1994-1996 Advisory Council on Social Security

Report of February 10 and 11, 1995 Meeting of the 1994-95 Advisory Council on Social Security

BENEFIT STRUCTURE ALTERNATIVES

Steve Sandell (Office of the Assistant Secretary for Planning and Evaluation) made the first of several presentations on alternatives for revising the benefit structure. Most of the alternatives discussed in these presentations would improve the equity or adequacy of benefits provided women. In general, the proposals were designed to be cost neutral by proportionately increasing or decreasing the benefit formula to offset the cost or savings of the change. (The attachment summarizes the proposals that were presented to the Advisory Council.)

The first group of proposals discussed were proposals that would improve equity for two-earner couples compared to one-earner couples. In general, these proposals would reduce benefits currently being paid to one-earner couples and pay benefits to survivors based on the total being paid to the couple (which would increase benefits for survivors of two-earner couples).

After some discussion about the effects of these changes on the poverty rates for couples and widows, the Council decided that it favored, in principle, the proposal to reduce spouse's benefits to 33 percent of the worker's benefit and base widow(er)'s benefits on a percentage of the couple's benefits. The Council discussed using either 67 or 75 percent of the couple's benefit, or some other variation. However, no agreement was reached on the percentage to be used for this purpose.

The next set of proposals presented by Mr. Sandell centered on proposals to increase benefits for certain groups. The Council decided to give further consideration to a proposal that would shift benefits from the couple to the surviving spouse by reducing couples' benefits by 10 percent and using the proceeds to increase survivors' benefits, but only if it were provided on an optional, rather than mandatory, basis.

With respect to a change that would raise the earliest retirement age, Advisory Council Member Edith Fierst suggested that consideration be given to a proposal that would permit workers to retire early only if the worker met a certain combination of age and years of work.

Peter Wheeler (Director, Office of Research and Statistics, Social Security Administration (SSA)) presented several proposals that are designed to target benefits for older widows, divorced spouses, or the very old. These proposals focus on those beneficiary groups that generally have higher poverty rates than the elderly population as a whole.

Advisory Council Chairman Edward Gramlich and Advisory Council Member Robert Ball indicated that they thought proposals of this kind would distort the Social Security program in order to address poverty. They suggested that the SSI program might be a more appropriate vehicle for addressing these problems. Ms. Fierst expressed concern that the SSI payment standard was less than the poverty level, and asked if there was any reason, other than cost, for not raising it to the poverty level. Mary Ann Prucnal (Office of Legislation and Congressional Affairs, SSA) made a presentation on earnings sharing at divorce. Under this change, the current benefits for divorced spouses and divorced surviving spouses would be replaced with a plan under which benefits for a divorced person would be based on shared earnings credits for years of marriage plus his or her own earnings when unmarried.

Advisory Council Executive Director David Lindeman noted that it would be difficult to "graft" such a different system onto the current benefit structure. Dr. Gramlich agreed that this would be a problem and asked if there would be any way to even out the benefits paid to divorced spouses while the husband is alive (50 percent of worker's benefit), compared to when the husband is deceased (100 percent of worker's benefit). After some discussion it was decided that, although logical, such a plan would shift benefits in the wrong direction--i.e., from the old-old to the young-old.

Mr. Lindeman then gave a presentation on variants of a "double decker" benefit structure and a two-bracket benefit structure. These proposals would change the distribution of benefits for people with different levels of lifetime earnings. He noted that the Council may want to consider these kinds of changes if there were interest in redistributing more benefits to those with low lifetime earnings. Mr. Ball expressed concern about proposals that would make the benefit formula more progressive than it is now, if it were done at the expense of above-average earners.

INVESTMENT ALTERNATIVES

Advisory Council Member Tom Jones said that, if the Social Security program were run like a private pension system, a primary goal would be to achieve greater efficiency before consideration of reduced benefits or increased contributions. He pointed out that, from 1926 through 1992, the interest rate on equities (for example, Standard and Poor 500 stocks) has averaged just under 10 percent, while that on Government securities has averaged just under 4 percent. He stressed that the Advisory Council should consider alternative Social Security trust fund investment strategies seriously.

Without endorsing any specific plan, Mr. Jones outlined four strategies designed to extend Social Security's financial solvency:

2. Same, but invest 15 percent of trust fund balance in equities. Mr. Jones estimated that trust fund revenues would increase by $1.9 trillion, and that the program's solvency would be extended through 2032.

3. Same, but invest 21 percent in equities. Mr. Jones estimated that trust fund revenues would increase by $2.7 trillion, and the program's solvency would be extended through 2034.

4. Invest 21 percent in equities initially, and 50 percent of each year's positive cash flow in equities. Mr. Jones estimated that trust fund revenues would increase by $4.4 trillion, and the program's solvency would be extended through 2036.

Mr. Jones said that his estimates are based on immediate enactment. For example, he noted that, if enactment of option 3 were delayed until 2000, the Social Security payroll tax would have to be increased to 15.4 percent in order to result in the same exhaustion date.

Barry Bosworth (Brookings Institution) said that 5 percent of the Nation's income is spent on Social Security, and that figure is projected to rise to 9 percent by 2070, primarily due to the large "baby boom" generation and longer life expectancies. Dr. Bosworth stressed that, if corrective measures are taken quickly, the program can be kept financially sound in the long term. He suggested achieving long-term actuarial balance through a 2 percent increase in the Social Security payroll tax rate. Upon reaching actuarial balance, trust fund assets would be invested in a vehicle earning annual interest of at least 1 percent more than current investments do. Mr. Ball said that he liked Dr. Bosworth's proposal, but doubted that a 2 percent tax increase of any kind could pass Congress.

Stephen Zeldes (Wharton School of Business and Technical Panel Member) said that the idea of investing Social Security trust fund assets in stocks is controversial due to the volatility of the private market. He said that, from the period from 1926 through 1992, the average value of Standard and Poor 500 stocks rose about 9 percent per year after inflation, while the return on Government bonds averaged about 2.2 percent per year after inflation. He noted, however, that, over the same period, stocks experienced deviations in annual return rates of up to 20 percent, while intermediate-term Government bonds never deviated by more than 7 percent. Thus, the higher returns in the private sector resulted from higher-risk investments.

Mr. Zeldes said that the period 1926 through 1992 is too short to rely on in attempting to project the future performance of the stock market. He stressed that the Advisory Council also keep in mind that taxpayers or Social Security beneficiaries would ultimately bear the risk of stocks not performing as well as bonds.

BUDGET TREATMENT ALTERNATIVES

Letitia Chambers (Chambers Associates) said that, up until 1969, when the Johnson Administration adopted the Unified Federal Budget, all Federal trust funds were counted separately. She stated that the trust funds had little impact on the Federal budget, largely because they did not accrue significant surpluses. Dr. Chambers cited three legislative changes leading to controversy about the size of the Federal budget deficit after 1969: partial advance funding of the Civil Service Retirement System in 1969; the Social Security trust fund buildup resulting from the 1983 amendments; the Federal Employee Retirement System (FERS) adopted in 1986.

She said that, although the FERS Thrift Savings Plan is not included in the Federal budget, the Federal trust funds currently have an overall surplus of $1.1 trillion. When annual trust fund surpluses are considered, the size of the Federal budget deficit is reduced correspondingly. However, in the view of Dr. Chambers, including trust fund surpluses masks the size of the deficit. She also pointed out that, although trust fund interest accounts for one-third of the interest paid by the Federal Government, it is generally not considered a factor in contributing to the size of the deficit. To the extent that the Government meets its expenses (including interest payments) through interfund borrowing, its total spending is unchanged, and it accrues no liabilities to outside lenders.

Dr. Chambers suggested that the Government consider adoption of a 3-part budget consisting of: a general fund budget to pay for overall Government operating expenses; a capital expenditure budget to fund such projects such as infrastructure; and a work replacement budget, which would fund programs such as Social Security.

CONGRESSIONAL BUDGET OFFICE FINDINGS

Joyce Manchester (Congressional Budget Office (CBO)) summarized a November 1994 CBO report which concluded that returning the Social Security program to "pay-as-you-go" financing through investment of trust fund reserves in the private sector might prolong the program's solvency. CBO also found that increased national saving might result if the Social Security program were actuarially balanced over the long term (as in Dr. Bosworth's plan). Mr. Lindeman expressed skepticism about the Congress's ability to control spending even if the Social Security program were to achieve long-term actuarial balance.

DISCUSSION BY ADVISORY COUNCIL MEMBERS

Dr. Gramlich asked if there was a consensus among Advisory Council members on approaches involving investment of the Social Security trust fund reserves in the private sector. Ms. Fierst said she opposed raising the Social Security payroll tax by the 2 percent needed to achieve long-term actuarial balance and did not believe the Congress would pass such a tax increase. Advisory Council Member Gerald Shea expressed concern about the administrative feasibility of private investments. Mr. Ball said he strongly opposed any plan based on individual investment accounts.

OVERVIEW OF LONG RUN ALTERNATIVES

Mr. Lindeman outlined a proposal designed to ensure Social Security's long-term solvency. It would gradually raise the normal retirement age from 65 to 68 between now and 2017 by 2 months per year, while raising the early retirement age from 62 to 65 beginning in 2006. An additional benefit formula "bend point" would be established for the highest earners, and average lifetime earnings above that point would result in a replacement rate of 10 percent of preretirement income. Social Security disability insurance benefits would be reduced to 80 percent of benefits calculated under the current formula. Mr. Lindeman said that projections of program solvency under this proposal would depend on the real interest rate of return on trust fund investments. At 2.3 percent, the trust funds would be exhausted in about 2060, but at 3.3 percent, the test of 75-year actuarial balance would be met. Time did not permit further discussion of the proposal.

MORBIDITY, MORTALITY, AND LIFE EXPECTANCY

Eileen Crimmins (Andrus Gerontology Center and Technical Panel Member) gave a presentation on the relationship of morbidity and mortality--i.e., the question of "when we live longer are we living healthier?" Although there have been some changes in health status of the elderly from the 1970's, the extent of active life expectancy without dependency has not changed greatly. The percentage of people in their 60's reporting that they cannot work has decreased by about 2 percent between 1987 and 1991.

Samuel Preston (University of Pennsylvania and Technical Panel Member) gave a presentation on the ethnic and social differences in life expectancy. African-Americans have the highest death rates and Asians have the lowest. Hispanics have lower death rates than Whites. Trends in death rates from the 1960's through 1987 show increasing differences by education levels, with better educated men and women having much lower death rates than lesser educated people. Increasing retirement age would be more disadvantageous for African-Americans and less educated people.

After some discussion, the Council asked the Technical Panel to recommend the type of data needed and the research to be carried out by SSA.

ATTACHMENT

SUMMARY OF PROPOSALS

PROPOSALS THAT ADDRESS HORIZONTAL EQUITY, Memorandum I, presents four proposals that improve equity for two-earner compared to one-earner couples. It is well known that compared to one-earner couples two-earner couples and survivors from those couples receive lower benefits for the same total lifetime earnings. All proposals change the way benefits for widows are calculated. Two also change the spouse benefit, and one changes the Social Security benefit structure so it is similar to private pensions. Because all of the proposals increase benefits for at least some widows from two-earner couples, they reduce their poverty rates and improve their economic well-being.

S33W75 Spouse benefit reduced to 33 percent; survivor's benefit 75 percent of new couple's benefit; Reduce PIA amounts by 1.5 percent.

S33W67 Reduce spouse benefit to 33 percent; pay survivor higher of worker benefit (current law survivor's benefit) or 67 percent of couple's benefit. (No PIA reduction).

S50W75 Current law spouse benefit; survivor's benefit 75 percent of couple's benefit (unreduced); Reduce PIA amounts by 4.1 percent.

WJS Worker Only Benefit with Mandatory Joint and Survivor Benefit: pay married workers 80 percent of PIA; eliminate spouse benefit; pay surviving spouse 65 percent of own PIA and 65 percent of deceased spouse PIA; increase PIA amounts by 18.2 percent.

PROPOSALS TO INCREASE THE BENEFITS OF CERTAIN GROUPS

, Memorandum II, considers proposals that alter the benefits of groups of retirees. Some of the groups (widows, the very old, divorced spouses) have substantially higher poverty rates than the elderly population as a whole. Proposals in this group include: reduce couples benefits and use the proceeds to increase survivors benefits; raise the earliest age people can claim benefits; raise the annual increase in benefits for retirees; target higher benefits for older widows, divorced spouses or the very old.

(FB65) Increase earliest eligibility age (This proposal is simulated by giving each widow an unreduced benefit.)

Reduce benefit formula/increase colas Because it is expected that wage increases in the future will outpace price increases, using a wage index to adjust post-retirement benefits would increase the real value of benefits of older retirees. The factors in the benefit formula would be reduced by 11 percent (from (90, 32, 15) to (80.1, 28.5, 13.3)).

(10%) Reduce couples' benefits by 10 percent and use proceeds to increase survivors' benefits.

(RW10%) Reduce the couples' benefit to 150 percent of the higher earning spouse's PIA. Use the proceeds to finance higher survivor's benefits.

Targeted proposals:

I Provide a one-time benefit increase to all beneficiaries aged 80 and over that would increase their basic benefit by the lesser of (a) 5 percent, or (b) the amount necessary to raise it to the poverty threshold.

IIA Increase the basic benefit for widow(er)s age 80 and over by the lesser of (a) 5 percent or (b) the amount necessary to raise the basic benefit to the poverty threshold.

IIB Eliminate the Widow(er)s limit for beneficiaries age 80 and over. (The widow(er)s limit is the actuarial reduction in survivors' benefits associated with the early retirement of the deceased worker.)

IIIA Increase the benefit rate for divorced spouses (currently 50 percent of the basic benefit) for 1 percentage point for each year of marriage to the worker in excess of 10 years, up to a maximum of 75 percent.

IIIB Increase the amount of a divorced spouse's benefit at age 70 from 50 percent of the basic benefit to the lesser of (a) 75 percent, or (b) the amount necessary to raise it to the poverty threshold.

EARNINGS SHARING AT DIVORCE

, Memorandum IV, discusses a proposal for earnings sharing at divorce. The proposal equally divides Social Security covered earnings at divorce between husbands and wives for years of marriage. The workers' benefits would be computed using earnings before and after the marriage and the shared credits from the marriage. When a divorced person dies, all credits acquired during the marriage would be credited to the earnings record of the surviving spouse (inheritance). Benefits for any subsequent spouse would be based on the divorced worker's altered-by-sharing earnings record.

PROPOSALS THAT ADDRESS VERTICAL EQUITY

, Memorandum III, examines proposals that affect the "vertical" distribution of benefits. It examines variants of a double-decker benefit structure. All vested participants and their spouses would receive a first tier benefit; the second tier would depend on lifetime earnings. It also presents variants of a two-bracket benefit structure. These proposals affect the distribution of benefits to the extent the proposed benefit structures change the bbenefits for people with different levels of lifetime earnings.

Two-Tier Options

DD1. If half of the payroll tax finances the bottom deck, and the other half the top deck, then the formula for a worker retiring at age 65 (or, later, as the NRA increases) would be: $400 per month plus 22 percent of AIME (average indexed monthly earnings). Spouse and widow benefits would be calculated as now, but using this formula instead.

DD2. If two-thirds of the payroll tax finances the bottom tier, and one-third the top tier, then the formula for a worker retiring at the NRA would be: $533 per month and 14.7 percent of AIME.

DD3. If the entire payroll tax were used to support just a one- tier benefit, then the formula would be: $800 per month.

Two-Bracket Options As with the two-tier options, these two- bracket options generally follow current law in all other respects.

WF1. If half the payroll tax is used to finance a bottom bracket that covers earnings below the average, then the resulting formula is: a 50 percent replacement up to average earnings, and a 21 percent replacement rate on above-average earnings. WF2. If half the payroll tax is used to finance a bottom bracket that covers earnings only up to one-half average earnings, the resulting formula is: a 69 percent replacement up to one-half average earnings, and a 21 percent replacement rate thereafter.

WF3. If two-thirds of the payroll tax is used to finance a bottom bracket that covers earnings below the average, then the resulting formula is: a 52 percent replacement up to average earnings, and a 14 percent replacement rate on above-average earnings.

WF4. If two-thirds of the payroll tax is used to finance a bottom bracket that covers earnings only up to one-half average earnings, the resulting formula is: a 77 percent replacement up to one-half average earnings, and a 14 percent replacement rate thereafter.

WF5. If the bottom 90 percent replacement rate under current law is extended upward to 40 percent of average earnings and the top 15 percent replacement rate of current law is extended downward to that level, today's middle 32 percent bracket would be eliminated entirely.

Social Security History