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

Old-Age Eligibility  Must work at least 10 years  While working, pay 6.2% (12.4%) payroll tax on earnings up to taxable maximum $106,800 in 2009  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 Age at claim (Claim at EEA of 62 = 30% reduction; Claim at 70 with DRC = 24% increase)

Primary Insurance Amount

Old-Age Benefits  Retired Workers 31.5 million beneficiaries in 2007  Average annual benefit was $12,900 in 2007  Auxiliary Beneficiaries Spouses: 2.4 million Survivors: 4.6 million Children: 2.4 million Also mother/father or parents

Spouse Benefits  Established in era of one-earner household Married to a worker at retirement Married for 10 years or more if divorced Receive benefit equal to 50 percent of PIA Reduced based on claim age of spouse  Average annual benefit was $6,400 in 2007  For two-earner household, spouse with lower earnings could receive no additional benefit even though paid tax of 12.4% on every dollar earned

Survivor Benefits  Established in era of one-earner household Married to a worker at death Married to deceased worker for 10 years or more if divorced Receive benefit equal to 100 percent of worker benefit Reduced based on claim age of survivor  Average annual benefit was $12,500 in 2007  Survivor in retired household faces up to 1/3 benefit reduction at death of spouse

Annual Cost-of-Living Adjustment  1973 a COLA created to account for impact of inflation on current beneficiaries Prior to then, required act of Congress  COLA is linked to consumer price index  High energy prices in 2008 pushed COLA to 5.8 percent Highest since 1982  Drop in energy prices in 2009 likely will push COLA to 0.0 percent  Cry for “relief”

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)  7.1 million beneficiaries in 2007 with average annual benefit of $12,000  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) Spike in claims during current recession among unemployed

Iowa’s Aging Population

Population Pyramid or Tower?

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

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

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

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

CBO Projected Outlays and Revenues

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)  CBO began long-run analysis in SocialSecurity_Update.pdf

Long-Run Projections Taxes t = Tax Rate t * Average Wage t * Number Workers t Benefits t = Average Benefit t * Number Beneficiaries t Trust Fund t = Trust Fund t-1 + Interest t + Taxes t – Benefits t

Projecting Taxes Taxes t = Tax Rate t * Average Wage t * Number Workers t  Average Wage depends on productivity (real wage growth), inflation, and wages as a share of compensation (growth of cash versus benefits)

Projecting Taxes Taxes t = Tax Rate t * Average Wage t * Number Workers t  Average Wage depends on productivity (real wage growth), inflation, and wages as a share of compensation (growth of cash versus benefits)  Number Workers depends on fertility, immigration and unemployment

Projecting Benefits Benefits t = Average Benefit t * Number Beneficiaries t  Average Benefit depends on past wages and inflation (along with all of the policy rules)

Projecting Benefits Benefits t = Average Benefit t * Number Beneficiaries t  Average Benefit depends on past wages and inflation (along with all of the policy rules)  Number Beneficiaries depends on fertility (60 years earlier), mortality, and disability rates

Projecting Trust Fund Balances Trust Fund t = Trust Fund t-1 + Interest t + Taxes t – Benefits t  Interest rates on government bonds (IOU’s to ourselves)

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

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

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

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

Actuarial Balance  75-Year Actuarial Balance Present value of taxes minus present value of benefits over present value of payroll The size of the tax increase needed today to fund the system for the next 75 years SSA projects (from last year)  Current economic weakness explains half of drop  Drop in immigration/lower future mortality CBO projects range -2.9 to -0.4

Income and Cost Rates  Income Rate/Revenues Payroll taxes as percent of GDP 2007: :  Cost Rate/Outlays Benefits as percent of GDP 2007: :

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 2037 (2040 last year) CBO projects between 2034 to 2072

CBO Projected Trust Fund Ratio,

Hope under Current Law? Taxes t = Tax Rate t * Average Wage t * Number Workers t Benefits t = Average Benefit t * Number Beneficiaries t Trust Fund t = Trust Fund t-1 + Interest t + Taxes t – Benefits t

Hope under Current Law? Taxes t = Tax Rate t * Average Wage t * Number Workers t Benefits t = Average Benefit t * Number Beneficiaries t Trust Fund t = Trust Fund t-1 + Interest t + Taxes t – Benefits t

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

Required Tax Rate Increases

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

Required Benefit Cuts

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

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

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

President Obama – Campaign  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

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

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

Even Bigger Mess: Medicare  Congressional efforts for Social Security reform ended with 2006 election  Current health care reform debate has shifted focus to Medicare Much bigger financial problem Same concerns about aging with little control on benefit costs Serves as an example of government-run health care Will serve as basis for reform or first to go?  Last action expanded the program!

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

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

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

How is Medicare financed?  HI financed through payroll taxes 1.45% (3.9%) on all earnings (HI Trust Fund)  SMI and Part D financed through monthly premiums (25%) and general revenues SMI $ (2009) each month  means-tested premium Part D varies by plan Deducted from Social Security checks Also co-pays and deductibles

Medicare in financial trouble  Dramatic growth in the program 1980: $37 Billion 2008: $462 Billion  Similar to Social Security, Medicare has a bleak financial future Baby boomers start to retire in next 5 years People living longer Health costs rising faster than economy as a whole

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

Medicare and Medicaid Spending as Share of GDP: Excess Cost Growth??

…so federal budget in trouble  HI Trust Fund, currently in surplus, is projected to be exhausted in 2017 as costs rise (between $980 billion and $1.4 trillion)  SMI will squeeze other federal spending as the Part B costs rise – 75% from current taxpayers  Part D cheaper so far, but cries to expand coverage may raise costs Estimated to cost $400 B over 10 years

Your future retirement?  Health care diminishing as private retirement benefit  Reliance on Medicare also uncertain  Health care likely to undergo major changes in next few years as costs rise  Economics informs us – solution is political