CRS Report Analyzing Social Security Reform Plans

                   CONGRESSIONAL RESEARCH SERVICE

[2] For the most part, the information provided in this memorandum is based on descriptions and estimates prepared by the Office of the Actuary of the Social Security Administration (SSA). The NCRP plan described here is one of four proposals priced by the actuaries, referred to as the Individual Savings Account (ISA) plus 2% plan. It is the one most closely resembling the NCRP plan released on May 19, 1998. The actuaries' estimates are contained in various memoranda summarizing aggregate trust fund impacts (i.e., on overall trust find income and outgo) and illustrative benefit and annuity outcomes for workers with different lifetime earnings levels. Because the actuarial data are not necessarily consistent from one memorandum to another, the reader should be advised that this analysis required some interpolation of the actuaries' data and should be considered as approximations only.

DESCRIPTION OF THE THREE PLANS

[3] All three plans include revenue increases and benefit reductions designed to bring the Social Security system into long- range actuarial balance. The SSA actuaries estimate that all would do so under the intermediate assumptions of the 1997 Social Security trustees' report. All three plans also include provisions either permitting or mandating the creation of new personal retirement savings accounts. A description of the plans as priced out by the actuaries follows.

[4] S. 1792 reduces the Social Security tax rate by 2 percentage points of taxable payroll (it is currently 12.4% of pay) in the short run -- 1 percentage point on employee and employer each -- and then raises it in the long run by 1 percentage point, bringing it to an ultimate rate 13.4% of pay in 2060 and later. Other measures to generate income for the Social Security system include: increasing the income taxation of Social Security benefits by requiring that benefits be taxed in the same fashion as private defined-benefit pension benefits (and would be fu1ly effective in 1999); raising the maximum amount of earnings subject to Social Security taxation in steps to $97,500 in 2003 (under current law, it is estimated to rise to $81,900); and extending Social Security coverage to all State and local government employees hired after the year 2000. It reduces benefits by: gradually increasing the age for full Social Security retirement benefits to 68 by 2017 and eventually to age 70 by 2065 (under current law the fu1l benefit age would rise to 67 by 2027); extending the period over which earnings are averaged for benefit computation purposes from 35 to 38 years by 2002; and permanently reducing Social Security cost-of-living adjustments (COLAs), as well as those of other indexed entitlement programs, by 1 percentage point per year beginning in 1998. This provision also would constrain the current indexing of income tax brackets (which would effectively increase income taxes). The bill also would eliminate the Social Security retirement earnings test for workers 62 and older. It further would permit workers to put 1% of pay into a new personal retirement savings account. Employers would be required to match these contributions.

[5] The NCRP plan reduces the Social Security tax rate on workers by 2 percentage points and mandatorily redirects the proceeds into new personal retirement savings accounts (effective for workers under age 55). It raises the Social Security system's income by extending Social Security coverage to all State and local government employees hired after 1999 and crediting certain proceeds from the current income tax on benefits to the Social Security trust funds that now go to the Medicare Hospital Insurance (HI) trust and. It reduces benefits by gradually increasing the age for full Social Security benefits to 70 by 2029 and the age for reduced benefits to 65 by 2017 (up from 62 under current law). After 2029, both would be increased by about 2 months every 3 years. It also: gradually reduces the top two (of the three) portions of the Social Security benefit formula from 32% and 15% respectively to 21.36% and 10.01% by 2020 (the first -- 90% -- bracket would not be changed); gradually reduces the dependent spouse's benefit from 50% to 33% of the worker's primary benefit; extends the period over which earnings are averaged for benefit computation purposes from 35 to 40 years by 2010; and reduces Social Security COLAs by .5 percentage points per year beginning in 1998. The plan also would eliminate the Social Security earnings test for recipients at or above the full retirement age (effective in 2003), and create a new system of "minimum" Social Security benefits for workers with 80 or more Social Security "quarters of coverage."

[6] The Ball plan increases income to the Social Security system by: requiring the investment of part of the Social Security trust funds in equities; increasing the income taxation of Social Security benefits by requiring that benefits be taxed in the same fashion as private defined-benefit pension benefits; raising the maximum amount of earnings subject to Social Security taxation (such that 87.3% of all earnings in covered employment would be taxable); and extending Social Security coverage to all state and local government employees hired after 1999. It reduces benefits by: extending the period over which earnings are averaged for benefit computation purposes from 35 to 38 years and permanently reducing Social Security cost-of-living adjustments (COLAs) by .3 percentage points per year. It also would allow workers to put 2% of pay (which would be over and above their Social Security taxes) into new personal retirement savings accounts.

THE IMPACT OF THE THREE PLANS ON BENEFIT EXPENDITURES OVERALL

[7] The SSA actuaries prepared estimates of the average 75- year financial impact of the three proposals on the Social Security system overall based on the 1997 trustees' report so-called intermediate assumptions (shown in memoranda dated March 4, 1998 from SSA's actuaries, Alice Wade and Seung An, for the NCRP proposal; April 27, 1998 from Stephen C. Goss, SSA's Deputy Chief Actuary, and Alice Wade for the NCRP plan; and May 1998 from Robert M. Ball showing the actuaries' estimates of his plan). Traditionally, the trustees' intermediate assumptions are considered their best guess at any given time about the factors that will affect the future condition of the system. It should be noted that while the 1998 trustees' report was released after the preparation of the estimated impacts of these plans, the intermediate assumptions in the 1998 report do not noticeably differ from those in the 1997 report.

[8] Traditionally, long-range Social Security income and expenditure estimates are shown as "percents of taxable payroll." Taxable payroll is the total amount of wages and salaries in the economy that are subject to Social Security taxation. In 1998, for instance, the Social Security system's costs are estimated to be equal to 11.18% of taxable payroll and its income, 12.65% of taxable payroll. The following table (Table 1) summarizes the average 75-year taxable payroll estimates of the impact of the three proposals under the 1997 trustees' report assumptions.

[9] To summarize the data briefly, the NCRP plan would reduce projected 75-year average Social Security expenditures by 23%; S. 1792 would reduce them by 16%; and the Ball plan would reduce them by 6% (see, for instance, the S. 1792 column in Table 1 -- proposed benefit reductions of 2.46% of taxable payroll divided by projected total current law expenditures of 15.6% of taxable payroll = 16%). The reader should note that the estimated impact of the proposed changes shown in Table 1 includes the income taxation of Social Security benefits contained in S. 1792 and the Ball plan (since increasing the taxation of benefits results in lower after-tax Social Security benefits).

 TABLE 1. COMPARISON OF PROJECTED 75-YEAR AVERAGE REDUCTIONS OF SOCIAL

[10] The actuaries' memoranda on the various plans contain illustrative "initial" benefit impacts for hypothetical low, average, and maximum earners who are assumed to work steadily at those levels throughout their working years (initial benefits are those paid at the point of retirement). However, their data are not consistently arrayed from one plan analysis to the next. With respect to S. 1792, for instance, the actuaries' memoranda provide benefit illustrations for retirement at ages 65 in 2025 and 2070. For the NCRP plan, they provide them for ages 65 and 67 in 5 year increments from 2000 to 2030. Illustrations for later years -- out to 2070 -- are provided for retirement at age 67 only. Despite these inconsistencies, the relative magnitude of the reductions that the plans would make can be observed from the data. The following table (Table 2) summarizes these estimated benefit reductions (blank cells in the table indicate the data were not available from the actuaries' memoranda).

   TABLE 2. COMPARISON OF SSA ACTUARIES' ILLUSTRATIVE REDUCTIONS IN

 TABLE 3. ILLUSTRATIVE REDUCTIONS IN INITIAL SOCIAL SECURITY BENEFITS

[13] The NCRP plan would incur the largest benefit reductions of the three plans. However, the actuaries' analysis shows that the cuts would be relatively progressive, i.e., low-wage earners would incur a lower percentage reduction in benefits than maximum-wage earners.

[14] As with S. 1792, the Ball plan would appear to be regressive in its benefit impact (although not reflected in the tables above -- see the footnote at the bottom of Table 3) because of the higher benefits payable in the maximum-wage earner case. Like S. 1792, the Ball plan would increase the maximum amount of earnings subject to Social Security taxation and have the effect of raising benefits for the maximum earner. Ignoring this provision, the cuts would be very small and proportional on workers of different earnings levels.

[15] SPEED OF IMPLEMENTATION OF BENEFIT REDUCTIONS -- The NCRP plan would implement its benefit reductions much more rapidly than S. 1792. As reflected in Table 2, where S. 1792 would cause an initial benefit reduction of about 11% for an average wage earner retiring at age 65 in 2025, the NCRP plan would cause a 10% reduction for a comparable wage earner in 2010 -- in other words, it would have approximately the same impact about 15 years sooner. For a 2025 retiree, the NCRP plan would create a reduction of 33% (roughly three times the magnitude of that of S. 1792).

[16] The Ball plan's reductions in "initial" benefits are marginal in both the short and long range (although the COLA reduction could have a noticeable impact on retirees' benefits late in life, e.g., age 80 or 95 -- see Table 4).

IMPORTANT OMISSIONS IN COMPARISONS OF "INITIAL" BENEFIT REDUCTIONS

[17] It is important to recognize that the actuaries' projections of "initial" benefit impacts in the previous examples do NOT ADEQUATELY REFLECT THE IMPACT OF VARIOUS FEATURES OF THE THREE PLANS. Specifically, they do NOT take into account (1) the proposed expansion of the taxation of benefits provided for under S. 1792 and the Ball plan, (2) the lifetime impact of the respective COLA constraints in the three plans, and (3) the lengthening of the earnings averaging period used to compute benefits that the three plans would make. The omission of these impacts is particularly relevant for the Ball plan, since without them, only very small reductions in benefits would appear to result from the plan.

[18] EXPANSION OF INCOME TAXATION OF SOCIAL SECURITY BENEFITS -- Both S. 1792 and the Ball plan would expand the number of people affected by, and increase the amount of, income taxation of Social Security benefits by (1) eliminating the income thresholds below which recipients pay no tax on their benefits and (2) taxing benefits in the same fashion as private DEFINED-BENEFIT pension plans. S. 1792 would have the changes take effect immediately. The Ball plan would appear to phase them in (Mr. Ball's description of the proposal does not mention a phase in, but the estimated savings shown for the measure suggest that there would be such a feature). The NCRP plan makes no change in the taxation of benefits (although it would credit certain proceeds from the current tax on benefits to the Social Security trust funds that now go to the Medicare HI trust fund).

[19] Currently, single retirees with incomes in excess of $25,000 (counting adjusted gross income and one-half of their Social Security benefits) pay income taxes on up to 85% of their benefits (up to 50%, if their incomes fall between $25,000 and $34,000). Couples with incomes in excess of $32,000 (again counting adjusted gross income and one-half of their Social Security benefits) pay income taxes on up to 85% of their benefits (up to 50%, if their incomes fall between $32,000 and $44,000). Today, approximately 75% of Social Security recipients pay no income taxes on their benefits, in large part because their incomes do not reach these thresholds. With elimination of the thresholds (or income exemptions) many more recipients would pay taxes on their benefits. In addition, the amount of benefits that would be taxable would rise in most instances. Estimates made by SSA's actuaries and the Congressional Budget Office (CBO) suggest that in a typical case 95% of benefits would be taxed using private pension rules (in lieu of the current maximums of 50% and 85%, depending on income).

[20] The potential impact of these provisions of S. 1792 and the Ball plan is clearly illustrated by examining the case where recipients now pay no income tax on their benefits. These retirees could incur as much as a 14.25% reduction in benefits (or in the value thereof on an after-tax basis), or, although unlikely, as much as a 26.6% reduction in benefits depending on their other income and income tax bracket. The reduction of 14.25% would be the maximum impact if 95% of a recipient's benefits fell into the first income tax bracket (15% x 95% of benefits); the 26.6% reduction would occur if 95% of the benefits fell into the second income tax bracket (28% x 95% of benefits).

[21] While the "zero bracket amount" (the combination of personal exemptions, regular standard deduction, and, if applicable, additional deductions for the elderly) would cause these proposals to have little or no impact on the lowest income retirees, those affected would not be exclusively high-income retirees. For example, if the proposal were fully effective in 1998, an age 65 retiree receiving an average Social Security benefit of $765 a month and having other annual income $8,000 would pay $1,308 in new income taxes. In other words, this person would go from paying no income taxes under current law to $1,308 under the proposal. Counting both the Social Security benefits and other income, his or her total income would be $17,180, which is considerably below the estimated average wage of $27,898 (under the trustees' intermediate assumptions).

[22] This potential impact of S. 1792 and the Ball plan is not reflected in Tables 2 and 3 above, and its omission distorts the potential benefit reductions these plans would make relative to the NCRP plan. The fact that the current law income exemptions for the taxation of benefits (i.e., $25,000 for a single recipient and $32,000 for couples) are not indexed does mean that a greater proportion of future retirees will find that at least part of their benefits is taxable. However, it will take many years before inflation makes these exemptions meaningless. Assuming the trustees' projected inflation rates, the zero bracket amount for a single elderly retiree may reach $20,000 by the year 2025, but the annual benefit for an average-wage earner retiring at 65 in that year is projected to be $30,208. Under current law, if this retiree had $20,000 in other income, $5,438 of his or her Social Security benefit would be taxable at a 15% rate. The income tax paid on these benefits would be $816, which means the benefits would be 3% lower on an after-tax basis. Under S. 1792 and the Ball plan, $28,000 or more of the benefits would become taxable at a 15% rate, thereby reducing the value of the annual benefits by $4,200. This means that the benefits would be 14% lower on an after-tax basis.

[23] Hence, taking the after-tax effects caused by the increased taxation of benefits into account narrows the difference in the size of the cuts between S. 1792 and the NCRP plan, and shows that the reductions under the Ball plan are not negligible (albeit still considerably smaller than the other two plans).

[24] COLA REDUCTIONS TO ADJUST FOR PERCEIVED OVERSTATEMENTS OF INFLATION -- All three plans would make reductions in Social Security COLAs to offset perceived overstatements of inflation as measured by the BLS's monthly Consumer Price Index (CPI). This is the index used to adjust Social Security benefits so that their purchasing power does not decline over the recipients' years on the benefit rolls. While all three plans appear to have the same motivation, they assume different degrees of inflation overstatement by the CPI. S. 1792 assumes the largest amount -- 1 percentage point annually. The trustees assume in their intermediate projections that the CPI will rise at an ultimate annual rate of 3.5%, and that COLAs of this amount would be paid annually. S. 1792 would reduce these COLAs by 1 percentage point annually, in essence, providing estimated COLAs of 2.5%, instead of 3.5%. The NCRP plan assumes the overstatement is 0.5 percentage point annually, and therefore it would provide estimated COLAs of 3%, instead of 3.5%. The Ball plan assumes the overstatement is 0.3 percentage point annually, and thus would provide estimated COLAs of 3.2%, instead of 3.5%.

[25] The real impact of these proposals is not adequately reflected in measurements of "initial" benefit impacts, particularly when looking at retirements occurring near age 62. Under current law, "initial" Social Security benefits are adjusted to reflect COLAs granted in and after the year in which a worker reaches age 62, regardless of whether the worker joins the benefit rolls in that year (this keeps workers who delay retirement beyond age 62 in the same position with respect to inflation as workers who retire at age 62 -- simply put, they are not disadvantaged because they didn't retire early). A worker retiring at age 65, for instance, will have 3 years' worth of COLAs built into his or her "initial" benefits at age 65.

[26] This aspect of the COLA reductions in the three plans is reflected in the actuaries' illustrations of "initial" benefit impacts, but the lifetime impacts of these cuts are not. For instance, under the Ball plan, as illustrated in Tables 2 and 3, the "initial" benefit reduction for an age 65 retiree is less than 1%. This is entirely the effect of reducing COLAs by 0.3 percentage points for 3 years. However, by age 80, this retiree's benefits would have been reduced by 0.3 percentage points for 18 years. With current law COLAs assumed to be 3.5%, this proposal would result in benefit levels at age 80 that would be 5.1% lower than under current law and at age 95, 9.1% lower. As reflected in the following table (Table 4), the late-life impacts of COLA cuts in S. 1792 and the NCRP plans would be considerably larger.

   TABLE 4. PROJECTED IMPACT ON SOCIAL SECURITY BENEFIT LEVELS FROM

[28] Taking these lifetime COLAs effects into account again narrows the difference in the size of the reductions made by S. 1792 and the NCRP plan, and better illustrates the reductions potentially arising from the Ball plan (although the Ball plan's reductions still would be much less than those caused by the other two plans).

[29] THE LENGTHENING OF THE EARNINGS "AVERAGING PERIOD" FOR COMPUTING SOCIAL SECURITY BENEFITS -- Under current law, Social Security benefits are computed from a worker's earnings record averaged over a 35-year period. The highest 35 earnings years are counted. All three plans would lengthen this averaging period. S. 1792 and the Ball plan would lengthen it to 38 years. The NCRP plan would lengthen it to 40 years. The impact of this change is not reflected in the actuaries' illustrations of "initial" benefit impacts largely because the illustrations reflect careers of steady earnings that exceed 35 years. However, the proposal's largest impact would be on workers with careers of erratic earnings, that may include significant periods of not working. For instance, a worker retiring at age 65 in 1998 with a 35-year career of average earnings would receive a monthly benefit of $938. If the averaging period were 38 years in length, this worker would have 3 years of zeros in his or her earnings record, and this would lower the average earnings level used to compute benefits. In this example, the worker would receive $885 in monthly benefits, representing a 6% reduction from the current law level. If the averaging period were 40 years, the monthly benefit would be $854, representing a 9% reduction.

[30] Hence, this proposal, as with the proposals to increase the taxation of benefits and reduce annual COLAs, has the potential to reduce benefits further than that shown by the actuaries' illustrative "initial" benefit impacts. The actuaries point this out in their memoranda by stating that even though the provision would have a negligible impact in the examples they use, overall the provision would reduce the total benefit cost of the Social Security system by 3%. Obviously, the longer the averaging period, the greater the reduction in benefits. In this respect, the provision in NCRP plan would cause the largest reductions since it would lengthen the averaging period by 5 years, whereas S. 1792 and the Ball plan would lengthen it by 3 years.

CONCLUSION

[31] In summary, using the SSA actuaries' analyses of the impacts of S. 1792, NCRP, and the Ball plan, the NCRP plan would cause the largest reductions in benefits for the Social Security system in the aggregate and as well as in individual recipient cases generally. S. 1792, however, does make a larger reduction in annual COLAs and increases the taxation of benefits (the NCRP plan does not). Thus, it is highly probable that in many instances the benefit reductions caused by S. 1792 would approach or even exceed the size of those arising from the NCRP plan. The Ball plan would clearly make the least reductions of the three plans, but they are not necessarily negligible as one might deduce from looking only at the plan's impact on "initial" Social Security benefits.