The Future of Social Security

Amy Rehder HarrisTax 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

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)

Primary Insurance Amount

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$0 $12,000 $24,000 $36,000 $48,000 $60,000 $72,000 $84,000

Average Annual Earnings

An

nu

al B

enef

it a

t N

RA

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

90 percent replacement up to $8,532

32 percent replacementthrough $51,456

15 percent replacement up to maximum

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 2030Percent of Total Population

2003

Source: U.S. Census Bureau, Population Division, Interim State Population Projections, 2005

2030

5 4 3 2 1 0 1 2 3 4 55 4 3 2 1 0 1 2 3 4 5

0 - 4 5 - 910 - 1415 - 1920 - 2425 - 2930 - 3435 - 3940 - 4445 - 4950 - 5455 - 5960 - 6465 - 6970 - 7475 - 7980 - 84 85+

Male Female Male Female

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

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

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1985 1995 2005 2015 2025 2035 2045 2055 2065 2075

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Outlays

Revenues

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-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) 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

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

Problems with scenario analysis Unlikely No measured probability of actually happening

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

Cost Rate/Outlays Benefits as percent of GDP 2007: 4.3 2082: 4.6-7.7

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

-25

-20

-15

-10

-5

0

5

10

1985 1995 2005 2015 2025 2035 2045 2055 2065 2075

Rat

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f T

rust

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to

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utl

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-25

-20

-15

-10

-5

0

5

10

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

0%

5%

10%

15%

20%

25%

2003 2013 2023 2033 2043 2053 2063 2073 2083 2093

Year

Ta

x R

ate

0%

5%

10%

15%

20%

25%

Employee Tax Increase

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

0%

10%

20%

30%

40%

50%

60%

70%

1941 1951 1961 1971 1981 1991 2001 2011 2021 2031

Age 62 Birth Cohort

Sh

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of

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rre

nt

Be

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fit

0%

10%

20%

30%

40%

50%

60%

70%

Benefit Cut

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??

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1985 1995 2005 2015 2025 2035 2045 2055 2065 2075

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Excess Cost Growth of 1 percent

Excess Cost Growth of 2.5 percent

No Excess Cost Growth

CBO Forecast

Percent

…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