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Analysis of the Fiscal Commission Chairmen's Report (Bowles-Simpson)

On December 1, 2010, the Chairmen of the National Commission on Fiscal Responsibility and Reform, Erskine Bowles and Senator Alan Simpson, released a report containing a set of recommendations for addressing the nation’s fiscal crisis.  Their proposed changes to Social Security are especially troublesome, as they represent a completely unbalanced approach to changing Social Security.  An overwhelming majority of the adjustments to the program come in the form of benefit cuts which will hurt generations of Americans, something repeated polls have shown the American people do not support.

The following outlines the changes and their impact on beneficiaries.

A Payroll Tax Holiday in 2011

Current Law:  The Social Security program is entirely financed by dedicated taxes, principally those deducted from workers’ earnings, which are matched by employers with an equal amount, and with the self-employed paying comparable amounts.  These taxes are paid periodically by employers and the self-employed into the Treasury of the United States.  These funds are then transferred from the general fund of the Treasury into the Old-Age, Survivors and Disability Insurance Trust Funds, where they remain available for the purpose of paying the costs of the Social Security program.  The primary costs are payment of benefits and the cost of administering the program.

The Board of Trustees of the OASDI Trust Funds report annually on the financial condition of the Social Security program.  In the report for 2010, the Trustees estimate that in 2011 the total revenue income to the OASDI Trust Funds, exclusive of interest, will equal about $732 billion.  About $707 billion derive from payroll taxes and the rest comes from income taxes collected on benefits paid to Social Security beneficiaries.  The total cost of the program in 2011, including payment of benefits and administrative costs, is estimated to be $729.6 billion.  Interest income to the Trust Funds for 2011 is estimated to be $118 billion.

Proposed Change:  Quoting from the Bowles-Simpson report, the proposal is as follows:  “Consider a tax holiday in FY 2011.  In order to spur short-term economic growth, the Domenici-Rivlin Bipartisan Policy Center Commission recommended a temporary payroll tax holiday in 2011.  Assuming it is accompanied by sufficient future deficit reduction, Congress should consider a temporary suspension of one side of the Social Security payroll tax, financed by transfers from general revenue.  Though this would cost $50-100 billion in lost revenue (depending on the design), CBO estimates that a payroll tax holiday of this magnitude would result in significant short term economic growth and job creation.” 

Impact:  Although there would be no effect on the program’s financing or its ability during 2011 to pay benefits or to meet the program’s administrative expenses, assuming timely transfers from the general fund, the proposal raises an important concern.

Throughout its history, the Social Security program has been funded through a dedicated payroll tax, an arrangement that has worked well over the years.  Depending on the magnitude of the tax holiday, shifting even a portion of Social Security’s funding away from its payroll tax and onto the general fund of the Treasury is a source of concern, even if done under the banner of economic development.  It should be noted, too, that the proposal does not specify whether only employers or workers benefit from the tax holiday.

Change in the Cost-of-Living Adjustment

Current Law:  The Social Security Act provides for an automatic increase in Social Security benefits each year if the Consumer Price Index for Urban Wage Earners and Clerical Workers (known as the CPI-W) increases.  This Cost-of-Living Adjustment (or COLA) is calculated by comparing costs from the third quarter of the last year to the third quarter of the current year.  The purpose of this adjustment is to protect beneficiaries from the effects of rising prices due to inflation, enabling them to maintain a constant standard of living from one year to the next.

Some analysts believe the CPI–W overstates increases in costs because it relies on a standard “market basket” of goods and services to measure average consumer spending and does not fully account for adjustments to spending patterns as prices increase.  For example, if the price of apples increases while the price of bananas remains constant, and consumers respond by buying fewer apples and more bananas, some economists argue the index does not fully account for the effects of the substitution. 

Other analysts believe that the CPI-W may understate the growth in the cost of living for some groups, such as the elderly, because the elderly spend a higher percentage of their income on health care.  In 1982, the Bureau of Labor Statistics created an experimental index to determine whether the difference in spending patterns by the elderly would impact the calculation of their COLA.  This CPI-E attempts to quantify the purchasing pattern of Americans 62 years of age and older.  Since 1982 annual inflation as measured by the CPI-E has been 0.3 percentage points higher than inflation as measured by the CPI-W.  Using this index to calculate COLAs would result in significant increases in Social Security benefits over time, as the impact compounds each year.  A challenge utilizing this index presents is the difficulty in accounting for changes in the quality of health care.  Consequently, more uncertainty exists about measures of price growth for health care than for other good and services.  
 
Proposed Change:  The Bowles-Sim,pson plan proposes to use a chained consumer price index (chained-CPI) to calculate all COLAs starting December 2011.  The chained-CPI attempts to fully account for the effects of economic substitution on changes in the cost of living.  The chained-CPI produces lower estimates of inflation than the traditional CPI does, averaging about 0.3 percentage points lower than the increases in the CPI-W since December 2000, the first year such comparisons became possible.
 
The loss of purchasing power stemming from this provision becomes increasingly severe as beneficiaries age.  Possibly in an effort to compensate for the impact of these reductions on older retirees who are more likely to rely on Social Security as their primary source of income, the Fiscal Commission proposes to provide a benefit boost to older retirees most at risk of outliving other retirement resources.  The proposal would increase a retiree’s benefit by 5 percent beginning 20 years after eligibility and would be phased in over five years starting in 2011.

Impact:  The Bowles-Simpson plan estimates that implementation of this proposal will address 26 percent of the shortfall in actuarial balance for the program.  This proposal will affect current and future beneficiaries uniformly.  The impact would occur after benefits are initiated, with each COLA, as the yearly increase in benefits would be slightly lower than would have been the case without the change.  The impact would be greater with each successive COLA.  For example, the Social Security benefits paid to someone collecting benefits for 10 years would be about 3 percent lower, on average, if the chained-CPI was used for the COLA instead of the current CPI-W.  After 20 years the reduction would reach 6 percent from the change in the formula alone.  Making matters worse, there would be an additional reduction based on the compounding effect of time.

In addition to the impact on beneficiaries, a technical drawback of using the chained CPI-U is that it is subject to two revisions after the initial release.  The CPI-W is not revised, thus making it more suitable for automatic adjustments.  The chained CPI-U does not become final until two years after its initial release.  Obviously there are technical implications with using an initial number that could be revised two years later, or waiting two years for a final number before applying a COLA.

The proposal to ameliorate the harshest impact of the COLA change by increasing benefits 5 percent after 20 years of eligibility would increase the actuarial shortfall by 8 percent.  It would apply uniformly to all beneficiaries who collect benefits for at least 20 years.  This would partially compensate for the 6 percent loss of benefits resulting from implementation of the chained–CPI. 

Increase the Retirement Age

Current Law:  The normal retirement age (NRA), which is the age at which a person can apply for Social Security benefits without any reduction, currently stands at age 66.  It is scheduled to remain steady until 2016, when it will begin rising at the rate of two months per year until it reaches age 67 in 2022 and subsequent years.  No additional increases in the NRA are scheduled.

Workers can apply for benefits as early as age 62, although they incur a reduction for electing early retirement.  Currently, the amount of this reduction is 25 percent.  The reduction will rise to 30 percent for those workers whose NRA will be 67.  Workers who qualify for disability prior to NRA avoid part or all of the reduction for early retirement, depending on the age at which they become disabled.

Proposed Change:  Under this proposal the NRA would continue to rise after reaching age 67 in 2022 based on continuing increases in longevity.  According to the description in the Commission’s report, the NRA would rise gradually until it reached 68 in about 2050 and 69 in about 2075.  The rate of increase, according to the memorandum prepared by the Office of the Social Security Actuary, would be 1 month every two years.  Whether there would be periods during which the NRA would remain constant or whether the rise would be continuous is not entirely clear.

In addition, the provision would gradually increase the early eligibility age (EEA) so that there would be no more than 5 years between the EEA and the NRA.  For example, when the NRA begins its proposed increase to age 68 and then to 69, the EEA would increase in tandem with it so that no more than 5 years would lie between them.  Thus, by 2050 the EEA would be 63 and by 2075 the EEA would be 64.  As a result, the reduction for early retirement would remain constant at 30 percent.

To counter the impact of increasing retirement ages on workers in physically demanding jobs, the proposal includes an attempt to provide some relief.  The proposal is not described in any detail, nor has it been evaluated by the chief actuary.  However, the concept is that the Social Security Administration would be required to develop some form of accommodation in the form of a “hardship waiver” for these workers before the longevity indexation begins, which appears to be scheduled to occur sometime after 2022.  The exemption would be limited to no more than 20 percent of retirees.  In addition, the SSA would be required to “set aside funds to pay for the new policy.”    

The SSA is already stressed by an unprecedented number of disability claims – projected to reach 1 million initial claims at the state level by the end of this year, with appeals of denied claims taking over 400 days to process.  It is unclear how the new “hardship waiver” would interact with the existing disability process, or how it might be designed to avoid the extreme delays and costs associated with the disability program. 

Impact:  Increasing the retirement age is first and foremost a cut in benefits.  The estimates prepared by the chief actuary reveal that gradually over time all workers would have their benefits reduced significantly.  By 2080 the reduction would be about 15 percent.

The increases called for in this proposal rest on the premise that, because people are living longer, they can therefore continue working for more years.  Although it is true that people, on average, are living longer, these longer life expectancies are by no means across-the board.   Over the last quarter-century, the life expectancy of lower-income men increased by one year compared to 5 years for upper-income men.  This is not surprising considering higher income workers are less likely to have physically demanding jobs and more likely to work in jobs with high-quality health coverage.  Lower-income women have actually experienced a decline in longevity during that period.  Yet the increases in retirement age apply to all workers, whether or not they are living longer. 

In addition, increasing the retirement age would have a severe impact on workers who are not healthy enough to continue to work, even though they would prefer to do so, especially those who have physically demanding jobs.  The Commission’s proposals provide scant comfort for such workers.  By moving the early eligibility age up to 64, older workers would have no choice but to continue to try to work, unless they were able to qualify for disability benefits. 

In acknowledgement of the detrimental impact of their proposals, the Commission offers up an alternative to disability that they want the Social Security Administration to develop.  But it is not funded and is not described in any meaningful detail.   In addition, it is limited to no more than 20 percent of retirees.  Capping a provision such as this would mean that some otherwise-eligible seniors would fail to find relief under this provision.  In addition to being unfair, it would be extremely difficult for the Social Security Administration to administer. 

Finally, while many older workers may be healthy enough to work, jobs for them may simply not exist.  Although studies have shown the many contributions older workers bring to their employers, most companies remain focused on the bottom line, which, due to higher health care costs, translates into a competitive disadvantage for older workers.  Unless there is a dramatic change in employer attitudes or in the structure of our workforce, most workers will continue to retire well below their full retirement age.  The Co-Chairs’ proposals to increase the retirement age will only add to the difficulties older Americans will face in the years to come.

Effect on Workers:  Although the Bowles-Simpson plan to index the retirement age to longevity plays out over many decades, the analysis by the SSA actuaries is consistent and clear.  Future retirees will face benefit reductions that grow larger with each generation.  By 2080, this proposal, by itself, will result in an across-the-board 15 percent cut in benefits for all Americans.   This provision addresses about 21 percent of the current shortfall in the program. 

Changes to the Benefit Formula

Current Law:  Under current law, an individual’s unreduced Social Security benefit, called the primary insurance amount, or PIA, is based on that individual’s lifetime earnings in covered work.  The first step in calculating the PIA is to identify the 35 years of highest nominal earnings.  These earnings are then indexed for growth in wages.  The indexed wages for each year are then added together and converted to average indexed monthly earnings, or AIME. 

A benefit formula is then used to convert the AIME into a PIA.  Thus, under the current formula, the PIA is the total of 90 percent of the first $761 of AIME plus 32 percent of AIME over 761 through $4,586 plus 15 percent of AIME over $4,586.  The percentages in the formula have been constant since 1977.  The dollar “bend points” change annually, as they are indexed by growth in wages.

The progressivity of the Social Security benefit derives from the fact that the formula replaces a much higher percentage of the pre-retirement wages of lower-income earners than it does for higher earners.  At the same time, the formula assures that higher earners receive benefits that are commensurate with their greater contribution to the program.

Under current law, Social Security contributions and benefits are based on earnings that fall below an annual cap, which currently is $106,800.  In the past, the tax cap has been set at a level that covered about 90 percent of all covered earnings.  Currently, however, less than 86 percent of earnings are subject to the Social Security payroll tax.  This erosion in covered earnings stems from the fact that wages for the highest paid six percent of workers have been rising faster than wages for the vast majority of people who earn less than the cap.

Proposed Change:  Although the details of this proposal are not clearly delineated, it appears to alter the bend points in the formula in a manner that yields an across-the-board reduction in benefits for virtually all beneficiaries.  Bowles-Simpson, in its presentation, says that it will, "Gradually move to a more progressive benefit formula by creating a new bend point at the 50th percentile and reducing upper replacing factors slowly over time, phased in by 2050."

In his estimate, SSA's chief actuary describes the provision as creating a new bend point at the 50th percentile career-average earnings level, [and] and reducing PIA factors (bend points) to 90/30/10/5 by 2050.  The provision would affect individuals becoming eligible for Social Security beginning in 2017.   

The Bowles-Simpson plan also proposes to increase the amount of wages subject to Social Security taxation so that 90 percent of all wages are taxed.  This proposal would also create a new 5-percent bend point in the benefit formula that would be applicable to the wages covered by the higher tax cap. 

Impact:  As stated earlier, the result of this change, by itself, is a reduction in benefits for all future beneficiaries.  Starting in 2030, a worker earning approximately $43,000 per year would experience a benefit reduction of almost 5 percent.  As the proposal is fully phased in, the resulting reductions, still modest for the lowest paid workers, grow.  By 2080, a worker earning approximately $69,000 in 2010 would witness a reduction of almost 23 percent, while a relative high earner, someone earning the taxable maximum of $106,800, would be reduced by 30 percent.

This proposal is a benefit reduction pure and simple.  It does nothing to enhance the progressivity of the Social Security program.  All workers will see their benefits reduced.  There is not a single group of workers who will see a benefit from this change.

As a companion to this change in formula, Bowles-Simpson also proposes increasing the taxable maximum so that it once more covers 90 percent of all covered wages.  (description below).  This is an important step in strengthening the financial basis of the Security program, and would reduce the program’s long-term deficit by nearly one-third.

Index the Taxable Maximum to 90 Percent of Wages

Current Law:  In 2009, earnings up to $106,800 are taxed and counted toward worker’s future Social Security benefits.  About 6 percent of all workers earn more than the cap.  The cap is indexed to keep pace with the growth in average earnings of all workers.  In the past, Congress set the level of the cap to cover 90 percent of the aggregate wages of all workers.  In 2009, the taxable maximum captured less than 86 percent of earnings, and is expected to fall to 82.5 percent by the end of the decade.  The decline has occurred because those at the top of the economic ladder, who make more than the cap, have experienced more rapid growth in earnings than those who make less than the cap.

Proposed Change:  The Bowles-Simpson plan proposes gradually increasing the taxable maximum to capture 90 percent of wages by 2050.  They argue phasing in a higher taxable maximum slowly will prevent large marginal changes and will prevent rapid buildup of the trust fund.  The proposal does not indicate the level of yearly increase the Commission contemplates. 

Impact:  The Bowles-Simpson plan estimates this revenue increase will reduce the program’s funding shortfall by 35 percent.  For the 94 percent of workers with earnings below the cap, there will be no change.  The 6 percent of workers affected by this proposal would see their FICA taxes increase, meaning deductions would continue for a few days longer into the year.  They would receive somewhat higher benefits as a result of their increased contributions, although Bowles-Simpson proposes subjecting all earnings above the current-law maximum to a new 5 percent bend point.  Together, these proposals address about 35 percent of the program’s current shortfall. 

Increase the Amount of the Special Minimum PIA

Current Law:  The special minimum benefit applies to workers who have been employed many years at low earnings. This computation method is only used if it results in a higher payment than the benefit computed by any other method. The Primary Insurance Amount for a worker with 30 years of coverage as of December 2008 is $763.20. 

Proposed Change: The Bowles-Simpson plan recommends adding a new special minimum benefit to keep full-career minimum wage workers above the poverty threshold by wage-indexing the minimum benefit. This benefit would be increased at implementation by setting the benefit level for 30 years of coverage at 125 percent of the poverty level (about $1,128 in 2009).  From 2009 to 2017, the poverty level would be indexed by the chain-CPI.  Thereafter, the benefit amount would be indexed for wage growth, so that the special minimum would keep up with the wage-indexed benefit formula.  This provision would take full effect for all newly eligible workers in 2017.

Impact:  The Bowles-Simpson plan estimates that implementation of this proposal will add 4 percent to the actuarial shortfall for the program.  Very low wage earners (those earning $10,771 in 2010) would benefit, with an increase of about 36 percent for workers attaining age 65 from 2010 through 2080.  Low wage earners (those earning around $19,388 in 2010) would see more modest increases, ranging from a 3.9 percent increase for those turning 65 in 2010 to a 5.7 increase for those turning 65 in 2080.  Medium, high and maximum earners (everyone earning above $43,084) would see no benefit from this provision.
 
Mandatory Coverage of State and Local Employees

Current Law:  Not all state and local government employees are currently covered by Social Security.  Approximately 25 percent of State and local government employees are covered by alternative pension systems and are not provided Social Security coverage. States with more than half their employees not covered by Social Security include Ohio, Massachusetts, Louisiana, Nevada, Colorado, California, Alaska and Maine.

Proposed Change:  The Bowles-Simpson plan recommends including newly hired state and local workers in Social Security after 2020.  This would achieve more universal coverage under Social Security, requiring workers to pay FICA taxes, making them eligible to receive benefits.

Impact:  The Bowles-Simpson plan estimates this proposal would reduce the current funding shortfall by 8 percent.  The change will impact the funding of state and local government pension systems.  State and local governments will need to modify their pension systems to fit with the Social Security program.  This was done for newly-hired federal employees after 1983.  The increase in revenue occurs because the newly-hired workers and employers start to pay into Social Security immediately, but will not claim benefits until later in the future.  However, the revenue increase is temporary as the newly covered workers will ultimately collect the benefits their contributions entitle them to receive.

Increased Flexibility in Applying for Benefits

Current Law:  The normal retirement age (NRA) is 66 and is scheduled to increase two months per year, beginning in 2016, until it reaches age 67 in 2022.  The earliest a worker can apply for benefits is age 62.  The current reduction for taking early benefits at age 62 is 25 percent.  This will increase to 30 percent when the NRA reaches age 67.

Proposed Change:  The Bowles-Simpson plan proposes offering retirees the choice of collecting half of their benefits early and the other half at a later age to minimize the impact of the actuarial reduction and support phased retirement options.  The proposal does not offer any information regarding when this option would become available or at what point the second half of the benefit could be collected.

Impact:  Without more specifics, it is difficult to determine the impact on solvency of the program.  Presumably it would be designed to have no impact.  While this proposal may offer an option for workers in good health who have control over their work environment and retirement date, it offers little assistance to older workers who lose their jobs or are physically unable to handle the demands of strenuous work.

 

Government Relations & Policy, November 2011



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