December 7, 2011

Social Security Reform Proposal From 2010 Gets Second Look

The Urban Institute looks back at a proposal from the NCFRR on ways to improve Social Security

Social Security checks being processed. (Photo: AP) Social Security checks being processed. (Photo: AP)

In December 2010, the National Commission on Fiscal Responsibility and Reform, a bipartisan committee created by President Barack Obama to identify policies to improve the fiscal situation in the medium term and develop sustainable financial practices in the long term, made recommendations to improve Social Security.

Following the supercommittee’s failure to make recommendations on how to reduce the deficit, the Urban Institute released on Monday a paper, “How Would the President’s Fiscal Commission’s Social Security Proposals Affect Future Beneficiaries?” analyzing the potential effects of the commission’s recommendations. The institute found that high-income seniors “several decades from now” could see their benefits reduced, but that seniors at the bottom of the lifetime earnings distribution would be “largely shielded” from significant reductions.

The proposal, put forth by Commission co-chairs former White House Chief of Staff Erskine Bowles and former Sen. Alan Simpson in November 2010, included recommendations to increase the amount of earnings subject to the Social Security payroll tax; modify the benefit formula to slow future benefit growth; replace the current CPI in cost-of-living-adjustments with the chained CPI; index the full retirement age as well as the early retirement age to life expectancy to maintain a fairly constantly ratio of working years to retired years; cover new state and local workers under Old-Age, Survivors, and Disability Insurance.

Of the 18 members on the commission, 11 voted in favor of the recommendations. However, 14 affirmative votes were needed to pass the report to Congress.

Authors Melissa Favreault and Nadia Karamcheva found that by 2070, the commission’s proposals would cut benefits to the top 20% of lifetime earners by one-quarter, compared with the bottom 20% who would lose 3% off their monthly checks.

If lawmakers wait until the Social Security Trust fund is exhausted, the authors write, “the required adjustments to OASDI benefits and/or payroll taxes would need to be considerable. Congress could avert these sorts of adjustments by starting to phase in provisions that would improve the program’s long-run financial status over the next two and a half decades.”

The report notes that there is a high degree of sensitivity in their analysis depending on which assumptions analysts use in their projections. As such, it’s important to focus on “relative differences across options, including counterfactuals like payable or feasible benefits, using consistent metrics, rather than focusing on any particular percentage or other value to summarize a complex set of interacting provisions like those in the NCFRR proposal.”

Actuaries claim the NCFRR’s proposal could close Social Security’s funding gap, the authors write, citing a 2010 letter to Erskine Bowles and Alan Simpson, chairmen of the NCFRR from Stephen Goss, chief actuary for the Social Security Administration. More than half of the shortfall would be compensated by reducing benefits. The remainder would be compensated by increasing the cap on what employees contribute to Social Security by 2% every year. In 2011, the cap was $106,800; under the commission’s proposal, by 2049, 90% of wages would be subject to the Social Security payroll tax, as was the case in 1982.

Currently, benefits are calculated by capping annual earnings at the taxable maximum, indexing them to the change in the national average wage, and dividing by 12 for the average indexed monthly earnings. The commission’s proposal adds two new bend points to leave workers with “lifetime earnings below the median essentially unharmed, while reducing benefit replacement rates for those above the median.” Rather than simply increasing retirement age, the commission’s proposal recommends indexing the early retirement age and the full retirement age, increasing both ages by one month every two years.

The Urban Institute notes, however, that longevity gains have been very “uneven,” benefiting better educated people in higher income communities more than their counterparts. The commission proposes a hardship exemption to apply increases in longevity more evenly.

“The proposed exemption would shield workers from the increase in the EEA and FRA if they have at least 25 years of work before age 62 and have AIMEs below 250 percent of the aged federal poverty level (FPL). The proposed exemption would phase out for workers with AIMEs between 250 and 400 percent of the poverty threshold,” it said.

Adopt an alternative measure of CPI, effective in 2012

Under the current Social Security benefit formula, most parameters are indexed to wages and updated annually, the authors write. Social Security benefits increase each year with inflation, they add, but the commission’s proposal recommends using the chained CPI for all urban workers (C-CPI-U) instead of the standard CPI for urban wage earners and clerical workers (CPI-W) that the formula currently uses. Urban Institute points to a Bureau of Labor Statistics assessment that found the chained CPI “better approximates true changes in the cost of living.”

The paper found that some states, including California, Colorado, Louisiana, Massachusetts, Nevada, Ohio and Texas, maintain separate retirement accounts for their employees rather than relying on Social Security. The Urban Institute points out that pension plans aren’t exactly in good shape either. To reduce the risk of a bailout for state pension plans, the commission recommends mandating coverage for new workers after 2020.

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