Over the past weeks we’ve been working our way through some of the recommendations made by the Congressional Budget Office in its report "Reducing the Deficit: Spending and Revenue Options" that have to do with Social Security. It wasn’t that long ago that I wouldn’t have spent much time on anything to do with Social Security. Back then few federal employees had much interest in the subject. However, times change. Now the vast majority of federal employees are covered by FERS and are depending on a Social Security benefit to complement what they will receive in their annuity and through their investments in the Thrift Savings Plan.
This time I’m going to deal with the last three of CBOs recommendations
Lengthen by Three Years the Computation Period for Social Security Benefits
Currently, the Social Security Administration calculates your retirement benefit based on your average indexed monthly earnings (AIME) over a 35 year period, filling in the blanks with zeros if you have fewer than 35 years. CBO recommends increasing the time period to 38 years for those who turn 62 in 2014 or later. Lengthening the years included in the calculation would reduce outlays by about $7 billion through 2016 and roughly $51 billion through 2012.
This change would be to respond to the fact that people are living longer and would be more likely to remain in the workforce, thereby boosting federal revenues from income and payroll taxes. However, such a change "would have the largest effect on people who worked for fewer than 38 years, because they would have additional years with no earnings included in the calculation of their benefits. However, the option would reduce benefits even for workers who worked 38 years or more, because those people would almost always have had lower average earnings in the additional computational years than they would have had in the 35 years of their highest earnings."
Apply the Social Security Benefit Formula to Individual Years of Earnings
As noted above, Social Security benefits are based on a formula involving your AIME. Through a set of adjustments, SSA comes up with your primary insurance amount (PIA). To get to the amount you’ll receive each month, the following formula is used, with the dollar amounts being those in place in 2011:
90% of the first $680 of your AIME, plus
32% of your AIME between $680 and $4,100, plus
15% of your AIME above $4,100
As you can see, the formula is titled to replace a larger share of the average career earnings of low income workers that those with higher incomes.
CBO recommends that this progressive approach to benefit determination be continued but that the progressivity be applied to annual earnings rather than to lifetime earnings. If that were done, federal outlays would be reduced by about $15 billion over five years and nearly $89 billion through 2021.
The net effect would be that most workers’ PIAs would be lower; however, the reduction would be greater for people who came in and out of the workforce or whose income roller coasters. The change would have little or no effect on those with steady earnings.
As with the recommendation above, it’s expected that making this change would encourage some people to work longer, which would benefit federal revenues.
Increase the Maximum Taxable Earnings for the Social Security Payroll Tax
I’ll end this series on Social Security changes with one that has been the subject of more debate than the others, raising the maximum earnings limit on which you have to have to pay taxes. Despite all the "fixes" applied over the last few decades, the percentage of taxable earnings for the highest-paid workers has grown much faster than the average.
CBO proposes raising the maximum taxable amount from $106,800 in 2011 to $170,000 in 2012. After that the maximum would be indexed the way it is now. According to their calculation, this change would increase revenues by $182 billion from 2012 thought 2016 and $468 billion over the 2012-2021 period. An extra benefit would be that it "would enhance the long-term viability of the Social Security program, which, according to Congressional Budget Office projections, will not have sufficient income to finance the benefits that are due to beneficiaries under current law."
While this change would also make the payroll tax less regressive, on the down side, "raising the cap would weaken the link between the taxes that workers pay into the system and the benefits they receive (because the additional to benefits would be modest relative to the increase in taxes). That link has been an important aspect of Social Security since its inception."
For my last article in this series, I’ll talk about a CBO proposal to reduce across-the-board pay adjustments for federal civilian employees.