1. 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)

2. 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

3. Old-Age Eligibility Must work at least 10 years While working, pay 6.2% (12.4%) payroll tax on earnings up to taxable maximum $97,500 in 2007 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 1960+ Age at claim (Claim at EEA of 62 = 30% reduction; Claim at 70 with DRC = 24% increase)

4. Primary Insurance Amount

5. Old-Age Benefits Retired Workers 31 million beneficiaries in 2006 Average annual benefit was $12,000 in 2005 Auxiliary Beneficiaries Spouses: 2.5 million Survivors: 4.5 million Children: 2.4 million Also mother/father or parents

6. 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 $6,000 in 2005 For two-earner household, spouse with lower earnings could receive no additional benefit even though paid 12.4% of every dollar

7. 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 $11,600 in 2005 Survivor in retired household faces up to 1/3 benefit reduction at death of spouse

8. 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) 6.8 million beneficiaries in 2006 with average annual benefit of $11,700 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)

9. Iowa’s Aging Population

10. Population Pyramid or Tower?

11. 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

12. Taxation of Social Security “Contributions” taxed as income Benefits initially non-taxable Federal: 1983 up to 50%, money to OASDI Trust Fund Income above $32,000/$25,000 1993 up to 85%, money to Medicare Iowa: Followed Federal 1983 rules 2006 tax change - benefits non-taxable by 2014

13. 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?

14. 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) Competition from CBO in 2004 Long-run (100 years)

15. 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

16. 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)

17. 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

18. 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)

19. 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

20. 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)

21. Ten Key Assumptions Four 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

22. Nine 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

23. SSA Projections Intermediate assumptions “Best guess” Uncertainty about 75 years into the future - Range on assumptions Low-cost High-cost Problems with scenario analysis

24. CBO Projections Stochastic projections (500 runs) Median Uncertainty about 100 years into the future - Range on outcomes 90 th percentile 10 th percentile

25. 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 -1.95 CBO projects range -3.9 to -1.1 CBO focuses on measures as a share of GDP and annual flows

26. Income and Cost Rates Income Rate/Revenues Payroll taxes as percent of GDP 2007: 4.9 2105: 4.3-5.4 Cost Rate/Outlays Benefits as percent of GDP 2007: 4.2 2105: 5.5-10.1

27. CBO Projected Outlays and Revenues 1985-2105

28. 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 2040 CBO projects between 2035 to 2075

29. CBO Projected Trust Fund Ratio, 1985-2105

30. 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

31. 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

32. 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

33. Required Tax Rate Increases

34. 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

35. Required Benefit Cuts

36. 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

37. 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”

38. 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

39. Commission to Strengthen Social Security – Dec 2001 President’s principles Preserve benefits for retirees and near retirees Social Security surplus only for Social Security No change in payroll tax No government investment in stock market Preserve Disability and Survivor benefits Allow individual voluntary private accounts

40. Details of CSSS IA’s 2% “carve-out” as opposed to “add-on” Required to invest in diversified funds At retirement, required to buy annuity Guaranteed annual payout Social Security benefit reduced – function of diverted taxes

41. 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

42. 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 Personal saving Economics informs us - solution is political

43. Even Bigger Mess: Medicare Efforts for Social Security reform ended with 2006 election CBO shifted focus to Medicare Much bigger financial problem Part of health care “crisis” in America Same concerns about aging with little control on benefit costs Last action expanded the program!

44. 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

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

46. 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

47. 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 $93.50-162.10 (2007) each month, Part D varies by plan - deducted from Social Security checks Also co-pays and deductibles

48. Medicare in financial trouble Dramatic growth in the program 1980: $37 Billion 2006: $380 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

49. Excess Cost Growth Growth in spending per beneficiary that exceeds growth in per capita GDP 3.0 percent over 1970-2005 2.1 percent over 1990-2005 Captures both policy changes and “residual” growth Assumption going forward dramatically alters projections of program growth

50. Medicare Spending as Share of GDP: Excess Cost Growth??

51. …so Federal budget in trouble HI Trust Fund, currently in surplus, is projected to be exhausted in 2019 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

52. Your future retirement? Health care diminishing as private retirement benefit Reliance on Medicare also uncertain Economics informs us – solution is political