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The Future of Social Security

The Future of Social Security . Amy Rehder Harris Tax Research and Program Analysis Section Iowa Department of Revenue (formerly of the Long Term Modeling Group, Congressional Budget Office, Washington, D.C). History of Social Security.

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The Future of Social Security

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  1. The Future of Social Security Amy Rehder Harris Tax Research and Program Analysis Section Iowa Department of Revenue (formerly of the Long Term Modeling Group, Congressional Budget Office, Washington, D.C)

  2. History of Social Security • Social Security (OASDI) is mandatory public insurance to alleviate poverty in old-age • Old-Age Insurance established 1935 • Expanded to include Survivors and Spouses in 1939 • Disability Insurance introduced 1956 • Hospital Insurance (Medicare) began 1965

  3. Old-Age Eligibility • Must work at least 10 years • While working, pay 6.2% (12.4%) payroll tax on earnings up to taxable maximum • $102,000 in 2008 • Upon retirement, benefits a function of • AIME: highest 35 years of earnings (indexed for inflation) • PIA: progressive formula – higher replacement for lower lifetime income • NRA: rising from 65 to 67 for birth years 1960+ • Age at claim (Claim at EEA of 62 = 30% reduction; Claim at 70 with DRC = 24% increase)

  4. Primary Insurance Amount

  5. Old-Age Benefits • Retired Workers • 31.5 million beneficiaries in 2007 • Average annual benefit was $12,500 in 2006 • Auxiliary Beneficiaries • Spouses: 2.4 million • Survivors: 4.6 million • Children: 2.4 million • Also mother/father or parents

  6. Spouse Benefits • Established in era of one-earner household • Married to a worker at retirement • Married for 10 years or more if divorced • Receive benefit equal to 50 percent of PIA • Reduced based on claim age of spouse • Average annual benefit was $6,200 in 2006 • For two-earner household, spouse with lower earnings could receive no additional benefit even though paid tax of 12.4% on every dollar earned

  7. Survivor Benefits • Established in era of one-earner household • Married to a worker at death • Married to deceased worker for 10 years or more if divorced • Receive benefit equal to 100 percent of worker benefit • Reduced based on claim age of survivor • Average annual benefit was $12,100 in 2006 • Survivor in retired household faces up to 1/3 benefit reduction at death of spouse

  8. Disability Insurance • Eligible if worked 5 of previous 10 years • Benefit is function of earnings divided by years worked prior to disability (minus lowest 5 years) • 6.8 million beneficiaries in 2006 with average annual benefit of $11,700 • Auxiliary beneficiaries: 1.8 million • Large growth in beneficiaries • Recent expansion to mental illness and back pain • Concerns about incentives to claim DI rather than OAI when nearing EEA (no benefit reduction)

  9. Iowa’s Aging Population

  10. Population Pyramid or Tower?

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

  12. Taxation of Social Security • “Contributions” taxed as income when earned by federal and state governments • Benefits paid at retirement non-taxable until 1983 • If other income above $32,000/$25,000, up to 50% taxable • Revenue to OASDI Trust Fund • Attempting to improve system finances in preparation for baby boomers • 1993 up to 85%, money to Medicare

  13. Taxation of Social Security in Iowa • Followed federal rules by taxing 50% of benefits for seniors with other income • Fear that encouraging high-income elderly to move out of state at retirement • 2006 change – phase-out of taxation on benefits by 2014 (43% of taxable benefits exempt in 2009) • Evidence suggests elderly move to warmer climates, not non-tax states

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

  15. CBO Projected Outlays and Revenues 1985-2082

  16. Social Security Administration • Social Security is administered by SSA, an executive branch agency • SSA produces an Annual Trustees report about the future of the system • Short-run (10 years) • Long-run (75 years) http://www.ssa.gov/OACT/TR/TR08/index.html • CBO began long-run analysis in 2004 http://www.cbo.gov/ftpdocs/96xx/doc9649/08-20-SocialSecurityUpdate.pdf

  17. Long-Run Projections Taxest = Tax Ratet * Average Waget * Number Workerst Benefitst = Average Benefitt * Number Beneficiariest Trust Fundt = Trust Fundt-1 + Interestt + Taxest – Benefitst

  18. Projecting Taxes Taxest = Tax Ratet * Average Waget * Number Workerst • Average Wage depends on productivity (real wage growth), inflation, and wages as a share of compensation (growth of cash versus benefits)

  19. Projecting Taxes Taxest = Tax Ratet * Average Waget * Number Workerst • Average Wage depends on productivity (real wage growth), inflation, and wages as a share of compensation (growth of cash versus benefits) • Number Workers depends on fertility, immigration and unemployment

  20. Projecting Benefits Benefitst = Average Benefitt * Number Beneficiariest • Average Benefit depends on past wages and inflation (along with all of the policy rules)

  21. Projecting Benefits Benefitst = Average Benefitt * Number Beneficiariest • Average Benefit depends on past wages and inflation (along with all of the policy rules) • Number Beneficiaries depends on fertility (60 years earlier), mortality, and disability rates

  22. Projecting Trust Fund Balances Trust Fundt = Trust Fundt-1 + Interestt + Taxest – Benefitst • Interest rates on government bonds (IOU’s to ourselves)

  23. Ten Key Assumptions • Five Economics Assumptions: • Future earnings (1) Real wage growth (2) Inflation (3) Unemployment (4) Wage as a Share of Compensation • Future benefits paid to retirees, the disabled, spouses and survivors • Earnings on the existing Trust Fund (5) Interest rate

  24. Ten Key Assumptions (cont) • Five Demographics Assumptions: • How many people will be paying taxes and receiving benefits (6) Mortality (7) Fertility (8) Immigration (9 & 10) Disability Incidence and Termination • Recent changes to immigration forecast led to improved finances (8% more workers by 2060 with more, younger immigrants assumed)

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

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

  27. Actuarial Balance • 75-Year Actuarial Balance • Present value of taxes minus present value of benefits over present value of payroll • The size of the tax increase needed today to fund the system for the next 75 years • SSA projects -1.70 (from -1.95 last year) • CBO projects range -2.7 to 0.1

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

  29. Trust Fund Ratio • Trust fund assets over annual expenditures • Measures if the system can pay benefits • Currently large surplus • Source of touted “Exhaustion Date” • SSA projects the system will “go broke” in 2040 • CBO projects between 2034 to beyond 2082

  30. CBO Projected Trust Fund Ratio, 1985-2082

  31. Hope under Current Law? Taxest = Tax Ratet * Average Waget * Number Workerst Benefitst = Average Benefitt * Number Beneficiariest Trust Fundt = Trust Fundt-1 + Interestt + Taxest – Benefitst

  32. Hope under Current Law? Taxest = Tax Ratet * Average Waget * Number Workerst Benefitst = Average Benefitt * Number Beneficiariest Trust Fundt = Trust Fundt-1 + Interestt + Taxest – Benefitst

  33. Changes to Current Law? • Increase taxes above current 6.2% • Regressive tax • Raise taxable maximum with no benefit increase? • Risk of doing nothing – required tax increases • Future workers pay

  34. Required Tax Rate Increases

  35. Changes to Current Law? • Increase taxes above current 6.2% • Reduce benefits paid to current or future beneficiaries • Raise NRA further? • Risk of doing nothing – about 2040 when system no longer takes in enough resources not all of promised benefits can be paid • Across-the-board benefit cuts? • Future beneficiaries pay

  36. Required Benefit Cuts

  37. Changes to Current Law? • Increase taxes above current 6.2% • Reduce benefits paid to current or future beneficiaries • Raise the interest earned by the Trust Funds through investing in more risky assets, either the government or individual workers • Current credit market problems make most wary

  38. Risks of Government Investing • Bad stock returns could harm new retirees (35% of the time – lose money) • Only 5% chance better off in all years over next 75 • Public control over private assets creates conflicts • “Social Investing”

  39. Individual Accounts • Allow individuals to take part of payroll tax and invest in higher returns paid by the stock market • Trade-off is must accept higher risks • Stock market is NOT a sure thing

  40. Obama’s Plan • Opposes any “privatization” • Proposes to improve finances by applying payroll taxes on high incomes • Proposed a 2% to 4% payroll tax on earnings above $250,000 starting roughly 10 years from now • Preliminary analysis suggests this could address 15% of long-run problem

  41. McCain’s Plan • Believes can meet benefit promises to current and future retirees without raising taxes • No specific plan to make changes • Supports personal accounts for current workers as a supplement • (Lead economic advisor is former CBO director during my tenure there – very aware of the future problems and supportive of individual accounts that were analyzed during my tenure)

  42. Nonpartisan Social Security Reform Plan (Three Economists) • Raise EEA from 62 to 65 • Raise NRA to 68 for 1955 and later • Reduce PIA replacement factors • Lowers benefits but more progressive formula • Raise taxable maximum (no benefits credit) • Low-earner benefit • Reduce spouse benefit • Individual Accounts – 1.5% carve-out and 1.5% add-on

  43. Your future retirement? • Social Security benefits are uncertain for your generation if reforms not instituted soon • Still not a great method of “saving” for retirement • Three-legged stool • Public pension (Social Security) • Private pension (401k) • Personal saving (Roth IRA) • Economics informs us - solution is political

  44. Even Bigger Mess: Medicare • Congressional efforts for Social Security reform ended with 2006 election • CBO shifted focus to Medicare • Much bigger financial problem • Part of health care “crisis” in America • Same concerns about aging with little control on benefit costs • Last action expanded the program!

  45. Medicare defined • Medicare is publicly-provided health insurance for the elderly • Medicaid is publicly-provided health insurance for low income uninsured • Four parts • Part A: Hospital Insurance (HI) • Part B: Supplemental Medical Insurance (SMI) • Part C: Medicare Advantage is alternative to A&B • Part D: Prescription Drugs

  46. Who is covered? • Elderly, 65+ (85% of beneficiaries) • Everyone automatically covered by HI, must sign up for SMI (95% do) • 36.9 million beneficiaries in 2007 • Disabled eligible after two years receiving DI benefits • 7.2 million beneficiaries • End stage renal disease (kidney dialysis)

  47. What is covered? • HI covers inpatient hospital care, skilled nursing facilities, home health services, and hospice care • SMI covers doctor visits, lab tests, and outpatient hospital care • Part D covers prescription drugs (w limits) • Does NOT cover nursing homes

  48. How is Medicare financed? • HI financed through payroll taxes • 1.45% (3.9%) on all earnings (HI Trust Fund) • SMI and Part D financed through monthly premiums (25%) and general revenues • SMI $96.40-238.40 (2008) each month, Part D varies by plan - deducted from Social Security checks • Also co-pays and deductibles

  49. Medicare in financial trouble • Dramatic growth in the program • 1980: $37 Billion • 2007: $432 Billion • Similar to Social Security, Medicare has a bleak financial future • Baby boomers start to retire in next 5 years • People living longer • Health costs rising faster than economy as a whole

  50. Excess Cost Growth • Growth in spending per beneficiary that exceeds growth in per capita GDP • 3.0 percent over 1970-2005 • 2.1 percent over 1990-2005 • Captures both policy changes and “residual” growth • Assumption going forward dramatically alters projections of program growth • Same issues for Medicaid (program for poor jointly funded by the states)

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