The Social Security Windfall Elimination Provision Prof. Jeffrey Brown, UIUC SUAA State Meeting October 10, 2007

First, a Disclaimer … The views I am presenting here today are my personal views, and do not necessarily reflect any official position of the Social Security Advisory Board or the Social Security Administration

Overview 1.The WEP / GPO exist for valid reasons 2.Legislative efforts to repeal the WEP/GPO are likely to fail and may have unintended consequences 3.Perhaps efforts better focused on a) educating participants and b) changing the method for calculating these provisions

Why Does the WEP Exist? Historically, government employees were not covered under SS due to concerns about federal taxes on state governments – this changed in 1983 California, Colorado, Illinois, Louisiana, Massachusetts, Ohio and Texas are only states not under SS WEP established in 1983 to “remove an unintended advantage that the weighting in the regular Social Security benefit formula would otherwise provide for persons who have substantial pensions from non- covered employment.” –Testimony of Robert M. Wilson, Deputy Commissioner for Legislation and Congressional Affairs, Social Security Administration, Hearing before the Subcommittee on Social Security Committee on Ways and Means, May 1, 2003

Let’s Get Technical for a Moment The core concept of a Social Security benefit is something called the “Primary Insurance Amount,” or PIA Normally, if one retires at the normal retirement age, one’s benefit is equal to the PIA The PIA is a non-linear function of one’s lifetime earnings

Calculating Benefits: Step 1 Take each year of annual earnings, and index them to average wage growth Take average of the 35 highest years of indexed earnings, and divide by 12 to get: “Average Indexed Monthly Earnings” A rough measure of where one falls in the lifetime earnings distribution (Rich or Poor?)

Calculating Benefits: Step 2 Run AIME (average indexed monthly earnings) through a non-linear benefit formula to compute the Primary Insurance Amount (PIA) Here is what the formula looks like for 2007 …

The Benefit (PIA) Formula (2007) PIA AIME 1 st bendpoint 2 nd bendpoint $680 $4,100 $612 $1706

Why the Complicated Formula? Idea is simple: to make the Social Security benefit formula more progressive To provide a higher income “replacement rate” for lower income individuals To provide higher benefit relative to lifetime earnings for lower income individuals

What About SURS Participants? Income from SURS-covered employment is not covered under Social Security No taxes paid on this income No benefits received from this income Many SURS participants, however, also have part of their lifetime income from sources that are covered by Social Security Former, subsequent, or second jobs Consulting income

What is the Problem? If one simply uses Social Security covered earnings, and ignores SURS income, then it provides an incorrect picture of one’s true lifetime earnings Ex: If only 10% of lifetime income is covered under SS, one would look like a “lifetime poor,” when in fact they are not The result of blindly applying the formula is that SURS employees would get too high a return on their contributions

Example if No WEP Existed Average Indexed Monthly Earnings Benefit if use SS only Benefit to Earnings SSSURSTotal Larry % Mo5,0000 1,84137% Curly5004,5005, %

Example if No WEP Existed Average Indexed Monthly Earnings Benefit if use SS only Benefit to Earnings SSSURSTotal Larry % Mo5,0000 1,84137% Curly5004,5005, %

Example if No WEP Existed Average Indexed Monthly Earnings Benefit if use SS only Benefit to Earnings SSSURSTotal Larry % Mo5,0000 1,84137% Curly5004,5005, %

Example if No WEP Existed Average Indexed Monthly Earnings Benefit if use SS only Benefit to Earnings SSSURSTotal Larry % Mo5,0000 1,84137% Curly5004,5005, %

What Does the WEP Do? Reduces first factor in the formula from 90% to 40% Reduces benefits by a maximum of $340 per month for 2007 cohort For each year over 20 years that one has “substantial” earnings under SS, this factor increases by 5 percentage points At 30 years of substantial earnings, the offset disappears

Benefits under WEP (<20 years) PIA AIME $680 $4,100 $612 $ $272

Example with WEP Existed Average Indexed Monthly Earnings Benefit Benefit to Earnings SSSURSTotal Larry % Mo5,0000 1,84137% Curly5004,5005, %

The Bottom Line The WEP exists for reasons of fairness, i.e., to avoid treating medium / high income state and local workers as if they were low income workers The need for it arises from the non- linearity of the benefit formula If formula provided flat replacement rate for all earnings, no adjustment would be needed

Government Pension Offset (GPO) The GPO affects government retirees who are eligible for two retirement benefits: A pension based on their own work in a Federal, State, or local government job that was not covered by Social Security, and A Social Security spouse's or surviving spouse's benefit based on their husband's or wife's work in covered employment. If the GPO applies, the person's Social Security spouse's or surviving spouse's benefit is reduced Reduction = two-thirds of the amount of the person's government pension based on work not covered by Social Security.

Intent of GPO Spousal benefits intended for non- working and/or low earning spouses GPO provision removes the possibility that an individual with a large public sector pension could also get the spousal benefit

Why WEP/GPO Won’t be Repealed 1.The White House, Treasury, Social Security Administration, and the relevant House and Senate committee staffs know and understand the reason it exists 2.The CBO, GAO and SSA Actuaries understand the reason it exists 3.It is expensive to repeal Roughly $5 billion annually $60+ billion over 10 year budget window Makes 75-year solvency problem worse Brings date of cash flow problem forward 1 year

Unintended Consequences It may make it more likely that the problem is addressed by folding state and local workers into Social Security Many argue that this would be “fair” The low “rate of return” to SS arises in large part from having to pay off the implicit debt to past generations of recipients State / local workers currently escape this burden SURS participants would be worse off if forced to participate in Social Security

Where to Focus from Here? While some form of WEP has a good reason to exist, the current adjustment is ad hoc While it may be roughly correct on average, it is not right for every individual Perhaps SUAA could focus on getting the calculation changed in a manner that might increase fairness across SURS employees Currently, low income SURS employee gets same offset as high income SURS employee (if # years outside of SURS the same)

How Change the WEP: One Idea Since 1977, SSA has kept track of both covered and uncovered earnings One could compute the PIA based on total (SS + SURS) earnings Then calculate what fraction of total lifetime earnings were under SS Give the person that fraction of the revised PIA In other words, if half your earnings were under SS, you get half the benefit This approach would: Reduce inequity Be much simpler to explain

In the Meantime: Framing Now: “Your benefit is $1200. But because you were under SURS, your benefit is reduced by $300 to reduce your windfall.” Alternative: “Your benefit is $900.”

Summary It is perfectly understandable why SURS annuitants are angry with WEP/GPO The provisions are not explained well The annual SS benefit statements do not show right amount for SURS participants Even the name, “windfall,” creates a negative climate But some version of a WEP/GPO is good policy, and efforts to repeal it may backfire Perhaps better to focus on (a) how it is calculated, and (b) education