A Paper Prepared for The Commission on the Social Security 'Notch' Issue

by  James W. Kelley
Former Staff Director, Subcommittee on Social Security, House Ways and Means Committee

and   Joseph R. Humphreys
Former Professional Staff Member, Senate Finance Committee




1. Legislative action in 1969
2. Legislative action in 1970
3. Legislative action in 1971
4. Legislative action in 1972





The 1970's were tumultuous years for the Social Security System. In 1972, legislation was enacted designed to automatically keep benefits up to date with inflation while at the same time assuring adequate financing to support the program into the long-range future. In addition, the 1972 legislation provided a one-time increase of 20% in Social Security benefit levels. Almost immediately economic conditions dramatically worsened with serious consequences for the Social Security program. Rapid inflation caused Congress to add additional ad hoc benefit increases. The unexpectedly high inflation also interacted unfavorably with the new automatic benefit formula, and caused benefit costs to eat into the trust fund reserves. During this same period, it became clear that other factors such as disability experience and long-range fertility trends were developing in ways that would undermine the program's financing. By 1977, the long-range actuarial situation of the Social Security system was enormously out of balance and, in the short-range, trust fund reserves were facing exhaustion within a very few years. At the same time, the 1970's was a recessionary period and the prospect of raising taxes -always unpleasant -- was particularly unappealing.

The 1977 Social Security amendments attempted to restore the program's financial soundness. A major element of those amendments was a change in the formula (i.e. benefit computation method) for Social Security benefits. Individuals born prior to 1917 were left under the old formula. Individuals born after 1916 were required to have their benefits computed under the new rules. Many of those born in 1917 and the years immediately following 1917 believe that the change unfairly discriminates against them as compared with persons born in earlier years and also as compared with those who come well after them.* This alleged discriminatory impact is referred to as the notch issue.

(*Note that individuals born on January 1 of a particular year are considered to have been born in the previous year.)

Social Security is a complex program having many rules which can significantly affect benefit levels. This makes it difficult to compare the benefits payable to individuals whose circumstances are not identical in every respect. Under either the old law or the new law, it is possible to draw examples of individuals who seem in many ways to be similarly situated but who get strikingly different benefits because they are not identically situated. It is also possible to find reasonable examples of a "reverse notch" under which the 1977 amendments have resulted in substantially higher benefits for persons born after 1916 compared to persons born a few days earlier (but just prior to 1917) who have very similar or even identical earnings histories.

Nonetheless, the basic operations of the new and old benefit formulas do tend in many cases to create the results cited as the notch issue. The two sides of the notch -- the comparison with later retirees and the comparison with earlier retirees -- arise from different decisions.

Future beneficiaries do better than those who came on the rolls in the years just after implementation of the 1977 amendments. The 1977 benefit formula is designed to provide stable replacement rates -- benefits as a percentage of preretirement earnings. Since, in most years, wages rise faster than prices, this tends to result in each year's new cohort of beneficiaries receiving benefits which are higher in real terms than the initial benefits for similar retirees in previous years. Both the mechanics of this result and the principle that it gives higher benefits for workers m the future appear to be a conscious policy choice made by Congress. A Congressional panel had recommended an alternative approach of keeping initial benefits level in real terms from year to year. One of the rationales stated for that approach in the panel's report was that it would avoid treating the retirees in future years better than the retirees in earlier years. This alternative approach was considered and specifically rejected by the Congress.

The other, and more widely discussed, side of the notch issue is the differential in benefits between those in the prenotch years (born prior to 1917) and those born in the notch years (the 5 to 10 years after 1916). In general terms, it can be said that the result is consistent with the overall objective that Congress intended to achieve which was to restore the solvency of the program by a combination of increased revenues and constrained benefits -- and in particular by adopting a new benefit formula that was less generous (particularly in times of high inflation) than the old law benefit formula.

In the 1977 Social Security amendments, therefore, Congress acted to restore the solvency of the program by a variety of measures aimed primarily at cutting costs and raising revenues. The most significant cost cutting item was the adoption of a new benefit formula that was intentionally set at a level which represented a rollback from the levels attained by the old formula. In implementing any new system, a decision has to be made as to when and how it will be applied. Congress chose to make the new formula effective for those who would attain retirement age starting about a year after the law was enacted, that is, those born in or after 1917, who would reach age 62 in or after 1979.

The fact that Congressional intent was to implement a less generous benefit formula is, in a general way, consistent with the result that those in the notch years receive lower benefits than those in the prenotch years. However, there is no evidence that Congress directly focused on the question of comparative benefits for the two groups. The legislation did include a transition clause for individuals reaching age 62 in the first five years after implementation, but this provision was aimed at protecting the benefit expectations of those individuals rather than at providing any type of parity with those born in other years. In the hearings on the legislation, one witness did submit with his testimony (before the Senate and House Committees) an addendum which clearly and specifically identified the notch issue, but there is no evidence of any follow up to this testimony.

Why did Congress not focus on this issue? The ability to analyze the impact of the 1977 benefit formula was constrained in a number of ways. There were a large number of major issues competing for attention including novel and controversial financing schemes and other difficult benefit rule changes. For most of the period of Congressional consideration, there were multiple contenders for the role of new benefit formula each of which would have affected the comparison in different ways. Also, the complexity of the Social Security system makes it difficult to construct truly typical examples.

Nonetheless, examples could have been constructed to address the question of benefit differentials between those coming under the new law and those remaining under the old law. Had such examples been constructed, they would have shown much smaller differentials than those which actually materialized because the assumptions underlying the 1977 amendments did not foresee the unprecedented inflation of the following several years.

It can only be a matter of conjecture as to how Congress would have reacted if the notch issue had been clearly framed at the time of the 1977 amendments. If Congress had wanted to change the policy, it could have done so. The notch, in fact, would not have occurred under the legislation originally submitted by the Administration in 1976 since it would not have permitted those born before 1917 to use post-1978 wages in an old-law computation. For reasons unrelated to the notch issue, this restraint was dropped when the new Administration resubmitted the legislation in 1977. The notch could also have been lessened by allowing those in the transition years (born 1917-1921) to use post-age-62 earnings, as apparently envisioned by the 1974 Advisory Council or by a transition clause involving a blending of old and new law benefit computations, as recommended by the Hsiao panel. Other approaches also might have been developed for Congressional consideration. If Congress had addressed the issue, the overwhelming concern to restore program solvency would logically have leant support to the approach of limiting benefit growth for those remaining under the old-law, rather than raising benefit levels for those qualifying for benefits under the new benefit formula.


This report was undertaken at the request of the Commission on the Social Security "Notch" Issue with a view to examining the legislative background of that issue and, insofar as possible, the Congressional intent underlying the legislation involved.

What is the Notch?

In the Social Security Amendments of 1977, Congress changed the formula for computing Social Security benefit amounts. The change in law was made effective for individuals reaching age 62 (the age of first eligibility for Social Security retirement benefits) in 1979 or later. Persons born in 1916 or earlier remained eligible for benefits under the old formula and were not allowed to use the new formula. Persons born in 1917 or later were required to use the new formula. They were not allowed to use the old-law formula, but a special "transitional" formula was provided as an alternative for those reaching age 62 in the first five years of the new law: 1979-1983.

The new formula, in its first year of applicability (1979), was designed to produce benefit levels averaging about 5% lower than those that would have resulted from the old formula.(1) However, under the transition formula, persons reaching eligibility age and retiring in 1979 were guaranteed a benefit at least equal to the benefit the old law formula would have produced.

For persons reaching age 62 after 1978, the new formula generally produced lower benefits than would have been available under the old formula. Both the old and new formulas were automatically adjusted in a way that results in increasing benefit levels from year to year. However, the growth rate in benefit levels under the old formula was higher than the growth rate under the new formula. Consequently, persons who could continue to use the old formula (i.e., persons who were born prior to 1917) and who worked beyond 1978 tended to receive benefits that were higher (in many cases significantly higher) than persons with comparable earnings who were required to use the new formula (i.e. persons born after 1916).(2)

For those born from 1917 through 1921, the transition clause provided a guarantee that their benefits would be no lower than what they would have qualified for under the old law formula as of 1979. However, the old law formula was applied for these persons without adjustment for inflation between 1978 and the year of first eligibility (age 62) and without the use of earnings after age 62. Both of these elements--inflation adjustments and post-62 earnings--tended to heavily influence the growth of benefit levels under the old law formula. Consequently, the transition formula often did little or nothing to lessen the differential between benefit levels for those born in and after 1917(3) compared with those born earlier.

(1)  Conference report on 1977 amendments (House Report No. 95-837) as printed in U.S. Congress, Congressional Record, (Permanent Edition), v. 128, p. 38943. (December 15, 1977).

(2)  It was, however, quite possible for some individuals to receive significantly higher benefits under the new benefit formula than what was payable to persons with similar earnings records who were born prior to 1917 and thus required to use the old law formula. An example would be two women, one born in December 1916 and the other in January 1917. If both had maximum earnings from 1951 through 1965 (age 35 through 49) and then dropped out of the work force to care for an elderly parent, the woman born in 1917 (a notch year) would qualify in January 1979 for a benefit of $241.80 while the pre-notch woman (born a few days earlier but in 1916) would have a benefit of $200.40. In other words, with the same earnings record and a birth date a few days apart, the notch years retiree would get a 20 % higher benefit than the pre-notch retiree.

(3)  There is no universally accepted definition of what constitutes the "notch years''. It clearly begins with those born in 1917 -- the first category permitted and required to use the new wage indexing formula. The birth year ending the notch period is most commonly considered to be either 1921 or 1926.

While most discussions of the notch issue focus particular attention on the noticeably lower benefit level for many of those born in and after 1917 compared with the benefit level for those born earlier, there is also an issue related to comparative benefits for those in the notch years and those who came on the rolls after the notch years. The very term "notch" implies a "V" or "U" shaped cut in which the area cut out is lower than the areas on either side of the cut. Because initial dollar benefit levels do grow from year to year under the new formula, individuals reaching eligibility age well after the 1979 changeover year will receive higher benefits than those who came before them. This is true even if benefit levels are adjusted for inflation.

Thus the notch category - those born in the first few years after 1916 -- did in many cases receive benefits which can be characterized as lower than the benefits for those who came before them and lower than the benefits for those who came after them. Benefits were lower than for those who came before them because the new benefit formula was intended to produce lower benefits than the prior law formula. Benefits were lower than for those who came after them because the new benefit formula is designed to provide each year's cohort of retirees with benefits which, in real terms, are higher than the benefits payable to comparable workers who reached retirement age in earlier years.

Congressional Intent

Congressional intent is sometimes clearly delineated in the legislation itself or in the Committee reports and floor debates accompanying the consideration of a measure. This is not the case with respect to the notch issue.

The legislative record contains some discussion, as noted later in this paper, of the fact that the new benefit formula provided lower real benefits for those reaching retirement age in any given year compared with those who would retire in later years. On the more prominent aspect of the notch issue, however, there is no outright statement in the "official" legislative history to indicate that Congress focused its attention on the question of whether those reaching eligibility in the first several years after enactment would receive substantially different benefits from those coming before them. Consequently, there is also no clear and obvious indication of whether such a result would or would not have been acceptable to the Congress at the time of enactment.

In the absence of any clear statements of intent, this paper attempts to provide an indirect analysis of Congressional intent by examining the context surrounding the 1977 amendments in addition to the official legislative history. What were the main objectives addressed by the legislation and how is the notch result consistent or inconsistent with those objectives? What alternatives did Congress consider and not adopt and how would those alternatives have affected the outcome of this issue? Since the 1977 legislation was designed in large part to remedy problems with the 1972 legislation, what was Congress trying to achieve in 1972 and to achieve better in 1977? What were the purposes of the 1977 transition clause, and how did it achieve, or fail to achieve, those purposes? What were the economic expectations underlying the 1977 amendments, and how did those expectations and the actual economic results affect the notch issue?


Benefit Increases Prior to the Automatic Cost of Living Adjustments

When the Social Security programs was enacted in the Social Security Act of 1935, it provided for benefit payments only to workers in "commerce and industry" when they retired from employment at age 65 or later. The system then established has been expanded in the intervening years both in coverage and in the types of economic protection afforded to workers and their dependents.

The major subsequent laws which broadened the system included benefits for dependents and survivors of covered workers enacted in 1939; coverage for additional types of workers, largely in the 1950's, 1960's, and 1970's; benefits for disabled workers enacted in 1956; and the creation of the Medicare program, financed in part by employment taxes, enacted in 1965.

The automatic cost of living adjustments were enacted in 1972 following a three-year period of intense Congressional action dealing with proposed changes to a broad range of Social Security Act programs. These included: the enactment of the Supplemental Security Income (SSI) program which federalized the state administered adult public assistance programs; reforms to the Aid to Families with Dependent Children (AFDC) program including the Nixon Administration's proposed Family Assistance Plan, which failed of enactment; numerous Medicare and Medicaid amendments; and major amendments to the unemployment compensation program. During the same period, the House Ways and Means Committee and Senate Finance Committee were also occupied with major trade and tax legislation.

The focus of this section is limited to the history of Social Security benefit increases that preceded the benefit formula provisions of the 1977 amendments, which resulted in the enactment of the "notch." Only those prior amendments that had some relationship to benefit increases will be mentioned.

The automatic cost-of-living benefit adjustments enacted in 1972 were based, in principle, on the same approach used in designing all of the ad hoc benefit increases that were enacted in prior years.

Prior to the 1972 amendments "static" economic assumptions were used to determine the long-range future cost of the Social Security program. The application of these static assumptions was a deliberately conservative approach to financing the program. In brief, the static assumptions held that wages and prices would not increase in the future but would remain at the same level they had attained at the time of the estimate.(5)

(4)  The Social Security Act of 1935 also contained separate titles to create additional programs for the needy and the unemployed which have developed independently. References in this paper to the Social Security program are to the Old-Age, Survivors, and Disability Insurance program (OASDI) which, in the 1935 legislation, was the Old-Age Insurance program.

(5)  See discussion of financing methodology in U.S. House of Representatives, Reports of the 1971 Advisory Council on Social Security, House Document No. 92-80, Washington, U.S. Government Printing Office, pp. 64-66.

The application of static economic assumptions resulted in periodic surpluses in the Social Security trust funds as wages levels increased providing additional Social Security tax income to the program. These surpluses, augmented by legislated changes in Social Security (FICA) tax rates and the amount of annual earnings subject to tax (the wage base), were used to finance ad hoc benefit increases and other program liberalizations prior to the adoption of the automatics in the 1972 amendments. The following table of benefit increases and price increases indicates that, except for the period prior to 1950(6) and in the case of the 1973 Amendments(7), Congress enacted ad hoc benefit increases that exceeded increases in the CPI, prior to the first scheduled operation of the automatics in June 1975.

(6) Social Security benefits were not paid until January 1940

(7) The 1973 amendments provided earlier benefit increases in 1974 that would not have occurred under the automatics until June of 1975.



Across-the-Board Increase in Benefits

Increase in CPI (1)


Date of Enactment

Effective Date

Each Amendment

Cumulative Since Amendments of 1939

Between Effective Dates

Cumulative Since Amendments of 1939











77.0% (2)







12.5 (3)







13.0 (4)







7.0 (5)

































7/ 1/72   









11.0 (6)









































































































































(1) 1967=100 CPI-W

(2) Average increase of about 77%--from 100% at lowest to 50% at highest level.

(3) Greater of 12.5% or $5

(4) Guarantee of 7% or $3

(5) Guarantee of 7% or $4

(6) 11% increase in benefits effective June 1994, with 7% of this amount payable March 1974. SOURCE: Social Security Administration

Following is a brief summary of legislative actions taken from 1969 through 1972 on ad hoc benefit increases and on the adoption of the automatic provisions

1. Legislative action in 1969

On September 25,1969, President Nixon sent his Social Security recommendations to Congress and they were introduced by Minority Leader Gerald Ford as H.R. 14080.(8)

The bill contained a 10% benefit increase and automatic benefit increases based on future increases in the cost-of-living plus additional amendments relating to benefit categories.

The House Ways and Means Committee started public hearings on September 30, 1969, on H.R. 14080, together with H.R. 14173, President Nixon's proposed welfare reform amendments. The hearings continued until November 13. The Committee went into executive session on November 19 to consider both the Social Security and the welfare reform proposals.

On December 8, the Ways and Means Committee unanimously reported a separate bill (H.R. 15095) which was introduced by Chairman Wilbur D. Mills and ranking Minority member John Byrnes on December 4. The bill provided a 15% benefit increase effective for January 1970 and numerous modifications to the President's proposals. The bill did not contain any financing amendments since the OASDI trust funds had a favorable actuarial balance of 1.16% of payroll.(9) Following floor debate, the House approved the bill by a 398 to 0 vote on December 15.

Meanwhile H.R. 13270, the-proposed Tax Reform Act of 1969, was being considered in the Senate. The Senate attached several Social Security amendments to the bill, including a 15% benefit increase effective for January 1970, and an increase in the minimum benefit from $55 to $100/month, and an increase in the taxable earnings base to $12,000 beginning in 1973. H.R. 13270 passed the Senate by a vote of 69 to 22 and it was sent to a Senate-House conference committee on December 11,1969, which considered the differences between the two bills. The conference committee agreed to the 15% benefit increase, approved by both Houses, omitted the Senate financing provisions and settled the differences on the other provisions of the bill. The conference committee bill was agreed to by both the House and the Senate on December 22 and the President signed the bill as Public Law 91-172 on December 30,1969.

2. Legislative action in 1970

The Ways and Means Committee carried on extensive executive sessions in the early months of 1970 and further considered the Administration's Social Security, Medicare, and Medicaid proposals. On May 11, 1970, Chairman Mills and Congressman Byrnes introduced H.R. 17550, containing the Committee's decisions. The bill contained an additional 5% benefit increase, effective for January 1971 but did not include the Administration's automatic benefit increase proposal.

H.R. 17550 also contained many additional amendments to the OASDI program and to the Medicare and Medicaid programs, along with financing provisions to maintain the fiscal integrity of the payroll-financed OASDI and Medicare (Hl) programs.

(8) Weekly Compilation of Presidential Documents, vol. 5, no. 39, pp. 1319-1324.

(9) The long-range solvency of the Social Security program is usually stated in terms of percentages of taxable payroll. Roughly speaking, a long-range deficit of l% of taxable payroll means that the actuarial projections of the income and outgo of the trust funds over the next 75 years show that outgo will exceed income and that income could be made to equal outgo by increasing the combined employer/employee tax rate by l percentage point (or by making other changes of an equivalent magnitude to the income or outgo of the program). Similarly a surplus of 1% of taxable payroll could be used to decrease the tax rates by a combined 1 percentage point or to make program changes with comparable costs.

While being debated in the House, H.R. 17550 was ordered recommitted with directions to report the bill back to the House with the Administration's recommendation for automatic adjustment of benefits, the wage base, and the retirement test. As so amended, the bill passed the House on May 21, 1970, by a vote of 344 to 42.

The Senate Committee on Finance began public hearings on H.R. 17550 and on H.R. 16311, the proposed welfare reform amendments on June 17 and went into executive session to consider the two bills on September 29. The Finance Committee bill was reported on December 9 with major modifications.

In place of the 5% benefit increase in the House passed bill, the Finance Committee bill provided a 10% increase. The minimum benefit would be increased to $100, rather than $67.20 which would have been payable under the 5% increase passed by the House. The Finance Committee bill also differed from the House bill with regard to financing the automatics. The House bill assumed that the program would be adequately financed from the additional revenues generated by automatic increases in the wage baseCthe maximum amount of annual earnings subject to Social Security tax. The Senate Finance committee bill would have required an actuarial evaluation of program finances each time a benefit increase was triggered. On the basis of that evaluation, program financing would be increased to the full extent necessary to cover the additional costs. One-half of those costs would be financed from increases in FICA tax rates and one-half from increases in the wage base.

Numerous other OASDI and HI amendments in the Finance Committee bill either were the same as modifications or deletions of, or additions to the provisions of the House passed bill.

The Finance Committee bill also would have created a new Federal program of catastrophic health insurance for all persons under age 65 who were insured for or entitled to Social Security, their spouses, and dependent children. The health services would have been the same as those provided under the Medicare program and would have been available after family health care expenses exceeded defined limits. Also included in the bill were provisions related to international trade and veterans benefits.

With regard to welfare changes, the Finance Committee considered H.R. 16311 the Administration's welfare reform proposal and, with major modifications, included its provisions in H.R. 17550. These modifications would have eliminated the House passed provisions to federalize the adult public assistance programs and establish a federal Family Assistance Plan in place of the State-run AFDC program, but the bill included a number of other modifications to the adult assistance programs and to the AFDC program.

During floor debate the Senate voted to recommit the bill to delete the catastrophic health insurance program and certain other provisions of the bill. As so amended, H.R. 17550 was passed by a vote of 81 to 0 on December 29.

The Senate requested a conference and appointed conferees. The House declined the request since Congress had set January 2, 1971, as final adjournment day. Chairman Mills declared his intention to make Social Security legislation the first order of business for the Ways and Means Committee in the about-to-convene 92nd Congress.

3. Legislative action in 1971

When the 92nd Congress convened on January 21, 1971, Chairman Mills and Representative Byrnes jointly introduced H.R. 1, the Social Security Amendments of 1971. The bill=s provisions were, for the most part, the same as those contained in H.R. 17550 as passed by the House in 1970 (but they did not include the automatic benefit increase provisions). The bill also included the welfare reform proposals passed by the House in H.R. 16311 in 1970.

The Committee on Ways and Means held executive sessions from February through May 1971 to consider H.R. 1.

During this same time, action was required on a bill to increase the public debt limit. When the public debt bill (H.R. 4690) was before the Senate, several Social Security amendments were adopted during floor debate. The principal amendment was a 10% Social Security benefit increase, including family maximum benefits, effective for January 1971. The conference committee on the debt limit bill deleted two of the Senate amendments (one providing for a $100 minimum and one providing for an increase in the retirement test (10) annual exempt amount to $1200), but accepted the remaining Senate amendments, including the 10% increase in benefits and family maximum benefits.(11)

The President signed H.R. 4690 into law (Public Law 92-5) on March 17, 1971.

Also during March 1971 the Advisory Council on Social Security(12), which had been appointed in 1969, issued its report. Its recommendations included most of the major changes in the OASDI program that were contained in H.R. 1. It also recommended changing from static to dynamic economic assumptions in estimating the costs of the OASDI program, and it endorsed the principle of current cost financing by which trust fund revenues and expenditures would generally be kept in balance with sufficient reserves to maintain funds to assure annual benefit payments.

The Ways and Means Committee reported H.R. 1 to the House on May 26, 1971. The reported bill provided a 5% Social Security benefit increase effective for June 1972. The OASDI, Medicare, and Medicaid provisions remained essentially patterned after H.R. 17550 but with additional modifications along the lines of Senate amendments to H.R. 17550 in 1970.

H.R. 1 as reported in the House also contained welfare reform provisions which differed considerably from those contained in H.R. 16311 of the previous Congress.

H.R. 1 passed the House by a vote of 288 to 132 on June 22 and was sent to the Senate. The Senate Finance Committee held public hearings in July and August of 1971 but took no further action on H.R. 1 during the remainder of 1971.

(10) The retirement test or earnings limit is the provision of law under which Social Security benefits are reduced when an individual to whom the test applies has earned income above a certain amount, referred to as the exempt amount. The test now generally applies to beneficiaries under age 70.

(11) It is of interest to note that in dealing with the l0% increase in the family maximum the amendment eliminated "notches" that had accrued for families affected by the family maximum under prior benefit increases. Such earlier benefit increases went only to families on the rolls on the effective date of a benefit increase, but not to families coming on the rolls in the future. This resulted because family maximum benefits were previously determined as a percentage of a worker's average monthly wage, which remained constant regardless of any benefit changes. The family maximum was, in effect, redefined by being stated as a percentage of a worker's primary insurance amount (PIA) which is the basic figure that is used to determine all individual benefits. As thus redefined, benefit increases were made applicable to family maximum benefits regardless of when a family became subject to the maximum. Since then, all benefit increases have applied to current and future families limited by the family maximum.

(12) Section 706 of the Social Security Act provided for the appointment every four years by the Secretary of Health Education and Welfare of a 13-member Advisory Council whose "members, shall to the extent possible, represent organizations of employers and employees in equal numbers and represent self-employed persons and the public." Legislation enacted in 1994 establishes a permanent advisory board and eliminates the requirement for quadrennial advisory councils.

4. Legislative action 1972

The Senate Finance Committee held additional public hearings on H.R. 1 in January and February of 1972 followed by executive sessions which lasted through June.

On February 23, 1972, while hearings on H.R. 1 were being conducted by the Senate Finance Committee, Chairman Mills introduced a bill (H.R. 13320) to provide a 20% Social Security benefit increase, effective for June 1972. The bill's financing provisions provided for increases in the wage base to $10,200 in 1972 and to $12,000 in 1973, and automatic increases in the wage base thereafter, and for reductions in the tax rates in the early years according to the following table showing rates for current law, H.R. 1 as passed by the House and for H.R. 13320.



Current law (1)

H.R . l (2)

H.R. 13320 (3)






2011 and after



















(1) $9,000 contribution and benefit base for 1972 and after.

(2) $10,200 contribution and benefit base for 1972 with automatic adjustments to increases in earnings levels thereafter.

(3) $10,200 contribution and benefit base for 1972 and $12,000 for 1973 with automatic adjustments to increases in earnings levels thereafter.

In introducing H.R. 13320, Chairman Mills explained that it was possible to finance a 20% benefit increase and the provisions in H.R. 1 and at the same time lower tax rates during the early years by applying the dynamic economic assumptions and the current-cost financing that had been recommended by the Advisory Council on Social Security and endorsed by the boards of trustees of the Social Security trust funds and by the Nixon Administration.(13)

Mr. Mills' bill met with an uncharacteristic questioning of its soundness. Employer interests and the conservative press and Congressional critics expressed concerns relative to the risks the system would assume if the finely-tuned economic assumptions on which financing of the Mills' bill was based failed to occur.(14)

Action on the 20% benefit increase and the automatics followed an unusual and unpredictable path in the Senate. This legislative course bypassed consideration by the legislative committees in both Houses of the 20% increase and the shift from static to dynamic assumptions.

(13)  U.S. Congress, Congressional Record, (Permanent edition), pp. 5269-5272, Feb. 23, 1972.

(14)  See statement of Congressman Conable at U.S. Congress, Congressional Record, (Daily edition), p. H1429, Feb. 24, 1972.

When the Senate was debating a bill (H.R. 15390) to extend the public debt limit, Senator Frank Church on June 28, 1972, offered a floor amendment to the bill that was essentially the same as H.R. 13320 but with a later effective date for the 20% benefit increase (September rather than June) and a one year delay in the wage base increases (to $10,800 in 1973 rather than 1972, and to $12,000 in 1974 rather than 1973).

H.R. 15390, with these and other technical amendments, was passed by both the Senate and the House on June 30 and signed by the President on July 1, the date by which final action on the debt limit was mandatory. (Public Law 92-336, 92nd Cong.)

Such was the highly charged legislative environment in which the automatic (COLA) provisions were enacted.

The Senate Finance Committee resumed consideration of H.R. 1 in September 1972 and reported the bill on September 26 with numerous amendments to the Social Security, Medicare/Medicaid, and welfare programs.

The Senate debated H.R. 1 from September 26 to October 6, again adding additional amendments, and passed the bill by a vote of 68 to 5.

The conference committee met on the bill on October 10 through October 14. The conference report was adopted by the House on October 17 by a vote of 305 to one and on the same day by the Senate by a vote of 61 to zero. On October 30, 1972, the President signed the bill into law as Public Law 92-603.


Actuarial Status in 1972

In 1972, when the automatic benefit increase provisions were adopted, inflation rates seemed to be declining from the unusually high levels (averaging 5% annually) of the past five years. For 1972, the inflation rate was 3.2%.(15) Near the end of 1972, the Finance Committee reported that the Social Security program of Old-age, Survivors, and Disability Insurance had a positive actuarial balance. The future cost of the system assumed an average annual inflation rate of 2.75% and a wage growth rate of 5%. For the first 37 years (through 2010), a safety factor of 0.375% was added so that the assumed real wage differential was 1.875% (5% wage growth minus 2.75% inflation. minus 0.375% safety factor). The first two automatic benefit increases were projected to take place in 1975 (5.1%) and 1977 (5.5%). (16)

1973 - Unexpected Inflation

By early 1973, it was clear that inflation would be much higher than had been expected in 1972. Instead of waiting for the first automatic increase to take effect in January of 1975, Congress passed Public Law 93-66 in July 1973 providing an ad hoc increase of 5.9% to become effective in June of 1974. This was a "down payment" on the January 1975 automatic increase which was then expected to be about 8%.

As inflation continued to mount, Congress again passed legislation in the closing days of the session to provide a two-step increase - an 11% increase effective for June 1974, 7% of which was payable in April. The previously adopted 5.9% increase was absorbed into this increase.

(15) Economic Report of the President, U.S. Government Printing Of lice, Washington, 1992., p. 361.

(16) Committee on Finance, U.S. Senate, Social Security Amendments of 1972 (Senate Report 92-1230 to accompany H.R. 1), U.S. Government Printing Of lice, Washington, 1972, pp. 341-344. Under the 1972 law, inflation would have to increase by at least 3 % since the last increase in order to trigger an automatic benefit adjustment. Under subsequent amendments, there is now an annual increase without regard to any such minimum.

Action on this legislation began with the introduction of H.R. 11333. The bill was favorably reported by the House Ways and Means Committee on November 9, 1973 (House Report No. 93-627). The bill, as it was reported and as it passed the House on November 15, provided for a two-step increase. A "flat" 7% payable for March 1974 and another increase payable for June 1974 which, together with the 7% increase, would equal a combined 11% increase.

The Senate acted on this increase as an amendment to H.R. 3153, a lengthy technical amendments bill to eliminate minor drafting errors in the Social Security law. The 1974 two-step benefit increase in the Senate amendment differed from the House provision in H.R. 11333 in three respects: first, the interim 7% increase would be for the month in which the bill was enacted rather than for March 1974 as in H.R. 11333; second, additional financing was provided in the form of increases in Social Security tax rates and in the taxable wage base; third, the interim 7% increase would be a "refined" increase rather than a "flat" increase as in H.R. 11333.(17)

A conference committee began to meet on H.R. 3153 in late December but no conference report was issued. Instead, by unanimous consent, floor action was taken in the House on December 20 and in the Senate on December 21. Both houses approved H.R. 11333 with the two-step 11% increase along the lines of the Senate amendment to H.R. 3153. The bill was signed on December 31, 1973, as Public Law 92-233.

In its report on the legislation which would become Public Law 92-233, the Senate Finance Committee indicated that it would leave the Social Security program with a long-range actuarial deficit of 0.56% of taxable payroll and a short-range situation in which end-of-year balances would grow from $44 billion in 1973 to $52 billion in 1978. (Although the Committee report did not point this out, the size of the short range fund balances relative to annual outgo were projected to decline over that period.) (18)

1974 Trustees Report Indicates a Problem

While the Finance Committee report in 1973 showed no great concern over the financial status of the program, the situation changed dramatically in 1974. Inflation, which, in the years since 1950, had never reached as much as 5% came in at 6.2 % for 1973 and continued to accelerate to nearly twice that rate in 1974. When the Social Security Board of Trustees(19) issued its annual report on the financial status of the program at the end of May, it revealed a startling actuarial imbalance of 2.98 % of taxable payroll. For the program to meet its benefit obligations over the 75-year estimating period, tax rates would have to be increased by some 27 percent. (20)

(17) Briefly, a "flat" increase involves applying the percentage increase to actual benefit amounts paid to beneficiaries rather than to the primary insurance amount (PIA) on which benefits are normally based and on which a "refined" benefit increase is based. The use of the former gives rise to more difficult administrative problems than the latter.

(18) Committee on Finance, U.S. Senate, Social Security Amendments of 1973 (Senate Report 93-553 to accompany H.R. 3153), U.S. Government Printing Office, Washington, 1972, pp. 10-16

(19) By law, the OASI and Dl trust funds each have a board who are required to make an annual report on the status of the funds. In 1974, the Board of Trustees was composed of the Secretary of Treasury, the Secretary of Health, Education, and Welfare, and the Secretary of Labor, with the Commissioner of Social Security acting as secretary to the Board.

(20) U.S. House of Representatives, 1974 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, House Document 93-313, Washington, U.S. Government Printing Office June 3, 1974, p. 36. The primary reason assigned by the trustees for the worsening of the financial condition of the funds was a change in population projections.

First Hsiao Panel Confirms a Very Severe Financing Problem

The Senate Committee on Finance responded to the Trustees' report by recommending a Senate Resolution calling for the appointment of a panel of actuaries and economists to provide a second opinion or, in the words of the resolution, "an expert independent analysis of the actuarial status of the Social Security system." The resolution was adopted by the Senate In of 1974, and a panel, headed by William C. L. Hsiao was convened.(21)

The Hsiao panel issued its report in January of 1975. The panel not only confirmed the Trustees' findings that the program was badly out of actuarial balance but also concluded that the deficit was roughly twice as bad as indicated in the Trustees' report. Where the trustees had indicated that tax rate increases of 27% would be needed for the program to meet its benefit obligations over the long-range estimating period, the Hsiao panel found that restoring solvency would require a 55% increase in tax rates (or other changes to benefits and financing with an equivalent impact).(22)

The Hsiao panel attributed the long-range financing problems of the Social Security program about equally to two main causes: demographics (a lower fertility rate than had previously been projected so that there would be fewer workers to pay taxes to support the program) and the nature of the benefit formula. The panel also examined the various factors which have an impact on program solvency and found that those factors with the highest impact (fertility, wage patterns, and inflation) were also the factors that are hardest to predict accurately.(23)

With respect to the benefit formula, the panel found that the formula adopted in 1972 "responds irrationally to changes in the rate of inflation, and can produce patterns of replacement ratios inconsistent with the generally understood purpose of the Social Security system." The panel recommended "That the benefit structure be changed to eliminate its irrational response to changes in the rate of inflation. This is essential to achieve financial soundness. The first step should be a prompt thorough study of several possible changes in the benefit structure."(24)


1974 Advisory Council Recommends Wage Indexed Formula

A new Social Security advisory council had been appointed to meet in 1974 under the chairmanship of W. Allen Wallis, Chancellor of the University of Rochester. The advisory council devoted its primary attention to the need to correct problems with the benefit formula adopted in 1972. Its report issued in March 1975 noted that "the method used for automatic cost-of-living adjustments has the side-effect of making replacement ratios (benefits as a proportion of earnings just before retirement) subject to unpredictable variations caused by changes in wage and price levels, an effect that presumably was not intended."(25)

(21) Committee on Finance, U. S. Senate, Report of the Panel on Social Security Financing pursuant to S. Res. 350, 93rd Congress. Committee Print, U.S. Government Printing Office, Washington, 1975, p. 1 (cited hereafter as Hsiao I).

(22) Hsiao I., p. 2.

(23) Hsiao I., pp. 2-6.

(24) Hsiao I., pp. 3-4.

(25) U.S. Congress, Reports of the Quadrennial Advisory Council on Social Security, House Document 94-75, U.S. Government Printing Office, Washington, 1975, p. l 30. Hereafter cited as Advisory council (74). Note: This quotation and some of the others in this paper come from an appendix to the advisory council report which was prepared by a panel of consultants to the council. Since the Advisory Council chose to incorporate their finding in its report and indicated no disagreement with them, this paper treats that appendix as part of the report.

The Hsiao panel had characterized the problem with the 1972 automatic benefit adjustment mechanism as one of "overindexing."(26) The advisory council report described it as a "coupled" system.(27) Both of these terms were widely used in discussions and documents at that time. They referred to the fact that initial benefit levels increased from year to year as a result of two separate indexing mechanisms. Initial benefit levels were computed by applying a formula to the retiree's average wages under Social Security. Under the 1972 legislation, the factors in the formula were periodically increased by the percentage increase in the Consumer Price Index.(28) The average wages to which this formula was applied also tended to increase as wage levels in the economy grew from year to year (and the 1972 legislation facilitated this impact by indexing for wage growth the maximum amount of annual earnings that could be counted in determining the average wages to which the benefit formula was applied). Thus, initial benefit levels were automatically increased by a mechanism which "coupled" the impact of price growth through an explicit indexing of the benefit formula and the impact of wage growth through the use of average wages. This "coupling" of the two factors made the increase in year to year benefit levels extremely difficult to predict since the increase would be based on both the absolute values and the interrelationship of inflation and wage growth. The result, under the revised economic assumptions of the mid-1970's was that benefit levels were increasing more rapidly than the financing of the system could sustain. Consequently, the "coupled" system adopted in 1972 was resulting in "overindexing" of benefits.(29)

The advisory council recommended that the situation be corrected by replacing the "coupled" mechanism for increasing initial benefit levels with a "decoupled" system which would rely entirely on wage indexing. Under the advisory council approach, the 1972 system in which the percentages in the benefit formula were indexed to the CPI each year would be dropped. A new formula would be adopted in which the percentage factors would not change from year to year. Instead of indexing the formula for price inflation, the new mechanism would index the wages to which the formula was applied. A retiree's creditable wages for each year would be adjusted to reflect wage growth in the economy between the year in which they were earned and the year of retirement. The benefit formula would then be applied to the average of those indexed wages.(30) Once individuals had their initial benefit levels computed at retirement, those benefits would be kept up to date through price indexing.

Although differing in some details, the wage indexing approach recommended by the advisory council, was essentially the approach ultimately enacted in the 1977 amendments.(31)

(26) Hsiao I., p. 17

(27) Advisory council (74), pp. 130-131.

(28) Strictly speaking there was no actual formula. Rather the law contained a benefit table which prescribed the full-rate benefit payable for workers at each level of average earnings. When benefits increased by a given percentage, all the benefit amounts in the table were increased by that percentage and, if the law also increased taxable wages, the table was

extended to prescribe benefit amounts at the resulting higher average wage levels. For all practical purposes, however, the result was the same as if there had been a benefit formula and all the factors in the formula were increased by the specified percentage.

(29) There was no "official" definition of the term "coupling," and it was somewhat confusingly used in two different meanings. As described here, it referred to the fact that the mechanism for adjusting initial benefits combined elements of price indexing with elements of wage indexing. It was also sometimes used in reference to the fact that the 1972 law used

the same mechanism--price indexed benefit formula factors--to increase initial benefit levels and to adjust benefits for those already on the benefit rolls. (A proposal described as "simple decoupling" would have eliminated price indexing for the factors in the benefit formula as it related to initial benefit levels but continued price indexing as it applied once an individual was on the benefit rolls.)

(30) The Social Security program weights the benefit formula to the advantage of lower income individuals. The benefit formula provides a higher percentage return on the lower part of an individual's average earnings than on the higher part. The "bend points" -- the levels of earnings at which the percentage in the formula changes -- were also to be indexed for wage growth in the economy under the advisory council proposal. Advisory council (74), p. 17.

(31) The advisory council proposed formula was 100 % of the first "A" dollars of average indexed monthly earnings (AIME) plus "B" % of AIME above "A" dollars. Instead of this 2-step formula, the actual 1977 legislation created a 3-step formula starting with 90% of the first "A" dollars. Advisory council (74), p. 17.

The question of how the change from the old to the new system would affect benefit levels in the years following the changeover was addressed in the advisory council report to some extent:



The consultants have no intention of reducing benefits when the new formula produces a lower result than the old one. It is clearly important that the new beneficiary of year y actually receive the greater of the new-formula PIA(32) and the old-system PIA. For those becoming beneficiaries after year y the same comparison is to be made and the greater benefit granted; with the understanding, however, that the old-system benefit table will not be updated for CPI changes after year y. As time goes on, the new-formula result (dynamic with average wages) will be greater than the PIA from the old system (static at the year y level) for a larger and larger percentage of the new beneficiaries, and the old system will be slowly phased out. The young-age death and disability cases will likely be the last to be payable on the new formula.(33)

In connection with the notch issue, there are several important points to be noted about the above quotation from the 1974 advisory council report.

The phase in described by the advisory council report matches the transition provision actually adopted in the 1977 legislation with 2 important exceptions. The actually enacted transition provision prohibits the use of wages earned in or after the year of reaching age 62 in computing a benefit under the old law formula. The benefit level differentials which give rise to the notch issue would have been less striking if the transition clause had permitted the use of post-age-61 wages.(34)

While the advisory council phase-in clearly anticipated that there would be no differential between old-law and new-law benefits for individuals retiring in the year the change became effective ("year y@), the above quotation shows that the report did recognize that the old-law benefits would for some time be higher for some beneficiaries than what would be payable under the new system. This finding, however, relates solely to a comparison of what the same individual would qualify for under the two approaches. There is no indication that the advisory council was aware of or addressed in any way the actual notch issue; that is, a differential in actual benefit levels payable to individuals subject to the new system and individuals who continued to be eligible under the prior system.

A second notable difference is that the Advisory Council Transition would have been available to all future retirees rather than only to those reaching retirement age in the first five years of the new formula. As the Council pointed out, however, the new formula would increasingly provide higher benefits than the static transition formula.

(32) The term "PIA" is an abbreviation for "Primary Insurance Amount". This is the "basic" benefit amount for an insured worker. For a retiree, it represents the amount that would be payable if the individual began receiving benefits at age 65. The actual benefit payable may differ, for example, because of reduction for early retirement.

(33) Advisory council (74), p. 130.

(34) For persons born in 1917, allowing post-6l wages to be used in an old-law computation would have eliminated any notch effect since such individuals were not affected by the other part of the notch, the rule that cost-of-living increases would not apply after 1978 and before the year of attaining age 62.

Second Hsiao Panel Recommends Price Indexed Approach

In April of 1975, the Congressional Research Service of the Library of Congress, on the basis of a request from the Senate Finance Committee and the House Ways and Means Committee, appointed a consultant panel of actuaries and economists to "examine the various ways in which the benefit structure could be revised to correct the problem of any overreaction to changes in price levels."(35) William Hsiao once again was selected as project director for this study. The panel submitted its report to the Congressional Research Service in April of 1976. The report was subsequently printed as a joint committee print in August, 1976. By the time the report was printed, the Ford administration had submitted legislation proposing a switch to a wage indexed mechanism along the lines of the recommendations made by the 1974 advisory council.

The Hsiao II panel looked at 5 alternatives to the 1972 benefit adjustment mechanism: a flat benefit formula, a money purchase plan, a "high-5" plan, a wage-indexed formula, and a price-indexed formula.(36) For the most part, however, the report concentrated on the price and wage indexing alternatives. The panel recommended a price indexing approach. This would have operated in the same way as the wage indexing proposals except that wages would have been adjusted for price inflation between the year of earnings and retirement instead of being adjusted for wage growth.

The price indexing approach recommended by the Hsiao II panel was expected to result in lower program costs than wage indexing.(37) The panel argued that price indexing would maintain the real, inflation-adjusted value of benefit levels while preserving a greater degree of control and flexibility for Congress to determine whether benefit increases in excess of inflation were appropriate. A second argument was that the price indexing approach involved a substantially lower long-range cost. The panel's third argument was that the price indexing approach would allow Congress to provide real increases in benefits for those already on the rolls:

  • In contrast to this, the wage-indexing method provides a sharp tilt in favor of workers retiring in the future. The increases in benefits for workers already retired are limited to increases in the rise in the Consumer Price Index. Yet workers who retire five years later will receive increments due to both price changes and increases in real wages. The difference in retirement benefits can be substantial.(38)

This last argument corresponds to that part of the notch issue which is based on the contention that those in the notch years received benefits which were lower than those paid to later retirees.

The Hsiao II panel also dealt with the issue of transition. They recommended that persons born in 1917 or earlier remain subject to the old law regardless of when they retired. For those born during the 4 transition years 1918-1921, the panel recommended the payment of a blended benefit comprised of an increasing percentage (20,40,60, and 80 percent) of the new law benefit and a decreasing percentage of the old-law benefit. Like the advisory council, the Hsiao II panel did not directly address the question of discrepancy between benefits for those born before 1918 and those born after 1917.

(35) Committee on Finance, U.S. Senate, and Committee on Ways and Means, U.S. House of Representatives, Report of the Consultant Panel on Social Security to the Congressional Research Service. Joint Committee Print, U.S. Government Printing Office, Washington, 1976, p. 1. (cited hereafter as Hsiao II)

(36) Hsiao II, p. 15.

(37) As it turned out, during the first few years during which the 1977 amendments were effective, price inflation outpaced wage growth so that costs of price indexing during that period would have been greater than the costs of the wage indexing system which was enacted. Over the long run, however, the price indexing approach would have cost significantly less.

(38) Hsiao II, p. 9.


As described under the preceding heading, during the period between the enactment of the 1973 ad hoc increase and the 1977 amendments, concerns over the financial integrity of the Social Security system mounted. Although no legislation to deal frontally with the financing problems was enacted during that period the legislative committees of both Houses maintained continuing oversight and acted to lay the groundwork for the 1977 corrective legislation.(39)

Ford Administration Proposal

The newly formed House Social Security Subcommittee(40) conducted eight days of hearings beginning on May 7, 1975 and ending on June 19, 1975.(41) During these hearings, testimony was received from representatives of the Ford Administration, the 1974 Advisory Council, and employer, labor and beneficiary organizations.

The Ford Administration took the position in 1975 that the long-range financing issues required further study and stated that a long-range financing bill would be submitted in 1976.

The House Subcommittee on Social Security conducted seven additional days of hearings from February 5th through 19th, 1976. The Secretary of Health, Education, and Welfare testified on the opening day of the hearings. The Secretary's testimony dealt only with the broad outlines of an Administration proposal, stating that an Administration bill would be drafted and submitted at a later date. He also suggested that the first order of business should be the short-range financing issues together with several program modifications that were being developed by the Administration.

The Ford Administration's proposal for changing the benefit formula was not submitted until June 17, 1976. It was introduced by Representative James A. Burke, the Chairman of the Social Security Subcommittee, as H.R. 14430, the Social Security Indexing Act of 1976.

The major features of H.R. 14430 were:

  • wage indexing of a worker's earnings through the second year before entitlement to retirement benefits, disability, or death;
  • a new benefit formula that would approximate the benefit levels of existing law at implementation and stabilize future replacement rates;
  • a 10-year transition guarantee that benefits would be no lower for those affected than benefits at implementation under previous law.

The House Social Security Subcommittee held three days of hearings on the Administration bill on June 18, July 23, and July 26 of 1976. The Subcommittee held markup sessions on the bill on August 5, 9, and 10, but ceased working on the legislation when it became apparent that there was insufficient time to complete action in the House and Senate on such complicated and controversial issues before a scheduled October final adjournment for the Fall elections.

(39) For example, the staff of the Ways and Means Committee conducted a two-year study of the disability insurance program and produced a report in 1974 warning of the potential costs resulting from administrative practices in the disability determination process. U.S. House of Representatives, Committee on Ways and Means, Committee Staff Report on the Disability Insurance Program, July 1974, 447 p.

(40) The Committee on Ways and Means did not maintain legislative subcommittees before 1975. The Legislative Reorganization Act of 1974 required all House Committees to establish subcommittees beginning in 1975.

(41) U.S. Congress, House of Representatives, Committee on Ways and Means, Hearings Before the Subcommittee on Social Security, 94th Congress, on Financing the Social Security System.

President Carter's Recommendations

President Carter announced his proposals to stabilize the Social Security benefit structure and reestablish the financial integrity of the system on May 9, 1977. The proposals were aimed at both the short-term and long-term financing problems.

The proposals also related to other issues that had been under discussion for some time including providing equal treatment for men and women, the retirement test, coverage of Federal, State, and local governmental employees and employees of non-profit organizations, and correcting weaknesses in the disability insurance determination process. While this paper discusses only those proposals directly related to financing and the notch issue, it is important to note that all of these other issues had to be dealt with and, to that extent, may have reduced the capacity of the Congress to analyze fully the narrower issue of implementing the change in the benefit formula.

The Carter Administration recommended that the Social Security benefit structure be "decoupled"(42) with future replacement rates stabilized at approximately the levels applicable under prior law for workers retiring in January 1979. The decoupled benefit structure, like that recommended in 1975 by the Advisory Council and by the Ford Administration would be based on indexing earnings to changes in average earnings over the individual's working years and indexing benefits to increases in prices (as measured by the Consumer Price Index) after the worker reached the age of eligibility (or became disabled or died in the case of disability and survivorship benefits).

The mayor elements of the Carter Administration short-term financing recommendations included:

  • eliminating the ceiling on the amount of annual earnings subject to the employer tax by 1981 with interim increases in the employer tax base to $23,400 in 1979 and to $37,500 in 1980(43);
  • increasing the wage base for employees and the self-employed by $600 in each of four yearsC1979, 1981, 1983, and 1985, in addition to the increases resulting from the automatic increases under the provisions of the existing law;
  • providing for "countercyclical" use of general revenues to compensate for Social Security revenue losses attributable to unemployment rates above 6 % in 1975 through 1978;
  • reallocating part of the Hospital Insurance tax rate increases scheduled in current law to the OASI and DI trust funds;
  • advancing the one percentage point tax rate increase then scheduled to go into effect in the year 2011 so that a 0.25% increase would go into effect in 1985 with the remaining 0.75% increase going into effect in 1990;
  • restoring the self-employment tax rate (which had been frozen at 7 % in 1973) to its historic relationship of one and one-half times the employee rate.

Difference in Administration Bills Concerning the Notch

In terms of the not&in issue, there was a very important difference between the Ford and Carter Administration bills which apparently has not been widely noticed up to now.

The Carter bill, as submitted and as ultimately enacted, essentially drew a strict dividing line between those born prior to 1917 and those born after 1916. Those born prior to 1917 and eligible for retirement benefits prior to 1979 were not only permitted but also required to use the old-law formula for determining benefits. They were not given the option of using the new wage-indexed formula even if it would result in a higher benefit. Those persons on the other side of the dividing line (i.e., those born after 1916) were not given the option to use the old-law benefit formula. They were required to use the new wage indexing formula or, if a higher benefit would result, a truncated version of the old-law formula which did not allow the use of earnings after the year of attaining age 61 and did not provide for cost-of-living increases after 1978 and prior to the year the individual reached age 62. (This alternative use of a truncated version of the old-law formula was available only to individuals born prior to 1922.)

(42) See footnote 29 for a discussion of "decoupling."

(43) In 1977, for both employer and employee, the tax base was $16,500.

The Ford Administration bill had not drawn this sharp distinction between the two groups. Individuals in either category could use the wage indexing formula and (in the case of individuals born before 1927) either group could use the truncated old-law whichever was more advantageous. However, neither group would be permitted to include earnings after 1978 in computing a benefit under the old-law formula.

If the Ford Administration approach had been adopted, the notch issue would not have arisen. Benefits for individuals in the notch years would be the same as under existing law, but the inflated benefits payable to those born in the years just prior to 1917 would have been avoided since they would have been unable to apply their post 1978 earnings to the old-law formula.

This significant difference between the Ford and Carter bills appears not to have been recognized either at the time or since. According to the recollections of Social Security Administration officials(44) the change appears to have come about in an attempt to close what seemed at the time to be an undesirable loophole. The old law formula bases benefits on an average of actual wages. The new formula bases benefits on an average of wages which have been inflated from their nominal value by a factor representing the growth of earnings in the economy since the year those wages were earned. Individuals already on the benefit rolls at the time of enactment, particularly those whose benefits were based largely on earnings many years earlier, might have qualified for a sudden large increase in benefits if they had been permitted to switch to the new wage-indexed benefit formula. This would have been possible under the bill as submitted by the Ford Administration.(45) In order to preclude this seeming windfall, the Carter Administration modified the bill so that individuals born before 1917 could not use the new, wage-indexed formula. The Carter bill was also changed to allow these same individuals to use wages earned after 1978 in computing benefits under the old-law formula. This latter change may have seemed necessary as a matter of fairness since, without it, any earnings after 1978 by persons born prior to 1917 would have been excluded from use under any formula. This is the cause of the "Notch".

House Action in 1977

The House Social Security Subcommittee began hearings on President Carter's recommendations on May 10, 1977 with testimony from Secretary of Health, Education, and Welfare Joseph A. Califano and other Administration witnesses.

Legislation embodying the Administration's proposals was submitted to Congress on July 11, 1977 and introduced as H.R. 8218(46) by Subcommittee Chairman James A. Burke on the following day. Public hearings were held on the Administration's proposals and other pending financing bills during the following two weeks on July 18-22 end duly 26-27.

On July 29,1977, the Social Security Subcommittee met to plan for markup sessions on the financing and decoupling issues. In view of an expected mid-October final adjournment date, the subcommittee considered bifurcating the short-range and long-range financing issues, acting on the former in the 1977 session, and deferring action on the more complex and controversial long-range financing issues until 1978. The subcommittee concluded, however, that enactment of comprehensive legislation was possible in 1977 and scheduled markup sessions for September 12, the earliest date available following an August recess.

(44) As related to the authors of this paper in informal conversations.

(45) The individuals affected would have been required to have some earnings in a year after 1978 to trigger a recomputation, but even a very small amount of earnings would have met this requirement.

(46) A companion bill (S. 1902) was introduced on July 21 by Senator Gaylord Nelson, Chairman of the Social Security Subcommittee of the Senate Committee on Finance.

The subcommittee began markup on the scheduled date and continued through September 22, concentrating on the provisions of H.R. 8218 and a "Republican Alternative" C a comprehensive package proposed by the minority members of the subcommittee. The Republican alternative was not introduced in bill form. The major features of the Republican plan included: wage indexing of automatic benefit increases with replacement rates about 10 % lower than those anticipated in 1979 under existing law; freezing the minimum benefit; a gradual increase from age 65 to age 68 in the age of eligibility for full (unseduced) benefits; coverage of Federal employees under Social Security; meeting financing needs by tax rate increases rather than wage base increases, and elimination of the retirement test.

The subcommittee decided on September 22, in view of the limited time to complete legislative action in 1977, to refer its recommendations to the full Ways and Means Committee without formally reporting a bill. This permitted the subcommittee staff to continue putting the subcommittee decisions into legislative language for consideration by the full committee at the earliest possible date.

The subcommittee's recommendations were introduced in bill form as H.R. 9346 by Representative Al Ullman, Chairman of the Ways and Means Committee, on September 27.

With regard to long-range financing issues, H.R. 9346 followed the lines of the Administration's decoupling proposal with the following modifications:

  • indexing a worker's earnings and the benefit formula(47) to reflect annual increases in average wage levels up to the second year before eligibility (age 62, disability, or death) rather than the second year before entitlement(48);
  • stabilizing replacement rates at approximately 5 % below the January 1979 replacement rates then expected under existing law;
  • guaranteeing for 10 years (rather than 5) that retirement benefits would not be lower than benefits under existing law as of December 1978 (without using post-1978 and pre-age 62 cost of living increases and without using post-age 61 earnings).

With regard to the short-range financing issues, H.R. 9346 provided for:

  • increasing the wage base for workers and employers to $20,900 in 1979, to $24,400 in 1980, and to $27,900 in 1981, with automatic increases thereafter;
  • in lieu of "countercyclical" general revenue contributions recommended by the Administration, providing standby authority for loans from general revenues to the OASI and DI trust funds whenever the assets of a fund at the end of a year dropped below 25 % of outgo for that year, with automatic repayment when assets in a fund at the end of a year reached 40 % of that year's outgo.
  • a reallocation of part of the scheduled increase in the HI tax rate for years after 1977 to OASDI and an adjustment of the tax rates so that the ultimate OASDHI tax rate for 1990 and after would be 7.45 % each for employers and employees.
  • re-establishment of the self-employment OASDI tax rate at one and one half times the employee rate.

The full Ways and Means Committee began markup on September 28, the day following the introduction of H.R. 9346. The Committee markup session continued through October 12, when H.R. 9346, as amended by the Committee, was reported to the House, with the following changes from the Subcommittee bill:

  • increase in the wage base beginning in 1978 (instead of 1979) to $19,900, to $22,900 in 1979, to $25,900 in 1980, and to $27,900 in 1981, with automatic increases thereafter;
  • modification of OASDI and HI tax rates to improve slightly the reserve ratios in each of the funds;
  • revision of the standby loan authority so that, if triggered, there would under certain conditions be an automatic tax rate increase of 0.10 percentage points for employers and employees (each) and of 0.15 percentage points for the self employed.

(47) The benefit formula percentages did not change. However, the amount of average indexed monthly earnings to which each percentage was applied was indexed by the growth of wages. These levels of average earnings at which a different percentage began to be applied are frequently referred to as the "bend points' of the formula.

(48) A worker, for example, might elect not to apply for and become entitled to benefits until age 64, 65, or later, even though he would be eligible to do so at age 62.

Another Committee amendment that had a significant impact on early year financing related to the coverage of Federal, State, local, and nonprofit employees, for whom the subcommittee had provided mandatory Social Security coverage effective in 1980. The full Committee bill extended coverage to the same groups of employees effective in 1982 (rather than 1980) and directed that the Department of Health, Education, and Welfare and the Civil Service Commission engage in a joint study and report to Congress with recommendations on how to coordinate civil service retirement with the Social Security program.

Before consideration by the House Rules Committee, H.R. 9346 was referred to the Post Office and Civil Service Committee which had jurisdiction over the Civil Service Retirement system. On October 13, that Committee ordered H.R. 9346 reported with an amendment to delete coverage for Federal employees and to substitute a two-year study on the feasibility and advisability of covering Federal workers under Social Security.

On October 18, the Rules Committee granted a "modified open rule" (as requested by the Ways and Means Committees(49)) to govern House floor debate on the bill. The rule allowed for the offering of the Post Office and Civil Service Committee amendment and eight other amendments to which the Ways and Means Committee had indicated its consent that they be brought up as floor amendments.

The House debated H.R. 9346 on October 26 and 27. During the debate, the provisions extending coverage to government and nonprofit workers were eliminated. The resulting early year revenue loss was balanced by an additional tax rate increase of 0.1 percentage points (employer and employee, each) in 1982 and by an increase in the wage base in 1981 to $29,700 (rather than $27,900 in the Committee bill). Also this amendment required a study on the feasibility and desirability of covering Federal, State, and local government employees. This study was to be undertaken jointly by the Departments of Treasury and of Health, Education, and Welfare and by the Civil Service Commission and the Office of Management and Budget.

Also during the debate, the bill's provisions relating to the retirement test were modified with regard to the years before 1982 and by elimination of the retirement test in 1982. An additional tax rate increase was required to finance this amendment.

The House of Representatives passed H.R. 9346 on October 27 by a vote of 275 to 146 and the bill was sent to the Senate. Since the Finance Committee was ready to report its version of the legislation to the Senate, the House bill was not referred to that Committee but was placed on the Senate Calendar.

(49) The Committee traditionally had requested a closed rule for major Social Security and tax bills. A closed rule would allow for no amendments and only one motion to recommit the bill.

Senate Action in 1977

At the start of the 95th Congress in January of 1977, the Senate Finance Committee found itself faced with a variety of pressing issues. With a new Administration coming in, the Committee had to deal with a number of Cabinet and subcabinet level nominations in the Departments of Treasury and Health, Education, and Welfare. As a result of a continuing recession, early attention was also required to tax legislation designed to provide economic stimulus and to the continuation of an emergency unemployment compensation system. The financial situation of the Social Security program, however, also required prompt action by the Committee.

The Carter Administration Social Security proposal was announced in May of 1977. The Finance Committee scheduled 5 days of hearings on this matter in June and July. On July 27, the Committee met to begin consideration of the matter and "agreed that it would prefer to finance such system through means other than the use of general revenues."(50) Further consideration of Social Security financing did not take place until after the August recess. During September and October, the Finance Committee met frequently to markup several legislative initiatives including a National Energy Tax Act, welfare legislation, black lung legislation, numerous trade bills, and Social Security financing. Altogether, from July 27 through November 1, the Committee held markup sessions on Social Security financing on 10 occasions. On November 1, 1977, the Finance Committee ordered the Social Security legislation reported, filed its report on the bill with the Senate, and took the legislation up on the Senate floor.

In dealing with the Social Security legislation, the Finance Committee faced a range of difficult and complicated questions. While the revision of the benefit formula was a very major element of the legislation, it primarily affected the long-range viability of the system. By 1977, the program was facing severe short-range problems. The reserves in the cash benefits trust funds would ideally have been equal to a full year's benefits. In 1977 they had dropped to less than half that level with rapid declines projected for the next few years and total depletion within 5 years.(51) The need for immediate short-range financing was complicated by the recessionary economic situation so that the "normal" financing method of raising the Social Security tax rates seemed undesirable.

The Carter Administration attempted to meet the program's immediate financing needs by two unusual mechanisms. It proposed to introduce some general fund financing under a provision which would have used general revenues to substitute for the loss in payroll tax revenues attributable to the recession. It also proposed to depart from the traditional equal employer and employee contributions by increasing the maximum amount of annual earnings on which employers were required to pay taxes while leaving unchanged the tax base for the employee tax. Both of these Carter Administration proposals proved highly controversial and, ultimately, neither of them was included in the enacted legislation. They did, however, occupy a great deal of the Committee's attention during the consideration of the bill.

In addition to financing and the benefit formula, the 1977 Social Security legislation included several other difficult issues including a proposal to limit payments of benefits to dependents that was necessitated by a potentially costly Supreme Court decision allowing non-dependent husbands and widowers to qualify for spousal benefits. (52)

(50) U.S. Congress, Congressional Record, (Permanent Edition), v. 128, p. D650.

(51) Committee on Finance, U.S. Senate, Social Security Amendments of 1977 (Senate Report 95-572 to accompany H.R. 5322), U.S. Government Printing Office, Washington, 1977, Table 1, p. 10. Hereafter cited as 77 Senate Report.

(52) A court decision in 1977 (Califano v. Goldfarb, 430 U.S. 199) would have allowed a husband or widower to qualify for benefits as a spouse of a woman worker on the same basis that a similarly situated woman was allowed to receive benefits as a wife or widow of a male worker, that is, without a requirement of proving dependency on the worker. This decision appeared likely to involve substantial additional cost just as Congress was grappling with the serious underfunding of the program, and almost all of the new beneficiaries were expected to be men who were not actually dependent spouses but rather had retirement income in the form of a pension from governmental employment. The Carter administration proposed to require that women also prove dependency in order to qualify. Congress opted instead to reduce benefits payable as a spouse by the amount of any governmental pension the wife, widow, husband, or widower had earned in employment that was not subject to Social Security. While the need to act in this area was clear, it also involved a reduction in benefits, and Congress devoted considerable attention to the question of how to accomplish this objective in a way which would minimize the loss to women who were near retirement age and had counted on receiving the benefits.

While all of these issues required considerable attention and many of them were controversial, the benefit formula was clearly the most complicated matter. The task before the Committee was not just the implementation of a new approach that commanded a clear consensus. Rather it was faced first with a choice among many different alternative approaches. A staff document prepared for the Committee markup of the legislation outlined half a dozen alternative ways in which the 1972 automatic benefit increase mechanism might be modified. These included the wage indexing approach proposed by the 1974 advisory council and the Ford and Carter Administrations, the price indexing approach proposed by the Hsiao II panel, "simple decoupling" (eliminate indexing of initial benefit levels), a so-called "combination proposal" (wage indexing to 1995, with subsequent increases reduced by half the gains in real earnings), wage indexing after a reduction in the existing replacement rates, and a continuation of the existing formula but with indexing limited to no more than 55% of wage increases. For present law and for each of these alternatives, the staff document included tables, prepared by actuaries of the Social Security Administration, showing the financial implications of the proposal and the projected benefits amounts and replacement rates that would result in future years. These projections went out to the year 2050 at 5 or 10 year intervals.(53)

The hearings held by the Committee in June and July received testimony from the Administration and from a wide variety of interested parties. Most of the testimony focused on the major issues: the choice of a benefit formula to replace the 1972 mechanism and the questions of taxes, general revenues, and financing generally. At committee hearings, witnesses typically make a brief oral presentation and then respond to questions from the Committee. A longer formal statement, sometimes accompanied by attachments, is often submitted and printed in the hearings record. As far as can be determined from the printed hearing record, the oral presentations and committee questions did not get into any discussions directly relevant to the notch issue apart from some discussion on the length of the transition clause which had been 10 years in the Ford proposal and was only 5 years in the Carter bill. However, one witness did address the notch issue very directly in an attachment to his printed testimony.

Robert J. Myers submitted with his testimony on behalf of the American Council of Life Insurance an addendum entitled "Recommended Minor Policy Changes and Legislative Drafting Points With Regard to S. 1902" This addendum included the following paragraph:

  • The bill would provide considerably different treatment as to computation of retirement benefit amounts for persons eligible before 1979 (i.e., generally who had attained age 62 before 1979) than for those who become eligible after 1978 (page 19, lines 16 and after). The latter can use the new indexed method and, if eligible before 1984, the frozen present new-start formula (or, strangely enough, the old-start method regardless of when eligible even if after 1983). Those eligible before 1979 can never use the new indexed method, but rather use the present new-start formula not frozen, but rather going on in the present coupled basis for all future years (it is not clear how, if at all, the old-start formula is used for this category). The result is certainly an undue discrimination between the two generation groups--it is not clear which way the discrimination goes or who it favors. There should be identical treatment for these two categories, so that both can use both the old formula frozen and the new indexed method.(54)

(53) Committee on Finance, U.S. Senate, Staff Data and Materials on Social Security Financing Proposals. Committee Print, U.S. Government Printing Office, Washington, 1977.

(54) Committee on Finance, Subcommittee on Social Security, U.S. Senate, Social Security Financing Proposals. Hearings, U.S. Government Printing Office, Washington, 1977, p. 345. Mr. Myers, a former official of the Social Security Administration (Chief Actuary and subsequently Deputy Commissioner) is a member of the Commission for which this paper is being prepared. He also testified before the House Ways and Means Committee in 1977 and included an essentially identical addendum to his testimony there. (Committee on Ways and Means, Subcommittee on Social Security, U.S. House of Representatives, President Carter's Social Security Proposals, Part I. Hearings, U.S. Government Printing Office, Washington, 1977, p.l45.)

On November 1, 1977, the Committee on Finance reported the 1977 Social Security amendments to the Senate. The reported bill replaced the benefit formula adopted in 1972 with a new formula based on the wage indexing model. There were some similarities between the old and new formulas. Both, for example, based benefits on average earnings over the same number of years. However, the new formula utilized quite different percentages and was applied to the average of earnings that had been indexed for wage growth as compared with the old formula which was applied to the average of actual earnings. Individuals who under the old law might have had identical average earnings and get the same benefit amount might well have different indexed earnings and qualify for quite different benefits under the new law. It was, therefore, not possible to construct a new benefit formula which, in the year of implementation, would provide all retirees in that year with the same benefits they would have received under the old law. Instead, the new benefit formula was created in a manner which was designed to produce benefit levels which on average would duplicate the benefit levels under the old law. (Because of the need to address a financing crisis in the program and because the old system had caused benefit levels to increase more rapidly than had been intended, the Finance committee bill actually used a new benefit formula which, when implemented in 1979, was designed to provide benefits at 1976 levels.)(55)

The Finance Committee bill followed the Carter Administration approach of allowing and requiring that those born before 1917 would continue to use the old law benefit formula. The committee report does not state any rationale for choosing this approach but it does explicitly point out that benefits for such individuals will be "computed-and recomputed under the provisions of present law even if they work in covered employment after 1978.(56)

The report of the Finance Committee on the 1977 amendments includes a table showing, by 5 or 10 year periods, the projections out to 2050 of the benefits and replacement rates under present law and under the committee bill. Nothing in the report shows (or indicates that the Committee gave any consideration to) the specific issue of how benefit levels would compare as between those remaining under the old law and those retiring under the new rules in the years immediately following implementation. However, the table in the report does fairly clearly indicate that there would be a substantial difference in benefit levels between the old and new systems within a short time after implementation. For a worker with average earnings retiring at age 65 in 1985 (6 years after the effective date), the table shows a reduction in benefits, after adjustment for inflation, exceeding $600 per year.(57)

(55) 77 Senate Report, p. 19.

(56) 77 Senate Report, p. 25.

(57) 77 Senate Report, p. 20

The Finance Committee bill adopted the transition clause as proposed in the Administration bill. Individuals born from 1917 through 1921 would receive the higher of the benefit computed under the new wage indexing formula or a benefit computed under the benefit formula in effect in 1978 without the use of any wages earned after age 61 and without any cost-of-living increases after 1978 and prior to the year in which the retiree reached age 62.

For a worker retiring at age 62 in 1979 with no significant earnings after 1978, the transition formula guaranteed the same benefit as prior law (or a higher benefit if the wage indexing formula produced such a benefit). However, workers with earnings after age 61 or workers reaching age 62 after 1979 would find the transition clause increasingly less useful as an alternative to the new wage-indexed formula.

The committee report describes the purpose of the transition clause as being "to protect the benefit rights of people who are now approaching retirement and whose retirement plans have taken Social Security benefits

into account."(58) This rationale does not seem to address the notch issue, that is how the benefits for those under the new system compare with benefits for those who remained under the old system. Rather, the transition clause appears designed to address the expectations issue. A person quite near retirement age may have already figured out how much he or she could expect to get under the old law benefit formula. In an individual case, it is possible that the use of the new formula could result in a much smaller benefit. This would be true, for example, for individuals with unusual wage patterns. The transition clause would narrow that differential. For those right at the point of retirement, i.e., those who would retire in the year of implementation (which was a bit more than a year after enactment), the transition clause would guarantee the full anticipated old-law benefit. For those retiring in the next four years, the guarantee was roughly based on what they could have expected on the basis of their earnings up to the point of enactment without any adjustments for subsequent inflation (until they reached retirement age).

While the Finance Committee reported the Social Security legislation to the Senate on a voice vote,(59) the Committee was not unanimous. The committee report includes minority views, signed by four Senators, opposing the bill's financing approach, which relied on a substantial increase in the amount of annual wages subject to the employer tax.(60) The committee report also included two sets of "additional" views. The "additional views" of Senator John C. Danforth criticized several of the basic committee decisions including the choice of wage indexing and raised rather specifically that part of the notch issue which relates to a comparison between notch year benefit levels and benefit levels for later retirees.:

  • I oppose this method of indexing because it is very expensive and because it draws invidious and unjustified distinctions between retirees of today and retirees 20 years from today. Thus, under wage indexing, a worker who retires today will receive a smaller benefit in real dollars than a worker with an identical wage history who retires 20 years from now even though both may be alive and drawing benefits. Under wage indexing, the current retiree is excluded from sharing in the real growth of our Nation's productivity.

    I favor price indexing. It protects workers against the erosion of benefits as a result of inflation. At the same time, while wage indexing only cuts the long-range deficit in half, price indexing reduces the deficit totally, placing the system in long-range actuarial balance. In this way, it makes unnecessary additional rate increases of 1.45 % which will be required if wage indexing is adopted. Finally, it provides Congress with the flexibility to make appropriate adjustments in the level of benefits which will benefit not only present workers, but also those who have already retired.

The Senate took up the Social Security bill on the same day it was reported and debate continued for four days. More than 20 floor amendments were offered and there were a dozen roll call votes. The debate did not, however, focus on issues related to the notch. On November 4, the Senate passed the legislation by a vote of 42 to 25. On the same day, the Senate requested a conference with the House and appointed its conferees.

(58) 77 Senate Report, p. 24

(59) Because the House was still considering H.R. 9346 at the time the Finance Committee was preparing to report its recommendations, the Finance Committee attached its proposals to a minor tariff bill (H.R. 5322, dealing with tariffs on istle). The Finance Committee amendments were then offered as a floor amendment to the House bill H.R. 9346.

(60) 77 Senate Report, p. 169- 172. The committee bill would have increased the annual wages subject to the employer Social Security tax to $50,000 in 1979 (compared with $18,900 under prior law) and to $75,000 in l 985. Much smaller increases in the employee tax base were provided through 1985 by which time the employee base was expected to be $30,300. Thereafter the employee wage base would continue to rise (as under prior law) by an index based on average wages, the employer tax base would remain at $75,000 until such time as the employee base reached the $75,000 level. Thereafter both bases would be indexed.

(61) 77 Senate Report, p.176-177.

Final Congressional Action

The House of Representatives agreed to a conference and appointed conferees on November 30. The conferees met on December 1, 5, 11, and 14. While there were a number of contentious issues in the conference, they did not include issues directly related to the notch. Both the Senate and House bills had adopted the wage indexing approach with an effective date which allowed prenotch individuals to use the old-law formula without constraint and required notch year individuals to use either the wage indexing formula or a transition formula without pre-age-62 inflation increases and without post-age-61 wages.

The last day of the 1977 Congressional session was December 15, and, on that date, both the Senate and House approved the conference agreement which had been reached on December 14. The Senate acted first, approving the conference report on a vote of 56 to 21. The House first voted on a rule governing debate on the conference agreement. The rule was agreed to by a vote of 178 to 175. The conference agreement itself was approved by a vote of 189 to 163. President Carter signed the 1977 Social Security amendments into law (Public Law 95-216) on December 20.

1979 Congressional Hearing on the Notch

The Subcommittee on Social Security of the House Ways and Means Committee held a brief hearing on the notch on September 27, 1979. This hearing also took testimony on another developing problem relating to the payment by employers of the FICA tax liabilities of their employees.(62)

(62) Hearing before the Subcommittee on Social Security, House Ways and Means Committee, Employer Payment of Social Security Taxes; Benefit Formula Differential, September 27, 1979 (Serial 96-45).

The subcommittee's hearing on the notch issue was not held in response to a groundswell of beneficiaries' concerns, but to consider recommendations proffered by Social Security technicians, including Professor Robert J. Myers, to avoid or alleviate its effects.

Testimony on the notch problem was given, in addition to Professor Myers, by only two other witnesses: The spokesmen for the Social Security Administration, and the American Association for Retired Persons (AARP).

Mr. Lawrence H. Thompson, Acting Associate Commissioner, presented the position of the Social Security Administration. After discussing general approaches to modify the transitional provisions of the 1977 Amendments, the SSA prepared statement concluded that no legislative action be taken:

  • "We believe that the schedule for transition from the old computation system to the new computation system which was adopted by the Congress in 1977 was a reasonable one. We do not believe that the schedule should be slowed down, as the first of these options would do. We believe that there are serious disadvantages in either of the propesed methods of accelerating the schedule for the transition, as the other two options would do. Finally, there is clearly not sufficient time between now and the end of the year to enact and administratively implement one of these taco options. Therefore, we urge that no change be made in the present transition provisions."

Professor Robert J. Myers' recommendation at the time of the 1979 hearing proposed that the transition provision of the 1977 Amendments be modified to provide that individuals attaining age 62 before 1979 not be allowed to have their post-age 62 earnings included in their benefit computations under the old law unindexed method which continued to give them the benefit of the flawed windfall effects of the 1972 Amendments. But rather, the benefit computations for such individuals should apply the new law benefit computation procedures of the 1977 Amendments applicable to earnings in 1979 or later. The SSA actuary estimated that this Myers' proposal would result in a five-year (1980 through 1984) savings of $34 billion under the 1979 intermediate economic assumptions.

The only other witness at the 1979 hearing who discussed the notch issue was James Hacking, speaking for the National Retired Teachers Association and the American Association of Retired Persons. This witness expressed opposition to the Myers' proposal because of its deliberalizing effect. He endorsed an amendment that would extend the transition period from five to ten years and gradual phase out of the old law benefit computation. The precise details of accomplishing this result were not addressed by the witness.(64)


The 1977 Social Security amendments changed the way of computing benefits for persons reaching age 62 in or after 1979. Congress clearly was aware that the new benefit formula would usually be less generous than the formula it replaced. Congress was also aware that benefit levels for future retirees would tend to grow faster than inflation. In at least a general way, therefore, it might be reasonable to conclude that Congress "intended" the result that those who came on the rolls in the years just after implementation would fare less well than those who immediately preceded them and than those who came after them. These results were consistent with the major policy choices which Congress made. Congress had concluded that the benefit formula enacted in 1972 had gone awry and was producing benefits far too generous for the financing of the program to support. It chose to substitute on a prospective basis a benefit formula that was less generous. Because of concern over the financial problems of the system (caused in part by the 1972 benefit formula, but also by other problems), Congress consciously adopted an initial benefit formula for the new system which represented a rolling back of benefit levels. Congress explicitly chose wage indexing over price indexing, knowing that it would cause initial benefit levels to grow so that each year's cohort of retirees would do somewhat better in real terms than the retirees of prior years.

On the other hand, it is not correct to conclude that the notch was an inevitable result of the policy choices made in 1977.

To begin with, the original Ford Administration bill submitted in 1976 would have accomplished the same policy objectives without creating the most significant of the benefit level differentials that gave rise to the notch issue. It would have done so by requiring those born prior to 1917 to use the new wage indexing formula if they wanted to have a benefit computed using wages earned after 1978. This would have eliminated the notch issue by holding down the growth in benefit levels for those in the pre-notch period. Benefits for those in the notch years would have been computed in the same manner as under present law. When the new Administration resubmitted the legislation in 1977, this provision had been changed. Individuals born prior to 1917 were not given the option of using the wage indexing formula but were permitted to use post-1978 wages in the old-law formula. It appears that the change was made to address a totally different issue (avoiding a potential windfall for certain beneficiaries who might do much better under wage indexing than under the 1972 benefit formula.) It seems likely that alternative ways of addressing that issue could have been found.65 There is no indication however, that Congress focused any attention on this change, and certainly no indication that Congress was aware of its implications for what would become the notch issue.

(63) 1979 Hearings at pp. 25 through 31.

(64) Ibid. pp. 32 through 40.

A second missed opportunity for avoiding the notch was the addendum to testimony submitted to both the Ways and Means and Finance Committees by Robert Myers. In this addendum, Mr. Myers explicitly identified the problem of differential benefit levels for the two categories of beneficiaries and proposed a way to avoid it. If greater attention had been paid to this testimony, it is at least possible that Congress would have modified the legislation along the lines he suggested and that the notch issue would not have arisen.

The blended transition approach recommended in the Hsiao II report would also have lessened the notch differentials. While Congress might not have accepted such an approach in view of the financial difficulties faced by the program, it does illustrate that a range of alternatives were available.

Given that it was possible for the notch problem to have been avoided, the question arises as to why it was not avoided. Why did not Congress examine and compare the benefit levels that would be payable to the old and new law retirees? Why was the transition clause not drawn in such a way as to minimize the differentials? Why was so little attention paid to the Myers addendum, to the differences in the two Administration bills, and to the blended transition approach in the Hsiao II report?

While there is no entirely satisfactory answer to these questions, the context in which the legislation was considered may provide some degree of explanation. The Social Security program had undergone massive changes in 1972. Benefits were increased by 20 per cent and a new, automatic system for increasing both benefits and program revenues was adopted with assurances that the revised program was soundly financed. Almost immediately thereafter, economic developments and revised projections of other factors (such as fertility) created a situation in which the solvency of the program was seriously undermined. As the 1970's progressed, the situation worsened and, by 1977, Congress found that the Social Security program had a truly massive long-range deficit and also was also facing rapid short-term fund depletion. By the time the Congressional Committees were considering the reported legislation, the long-range deficit was estimated at 8.2 % of taxable wages. In other words, the combined employer-employee tax of 9.9 % would have to have been increased to 18.1 % to solve the problem with a tax rate increase. In the short run, fund reserves, ideally at least equal to 12 months' benefits were below half that level at the start of 1977 and were projected to decline to total exhaustion within 5 years.

To address this major financing problem, Congress considered a variety of proposals. The need to adopt a new benefit formula was clear, but which formula to adopt was not so clear. An advisory council and the Administration recommended the wage-indexing approach. A congressional appointed panel recommended a price indexing approach. Several other approaches were also under serious consideration.

At the same time, Congress was considering various different (and controversial) proposals to provide added revenue to the program and was also considering ways to reduce program outgo through benefit rule changes such as the government pension offset.

(65) For example, those in the prenotch years could have been allowed to use their post- 1978 wages in a wage indexed recomputation but with the benefit limited to no more than would have been produced by the old-law formula. Such a restriction would, of course, have created to some extent the ''reverse notch" which exists under present law in certain cases (like the one described in footnote 2) to the disadvantage of those born prior to 1917.

The capacity to analyze the detailed impact of changes on individual benefit levels was limited by both the complexity of the new, indexed benefit formulas and by the number of alternatives under consideration. Even so, the Committees did ask the actuaries to provide fairly extensive comparisons of benefits for low, average, and maximum earners under prior law and each of the alternative proposals. The tables produced, however, did not clearly illustrate what came to be known as the notch issue. They were designed primarily to deal with what then appeared to be the major issue of comparative replacement rates.

The design of the transition clause appears from the legislative history to have been aimed at the question of preserving individual expectations rather than at avoiding differentials.

Even if Congress had developed examples illustrating benefit differentials among different categories of recipients, they would not have shown as great differentials as actually developed. To a significant extent, the notch results from the impact of inflation on the old-law benefit formula. At the time the 1977 amendments were considered, inflation rates were expected to return to more "normal" levels. The trustees' report issued a few months after the 1977 amendments became law projected that Social Security benefit increases would decline from 6.5 % in 1978 to 5.0 % in 1982.(66) In fact, inflation rates were about to reach historically high levels. The average benefit increase over that 5-year period turned out to be 9.9 % with a 1-year high of 14.3 % in 1980.

It is not at all clear what kind of examples Congress would have asked for if it had decided to address the benefit differential question. Comparisons of benefits for persons born in different years are not easy to make because, even under prior law, there were factors which provided advantages on the basis of birth date. At the time of the 1977 amendments, the length of time over which earnings were averaged was gradually increasing. For persons reaching age 62 in 1976, earnings would be averaged over 20 years. For a person reaching age 62 in 1977, earnings would be averaged over 21 years and so forth. With the same total wages, the older person would receive a higher benefit because those wages would be averaged over fewer year. On the other hand, if the comparison were based on benefits payable for retirement at a given age, e.g. age 65, the younger person might get some advantage from having had an additional year of earnings when maximum creditable earnings were high enough to increase average wages even when averaged over an additional year.

A comparison of benefits payable to beneficiaries with different birth years is thus complex and likely to be confusing. Quite different results would be shown depending on the particular characteristics of the two individuals compared. As was noted earlier, examples can even be drawn showing a "reverse notch" under which certain notch year retirees fare substantially better than approximately identical retirees born in the pre-notch period (see footnote 2).

(66) U.S. House of Representatives, 1978 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, House Document No. 95-336, Washington, U.S. Government Printing Office, May 16, 1978.

One possible approach would have been to compare the benefits actually payable to "typically individuals born in a given year under the new formula with the benefits which would have been payable under the old-law formula to those same "typical" individuals. While this would not be a comparison across different age cohorts, it would have shown the potential for such disparities in a way which zeroed in on the impact of the 1977 legislation and filtered out differentials attributable to other aspects of the program. The following table illustrates this approach by comparing the old and new law benefits for individuals born in the notch years. Two comparisons are shown. The left side of the table shows the benefit levels that would have been projected under the economic assumptions that the Congress used in crafting the 1977 amendments. The comparison on the right hand side of the table shows the benefits that would have resulted under the actual economic situation that developed after enactment. The flaw that the new formula was trying to correct was an overreaction to inflation. Since inflation turned out to be higher than expected, the benefits under the inflation-sensitive old law formula grew much more rapidly than the benefits under the revised formula.

As the left side of the table shows, a projection in 1977 of benefits for average earners retiring at age 65 would have shown a 10 % ($50 monthly) differential in benefit amounts for the first group affected Chose born in 1917) if they continued to work after enactment until they retired at age 65 (in 1981). The differential increases to 13 %($70) for the second group and then to 14 % for all subsequent groups.

It is possible (though not at all certain) that the availability of the projections shown on the left side of the table under the 1977 assumptions might have led Congress to consider a somewhat smoother transition. It seems less likely that it would have aroused substantial concern over the benefit disparities it implied between the notch year workers shown in the table and prenotch workers who would continue to benefit from the old law formula.

(67) Most of the examples used to illustrate benefits in 1977 (and later) are based on "typical" workers who have steady earnings at specific levels such as the average wage or the maximum wage creditable for Social Security. The difficulty in finding truly typical examples is described in the following excerpt from the Finance Committee print which was prepared for the use of the Committee in its consideration of the 1977 amendments:

  • The wage-indexed formula is designed to accommodate an earnings pattern in which an individual's earnings start at a low level and rise at a rate approximating the changes in average covered earnings. The Hsiao panel points out, however, that this may not be the normal pattern and that for a significant part (and perhaps the major part) of the population there is considerable variation with maximum earnings at some point considerably earlier than retirement. Others have wages which go up in one period, fall in another, rise in another, and so on. In addition to cases of disability, for example, there are persons who have varying wage levels as they move from job to job, persons (such as married women) who may be out of the labor force for some extended periods of time, persons who may work in non-covered employment (such as employment abroad or for a Governmental agency) for some part of their career. Depending on the particular circumstances involved, such irregular coverage patterns could result in greatly different benefits under an indexed system than under existing law. For some individuals, the difference could be quite favorable and for others it could be quite unfavorable. (U.S. Senate, Committee on Finance, Staff Data and Materials on Social Security Financing Proposals, U.S. Government Printing Office, Washington, September 1977, p. 61-62.) Nonetheless, the steady earner (presumably for lack of a better alternative) was and continues to be used as a proxy for a "typical" individual.       

Old vs New Law -- Benefit Differentials for Worker   with Average Earnings Retiring at Age 65 (68)

Birth  Year

Under 1977 projections

Under actual conditions

  Old Law New Law Difference in % Difference in $ Old Law New Law Difference in % Difference in $


























































































The disparities which the right side of the table illustrates under the actual (but then unanticipated) conditions of double digit inflation are far more compelling. The first group of retirees (born in 1917) had a 13% differential and by the fourth year the differential had grown to 29% with a dollar amount of $227. Thereafter the differential remained in the range of 28-30 % reaching a dollar amount in excess of $300 by the 10th year. It is certainly possible that differentials of this magnitude, if they had been known in 1977, would have raised questions about the appropriateness of making a sharp break between the old law rules for workers born before 1917 and the new law rules for workers born in and after 1917.

The numbers on the left side of the table could have been provided to the Congress in 1977. There would have been no basis for providing the much more substantial (and, as it turned out, accurate) numbers on the right hand side. The question of how Congress would have reacted to either set of these numbers can only be speculation. However, if one assumes that Congress would have reacted by trying to lessen the implicit differential between the notch and prenotch groups, some reasonable conjectures can be made from the legislative history and context.

First of all, there was a solution at hand. Both the Ford Administration proposal and the testimony of Robert Myers (whose views were accorded great deference by the Ways and Means and Finance Committees) provided the same solution; namely, prohibit persons in the prenotch group from using post-1978 wages in an old-law computation. Moreover, since the major task faced by Congress was restoring solvency to the system, the Ford Administration / Myers solution would have recommended itself on the grounds that it would have helped reduce the cost of the program. By contrast, a solution which would have increased benefits for individuals in the notch years would have exacerbated the problems Congress was facing in financing the program. In particular, had Congress projected anything like the actual inflation experience that gave rise to the differentials shown on the right side of the table, it would have been under even greater pressure to hold down benefit costs.

On the other hand, it should be pointed out that Congress did include in the 1977 legislation some provisions which increased benefit costs. Consequently, whether and how Congress would have addressed the issue must remain a matter of speculation. Apart from the apparently overlooked addendum to the Myers testimony, we have found no indication of any effort at that time to bring up the notch issue for closer Congressional scrutiny. The attention of Congress was focused on other Social Security issues such as the choice among several alternative benefit formulas and among alternative and highly controversial methods for increasing program revenues.

(68) The benefit amounts in this table were computed by the Office of the Actuary of the Social Security Administration in a memorandum of July 14, 1994 prepared by Richard S. Foster entitled, "Anticipated Versus Actual OASDI Replacement Rations and Monthly Benefit Amounts under Social Security Amendments of 1917." This memorandum was prepared in response to a request from the Commission.

(69) For example, the 1977 legislation eased the retirement test so that it would no longer apply to individuals aged 70 or overCcompared with aged 72 or over under prior law. (This change was to be effective in 1982, but legislation enacted in 1981 deferred it until 1983.) Liberalizations were also included in the benefit rules for remarried widows and divorced spouses.