The Future of Social Security

1
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)

2
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

3
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
• Upon retirement, benefits a function of
• 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)

4
Primary Insurance Amount
5
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

6
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

7
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

8
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)

9
Iowas Aging Population
10
Population Pyramid or Tower?
11
Impact of Aging Population

• Rising Worker-Beneficiary Ratio
• Iowa and US 3.3 falling to 2.0
• Deteriorating Tax Bases
• OASDI Wages
• Income Taxes Pensions and investment earnings
  often receive preferential tax treatment,
  additional exempt earnings by age

12
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

13
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

14
Social Security Long Run Finances

• Social Security currently running surpluses
  saved in OASDI Trust Fund
• Taxes gt Benefits
• Projections show future will have large deficits
• How are those projections made?
• What can Congress do to prevent the system from
  going broke?

15
CBO Projected Outlays and Revenues 1985-2082
16
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/doc9649/08-20-Soc
  ialSecurityUpdate.pdf

17
Long-Run Projections

• Taxest Tax Ratet Average Waget
• Number Workerst
• Benefitst Average Benefitt
• Number Beneficiariest
• Trust Fundt Trust Fundt-1 Interestt
• Taxest Benefitst

18
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)

19
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

20
Projecting Benefits

• Benefitst Average Benefitt
• Number Beneficiariest
• Average Benefit depends on past wages and
  inflation (along with all of the policy rules)

21
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

22
Projecting Trust Fund Balances

• Trust Fundt Trust Fundt-1 Interestt
• Taxest Benefitst
• Interest rates on government bonds (IOUs to
  ourselves)

23
Ten Key Assumptions

• Five Economics Assumptions
• Future earnings
• (1) Real wage growth
• (2) Inflation
• (3) Unemployment
• (4) 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

24
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)

25
SSA Projections

• Intermediate assumptions
• Best guess
• Uncertainty about 75 years into the future -
  Range on assumptions
• Low-cost
• High-cost
• Problems with scenario analysis
• Unlikely
• No measured probability of actually happening

26
CBO Projections

• Stochastic projections (500 runs)
• Median
• Uncertainty about 75 years into the future -
  Range on outcomes
• 90th percentile
• 10th percentile

27
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

28
Income and Cost Rates

• Income Rate/Revenues
• Payroll taxes as percent of GDP
• 2007 4.9
• 2082 4.2-5.1
• Cost Rate/Outlays
• Benefits as percent of GDP
• 2007 4.3
• 2082 4.6-7.7

29
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

30
CBO Projected Trust Fund Ratio, 1985-2082
31
Hope under Current Law?

• Taxest Tax Ratet Average Waget
• Number Workerst
• Benefitst Average Benefitt
• Number Beneficiariest
• Trust Fundt Trust Fundt-1 Interestt
• Taxest Benefitst

32
Hope under Current Law?

• Taxest Tax Ratet Average Waget
• Number Workerst
• Benefitst Average Benefitt
• Number Beneficiariest
• Trust Fundt Trust Fundt-1 Interestt
• Taxest Benefitst

33
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

34
Required Tax Rate Increases
35
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

36
Required Benefit Cuts
37
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

38
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

39
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

40
Obamas 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

41
McCains 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)

42
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

43
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

44
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!

45
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 AB
• Part D Prescription Drugs

46
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)

47
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

48
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

49
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

50
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)

51
Medicare and Medicaid Spending as Share of GDP
Excess Cost Growth??
52
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

53
Your future retirement?

• Health care diminishing as private retirement
  benefit
• Reliance on Medicare also uncertain
• Economics informs us solution is political