
  on their contributions

12
Example if No WEP Existed
13
Example if No WEP Existed
14
Example if No WEP Existed
15
Example if No WEP Existed
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What Does the WEP Do?

• Reduces first factor in the formula from 90 to
  40
• Reduces benefits by a maximum of 340 per month
  for 2007 cohort
• For each year over 20 years that one has
  substantial earnings under SS, this factor
  increases by 5 percentage points
• At 30 years of substantial earnings, the offset
  disappears

17
Benefits under WEP (lt20 years)
PIA
1706
.15
.32
612
.9
272
.4
4,100
AIME
680
18
Example with WEP Existed
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The Bottom Line

• The WEP exists for reasons of fairness, i.e., to
  avoid treating medium / high income state and
  local workers as if they were low income workers
• The need for it arises from the non-linearity of
  the benefit formula
• If formula provided flat replacement rate for all
  earnings, no adjustment would be needed

20
Government Pension Offset (GPO)

• The GPO affects government retirees who are
  eligible for two retirement benefits
• A pension based on their own work in a Federal,
  State, or local government job that was not
  covered by Social Security, and
• A Social Security spouse's or surviving spouse's
  benefit based on their husband's or wife's work
  in covered employment.
• If the GPO applies, the person's Social Security
  spouse's or surviving spouse's benefit is reduced
  
• Reduction two-thirds of the amount of the
  person's government pension based on work not
  covered by Social Security.

21
Intent of GPO

• Spousal benefits intended for non-working and/or
  low earning spouses
• GPO provision removes the possibility that an
  individual with a large public sector pension
  could also get the spousal benefit

22
Why WEP/GPO Wont be Repealed

• The White House, Treasury, Social Security
  Administration, and the relevant House and Senate
  committee staffs know and understand the reason
  it exists
• The CBO, GAO and SSA Actuaries understand the
  reason it exists
• It is expensive to repeal
• Roughly 5 billion annually
• 60 billion over 10 year budget window
• Makes 75-year solvency problem worse
• Brings date of cash flow problem forward 1 year

23
Unintended Consequences

• It may make it more likely that the problem is
  addressed by folding state and local workers into
  Social Security
• Many argue that this would be fair
• The low rate of return to SS arises in large
  part from having to pay off the implicit debt to
  past generations of recipients
• State / local workers currently escape this
  burden
• SURS participants would be worse off if forced to
  participate in Social Security

24
Where to Focus from Here?

• While some form of WEP has a good reason to
  exist, the current adjustment is ad hoc
• While it may be roughly correct on average, it is
  not right for every individual
• Perhaps SUAA could focus on getting the
  calculation changed in a manner that might
  increase fairness across SURS employees
• Currently, low income SURS employee gets same
  offset as high income SURS employee (if years
  outside of SURS the same)

25
How Change the WEP One Idea

• Since 1977, SSA has kept track of both covered
  and uncovered earnings
• One could compute the PIA based on total (SS
  SURS) earnings
• Then calculate what fraction of total lifetime
  earnings were under SS
• Give the person that fraction of the revised PIA
• In other words, if half your earnings were under
  SS, you get half the benefit
• This approach would
• Reduce inequity
• Be much simpler to explain

26
In the Meantime Framing

• Now Your benefit is 1200. But because you
  were under SURS, your benefit is reduced by 300
  to reduce your windfall.
• Alternative Your benefit is 900.

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Summary

• It is perfectly understandable why SURS
  annuitants are angry with WEP/GPO
• The provisions are not explained well
• The annual SS benefit statements do not show
  right amount for SURS participants
• Even the name, windfall, creates a negative
  climate
• But some version of a WEP/GPO is good policy, and
  efforts to repeal it may backfire
• Perhaps better to focus on (a) how it is
  calculated, and (b) education