2007 Social Security

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SOCIAL SECURITY:

How It Works and How to Fix

ItJonathan Barry Forman (Jon)

Alfred P. Murrah Professor of Law

September 2007


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Overview

How Social Security Works Financing Social Security How Benefits Are Determined

Financial Troubles How to Fix It

Raise Taxes

Cut Benefits Increase Investment Returns

A two-tier System


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How Many People Get SocialSecurity?

47.7 million people receive Social Securityeach month

1 in 6 Americans get Social Securitybenefits

Nearly 1 in 4 households get income fromSocial Security

National Academy of Social Insurance, Social Security Finances: A Primer (2005)


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Who Gets Social Security?

30.0 million retired workers

4.8 million widows and widowers

6.2 million disabled workers 0.8 million adults disabled since

childhood

3.1 million children



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How Much Does Social Security Pay?

www.ssa.gov/OACT/COLA/colaeffect.html

Type of Beneficiary Average

MonthlyBenefit

All Retired Workers $1,044

Aged widow(er), non-disabled $1,008

Disabled worker $979

Aged couple-both receiving $1,713

Widowed mother and two children $2,167
http://www.ssa.gov/OACT/COLA/colaeffect.htmlhttp://www.ssa.gov/OACT/COLA/colaeffect.htmlhttp://www.ssa.gov/OACT/COLA/colaeffect.htmlhttp://www.ssa.gov/OACT/COLA/colaeffect.html


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Social Security and Poverty

2007 Poverty Levels Single individuals $10,210 ($851/month)

Married couples $13,690 ($1,141/month)

With Social Security only 9% were poor in 2000

Without it, 48% would have been poor


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Financing Social Security

Workers and their employers pay withSocial Security taxes

Workers pay

6.2% of their earning for Social Security, and 1.45% of their earnings for Hospital Insurance

under Medicare (Part A)

Employers pay an equal amount

The total is 12.4% for Social Security and2.9% for HI Social Security tax base is $97,500 in 2007


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Worker Benefits

Workers over 62 are eligible If they have worked 10 years

Benefits are based on a workers earningshistory Career-average earnings

Average Indexed Monthly Earnings (AIME)


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Average Indexed MonthlyEarnings (AIME)

Determine how much the worker earnedevery year through age 60 Determine Benefit Computation Years And Earnings in those years

Index those Earnings for Wage Inflation Up to the year the worker turns 60

Subsequent Work Years Also Count Pick the Highest 35 Years

Drop the rest


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Average Indexed MonthlyEarnings (AIME), continued

Add those highest 35 years ofearnings up

Divide by 35; Divide by 12 Result is called Average Indexed

Monthly Earnings (AIME) AIME is then linked by formula to the

basic retirement benefit Result is called Primary Insurance

Amount (PIA) Paid at full retirement age


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Full Retirement Age

http://www.ssa.gov/retire2/retirechart.htm

Year of Birth Full Retirement Age

1937 or earlier 65

1938 - 1942 plus 2 months per year

1942 1954 66

1955 - 1959 plus 2 months per year

1960 and later 67
http://www.ssa.gov/retire2/retirechart.htmhttp://www.ssa.gov/retire2/retirechart.htmhttp://www.ssa.gov/retire2/retirechart.htm


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Primary Insurance Amount(PIA)

For a worker turning 62 in 2007,

PIA = 90% of first $680 of AIME

+ 32% of AIME from $680 to $4,110 (ifany)

+ 15% of AIME over $4,110 (if any)

$680 and $4,110 are called bend points PIA indexed by cost of living after 62

Provides higher benefits relative to earnings

for lower paid


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Primary Insurance Amount (PIA) formula

for persons turning age 62 in 2007

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

$2,200

$0 $1,000 $2,000 $3,000 $4,000 $5,000 $6,000

Average Indexed Monthly Earnings

PrimaryInsurance

Amo

PIA

Second

Bend Point

$4,110

First

Bend Point

$680


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How do benefits compare to earnings?

$19,600$22,500

$15,800

$35,300

$55,400

$90,000

$14,800

$9,000

57%

42%

35% 25%

$0

$20,000

$40,000

$60,000

$80,000

"low" "medium" "high" "maximum"

Earnings Amount

Past Wages Benefits

Retired worker age 65, 2005


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Worker Benefits:Increases and Decreases

Indexed for inflation Actuarial decrease for early retirement

Example: average-wage worker, 62 in 2006

Will get $1,332.80 per month at her fullretirement age of 66

or $999 per month at 62

Actuarial increase for later retirement

8 percent per year Retirement Earnings Test

In 2007, early retirees lose $1 of benefits foreach $2 of earnings over $12,960


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How many people rely on SocialSecurity for most of their income?

90% of people 65 and older get SocialSecurity

Nearly 2 in 3 (66%) get half or moreof their income from Social Security

About 1 in 5 (22%) get all theirincome from Social Security



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Most elderly dont receive pensions

Percent with Employer-SponsoredPensions

All age 65+ 41%

Couples 51%

Unmarried men 39%

Unmarried women 32%



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Family Benefits

Spouses, dependents, and survivors

Husband or wife gets 50% of workers

PIA Together, couple gets 150% Widow or widower gets 100% of

workers PIA

A joint and two-thirds annuity

Dual entitlement rule limits benefits


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Estimates for 2006 Finances

Trust Fund income = $745 billion (taxes)

Trust Fund outgo = $555 billion (benefits)

Surplus = $190 billion

By law, surpluses are invested in U.S.

government securities and earn interestthat goes to the trust funds.

Social Security Administration 2007 Trustees Report


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How do actuaries estimate thefuture?

Review the past: birth rates, death rates,immigration, employment, wages,inflation, productivity, interest rates

Assumptions for the next 75 years

Three scenarios: Low cost; High cost;Intermediate (best estimate)



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21Social Security Administration, 2007 Trustees Report


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The Long-Range Forecast(Best estimate)

In 2017, tax revenues into the trust fundsforecasted to be less than benefits duethat year. Interest on the reserves andthe assets themselves will help pay for

benefits until 2041. In 2041, reserves are projected to be

depleted. Income is forecast to cover75% of benefits due then.

By 2081, assuming no change in taxes,benefits or forecasts, revenue would cover70% of benefits due then.


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Social Securitys Financing Problem

2007 Trustees Report shows Expenses will exceed payroll tax income in 2017

Trust funds will be out of money in 2041

75-year deficit equals 1.95% of taxable payroll Immediate payroll tax increase of 1.95% needed to

restore actuarial balance

Alternatively, immediate ~12.8% across-the-board

benefit cut $4.7 trillion unfunded liability

About 0.7% as a share of the entire economy (GDP)


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Why is the deficit so muchsmaller as a share of GDP?

The answer is because Social Securitytaxable wages are only a relativelysmall part of GDP. Wages taxed for Social Security are 39

percent of GDP.

The other 61 percent of national income

is not taxed to help pay for SocialSecurity.



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What is that non-taxableincome?

Income not subject to Social Securitytaxes includes: earnings above the tax cap ($97,500 in

2007); tax exempt compensation (non-taxable

fringe benefits, tax-deferred accounts, etc); wages of about one in four state and local

workers who are not covered by Social

Security; income from property stock dividends,

interest, and rental income.



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Only 3 Ways to Fix Social Security

Raise Taxes

Cut Benefits

Increase Investment Returns Private investment

Either government or individual


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Options: Raise Taxes

OPTION

Increase tax rate by2% total

Tax all earnings Tax 90% of earnings

Include new state &

local govt. workers Tax SS benefits like

pensions

% of Deficit Eliminated

104%

93%

40%

10%

20%

National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy ofActuaries (2004).


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Options: Cut Benefits

OPTION Raise retirement age

(to 67 faster & index)

Reduce COLA by %each year

Cut benefits by 5% forthose starting to get

benefits in 2005 Increase # years in

wage avg. to 40


28%

41%

32%

21%



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Options: Increase InvestmentReturns

OPTION

Investments in equities


36% - 50%



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Long-term Reform

Social Security should ensure thatevery elderly American has anadequate retirement income

We could redesign the system

Two-tier system First tier: poverty-level benefit

Second tier: earnings-related benefit

Earnings sharing


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First Tier: Basic Benefit

Government guarantee of poverty-levelincome

2007 Poverty Levels Single individuals $10,210 ($851/month)

Married couples $13,690 ($1,141/month)

Would replace SSI and redistribution

within the current SS system Pay for with general revenues


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Second Tier: Earnings-relatedBenefit

Individual accounts Hypothetical (cash balance) accounts

Invested by professionals

Pay for with reduced payroll taxes

Pay out lifetime annuities Inflation-adjusted annuities


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Earnings Sharing

Credit each spouse with one-half ofcouples combined earnings duringmarriage

At retirement, each spouses benefitwould be based on her half of thecouples earnings, plus her prior

earnings Would replace spousal benefits


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Conclusions

$4.7 Trillion Unfunded Liability

Oldest baby-boomers are 60

Social Security should provideadequate incomes throughoutretirement

Reform is needed


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Sources American Academy of Actuaries, Social Security Reform: Solutions Inside

the Box: Proposals Not Including Individual Accounts (2004), available athttp://www.actuary.org/pdf/socialsecurity/briefing_041604.pdf.

Jon Forman, Reforming Social Security, 76 (9) Oklahoma Bar Journal657-661 (March 12, 2005), available athttp://jay.law.ou.edu/faculty/jforman/SS-OBJ-2005.pdf.

National Academy of Social Insurance, Social Security Finances: A Primer(April 2005), available at http://www.nasi.org/usr_doc/Financing_Social_Security.ppt.

National Academy of Social Insurance, Options to Balance Social SecurityOver the Next 25 Years (Social Security Brief No. 18, February 2005),available at http://www.nasi.org/usr_doc/SS_Brief_18.pdf.

Social Security and Medicare Boards of Trustees, 2007 Annual Report of theBoard of Trustees of the Federal Old-Age and Survivors Insurance and

Disability Insurance Trust Funds (2007), available athttp://ssa.gov/OACT/TR/TR07/tr07.pdf.
http://www.actuary.org/pdf/socialsecurity/briefing_041604.pdfhttp://jay.law.ou.edu/faculty/jforman/SS-OBJ-2005.pdfhttp://www.nasi.org/usr_doc/Financing_Social_Security.ppthttp://www.nasi.org/usr_doc/Financing_Social_Security.ppthttp://www.nasi.org/usr_doc/SS_Brief_18.pdfhttp://ssa.gov/OACT/TR/TR07/tr07.pdfhttp://ssa.gov/OACT/TR/TR07/tr07.pdfhttp://www.nasi.org/usr_doc/SS_Brief_18.pdfhttp://www.nasi.org/usr_doc/Financing_Social_Security.ppthttp://www.nasi.org/usr_doc/Financing_Social_Security.ppthttp://jay.law.ou.edu/faculty/jforman/SS-OBJ-2005.pdfhttp://www.actuary.org/pdf/socialsecurity/briefing_041604.pdf


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About the Author Jonathan Barry Forman (Jon) is the Alfred P.

Murrah Professor of Law at the University of OklahomaCollege of Law, where he teaches courses on tax,pension, and elder law.

Professor Forman is also Vice Chair of the Board of

Trustees of the Oklahoma Public Employees RetirementSystem (OPERS) and the author ofMaking America Work(Washington, DC: Urban Institute Press, 2006).

Prior to entering academia, Professor Forman served inall three branches of the federal government. He has alaw degree from the University of Michigan, and he alsohas masters degrees in economics and psychology.

Jon can be reached [email protected] or (405) 325-4779. His web page iswww.law.ou.edu/faculty/forman.shtml.
mailto:[email protected]://www.law.ou.edu/faculty/forman.shtmlhttp://www.law.ou.edu/faculty/forman.shtmlmailto:[email protected]

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