SOCIAL SECURITY: How It Works and How to Fix It Jonathan Barry Forman (“Jon”) Alfred P. Murrah Professor of Law September 2007

2 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

3 How Many People Get Social Security?  47.7 million people receive Social Security each month  1 in 6 Americans get Social Security benefits  Nearly 1 in 4 households get income from Social Security National Academy of Social Insurance, Social Security Finances: A Primer (2005)

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

5 How Much Does Social Security Pay? Type of BeneficiaryAverage Monthly Benefit 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

6 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

7 Financing Social Security  Workers and their employers pay with Social 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 and 2.9% for HI  Social Security tax base is $97,500 in 2007

8 Worker Benefits  Workers over 62 are eligible If they have worked 10 years  Benefits are based on a workers earnings history Career-average earnings Average Indexed Monthly Earnings (AIME)

9  Determine how much the worker earned every 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

10 Average Indexed Monthly Earnings (AIME), continued  Add those highest 35 years of earnings 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

11 Full Retirement Age Year of BirthFull Retirement Age 1937 or earlier plus 2 months per year 1942 – plus 2 months per year 1960 and later67

12 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 (if any) + 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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14 How do benefits compare to earnings? Retired worker age 65, 2005

15 Worker Benefits: Increases and Decreases  Indexed for inflation  Actuarial decrease for early retirement Example: average-wage worker, 62 in 2006 Will get $1, per month at her full retirement 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 for each $2 of earnings over $12,960

16 How many people rely on Social Security for most of their income?  90% of people 65 and older get Social Security  Nearly 2 in 3 (66%) get half or more of their income from Social Security  About 1 in 5 (22%) get all their income from Social Security National Academy of Social Insurance, Social Security Finances: A Primer (2005)

17 Most elderly don’t receive pensions Percent with Employer-Sponsored Pensions All age 65+41% Couples51% Unmarried men39% Unmarried women32% National Academy of Social Insurance, Social Security Finances: A Primer (2005)

18 Family Benefits  Spouses, dependents, and survivors  Husband or wife gets 50% of worker’s PIA Together, couple gets 150%  Widow or widower gets 100% of worker’s PIA  A joint and two-thirds annuity  Dual entitlement rule limits benefits

19 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 interest that goes to the trust funds. Social Security Administration 2007 Trustees’ Report

20 How do actuaries estimate the future?  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) National Academy of Social Insurance, Social Security Finances: A Primer (2005)

21 Social Security Administration, 2007 Trustees’ Report

22 The Long-Range Forecast (Best estimate)  In 2017, tax revenues into the trust funds forecasted to be less than benefits due that year. Interest on the reserves and the assets themselves will help pay for benefits until  In 2041, reserves are projected to be depleted. Income is forecast to cover 75% of benefits due then.  By 2081, assuming no change in taxes, benefits or forecasts, revenue would cover 70% of benefits due then.

23 Social Security’s 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)

24 Why is the deficit so much smaller as a share of GDP?  The answer is because Social Security taxable wages are only a relatively small 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 Social Security. National Academy of Social Insurance, Social Security Finances: A Primer (2005)

25 What is that non-taxable income?  Income not subject to Social Security taxes 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. National Academy of Social Insurance, Social Security Finances: A Primer (2005)

26 Only 3 Ways to Fix Social Security  Raise Taxes  Cut Benefits  Increase Investment Returns Private investment Either government or individual

27 Options: Raise Taxes OPTION  Increase tax rate by 2% 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 of Actuaries (2004).

28 Options: Cut Benefits OPTION  Raise retirement age (to 67 faster & index)  Reduce COLA by ½% each year  Cut benefits by 5% for those starting to get benefits in 2005  Increase # years in wage avg. to 40 % of Deficit Eliminated 28% 41% 32% 21% National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of Actuaries (2004).

29 Options: Increase Investment Returns OPTION  Investments in equities % of Deficit Eliminated 36% - 50% National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of Actuaries (2004).

30 Long-term Reform  Social Security should ensure that every elderly American has an adequate retirement income  We could redesign the system  Two-tier system First tier: poverty-level benefit Second tier: earnings-related benefit Earnings sharing

31 First Tier: Basic Benefit  Government guarantee of poverty-level income  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

32 Second Tier: Earnings-related Benefit  Individual accounts Hypothetical (“cash balance”) accounts Invested by professionals  Pay for with reduced payroll taxes  Pay out lifetime annuities Inflation-adjusted annuities

33 Earnings Sharing  Credit each spouse with one-half of couple’s combined earnings during marriage  At retirement, each spouse’s benefit would be based on her half of the couple’s earnings, plus her prior earnings  Would replace spousal benefits

34 Conclusions  $4.7 Trillion Unfunded Liability  Oldest baby-boomers are 60  Social Security should provide adequate incomes throughout retirement  Reform is needed

35 Sources  American Academy of Actuaries, Social Security Reform: Solutions Inside the Box: Proposals Not Including Individual Accounts (2004), available at  Jon Forman, Reforming Social Security, 76 (9) Oklahoma Bar Journal (March 12, 2005), available at  National Academy of Social Insurance, Social Security Finances: A Primer (April 2005), available at  National Academy of Social Insurance, Options to Balance Social Security Over the Next 25 Years (Social Security Brief No. 18, February 2005), available at  Social Security and Medicare Boards of Trustees, 2007 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (2007), available at

36 About the Author  Jonathan Barry Forman (“Jon”) is the Alfred P. Murrah Professor of Law at the University of Oklahoma College 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 Retirement System (OPERS) and the author of Making America Work (Washington, DC: Urban Institute Press, 2006).  Prior to entering academia, Professor Forman served in all three branches of the federal government. He has a law degree from the University of Michigan, and he also has master’s degrees in economics and psychology.  Jon can be reached at or (405) His web page is