The Social Security Windfall
Elimination Provision
Prof. Jeffrey Brown, UIUC
SUAA State Meeting
October 10, 2007
First, a Disclaimer …
The views I am presenting here today
are my personal views, and do not
necessarily reflect any official position
of the Social Security Advisory Board or
the Social Security Administration
Overview
1. The WEP / GPO exist for valid reasons
2. Legislative efforts to repeal the
WEP/GPO are likely to fail and may
have unintended consequences
3. Perhaps efforts better focused on a)
educating participants and b)
changing the method for calculating
these provisions
Why Does the WEP Exist?
Historically, government employees were not covered
under SS due to concerns about federal taxes on state
governments – this changed in 1983
California, Colorado, Illinois, Louisiana, Massachusetts,
Ohio and Texas are only states not under SS
WEP established in 1983 to “remove an unintended
advantage that the weighting in the regular Social
Security benefit formula would otherwise provide for
persons who have substantial pensions from noncovered employment.”
– Testimony of Robert M. Wilson, Deputy Commissioner
for Legislation and Congressional Affairs, Social Security Administration, Hearing
before the Subcommittee on Social Security Committee on Ways and Means, May 1,
2003
Let’s Get Technical for a Moment
The core concept of a Social Security
benefit is something called the “Primary
Insurance Amount,” or PIA
Normally, if one retires at the normal
retirement age, one’s benefit is equal to
the PIA
The PIA is a non-linear function of one’s
lifetime earnings
Calculating Benefits: Step 1
Take each year of annual earnings, and
index them to average wage growth
Take average of the 35 highest years of
indexed earnings, and divide by 12 to get:
“Average Indexed Monthly Earnings”
A rough measure of where one falls in the
lifetime earnings distribution (Rich or Poor?)
Calculating Benefits: Step 2
Run AIME (average indexed monthly
earnings) through a non-linear benefit
formula to compute the Primary
Insurance Amount (PIA)
Here is what the formula looks like for
2007 …
PIA
The Benefit (PIA) Formula (2007)
$1706
.15
2nd bendpoint
.32
$612
1st bendpoint
.9
$680
$4,100
AIME
Why the Complicated Formula?
Idea is simple: to make the Social
Security benefit formula more progressive
To provide a higher income “replacement
rate” for lower income individuals
To provide higher benefit relative to lifetime
earnings for lower income individuals
What About SURS Participants?
Income from SURS-covered employment is
not covered under Social Security
No taxes paid on this income
No benefits received from this income
Many SURS participants, however, also have
part of their lifetime income from sources that
are covered by Social Security
Former, subsequent, or second jobs
Consulting income
What is the Problem?
If one simply uses Social Security covered
earnings, and ignores SURS income, then it
provides an incorrect picture of one’s true
lifetime earnings
Ex: If only 10% of lifetime income is covered
under SS, one would look like a “lifetime
poor,” when in fact they are not
The result of blindly applying the formula is
that SURS employees would get too high a
return on their contributions
Example if No WEP Existed
Average Indexed Monthly
Earnings
SS
SURS
Total
Larry
Mo
Curly
Benefit Benefit
if use
to
SS only Earnings
500
0
500
450
90%
5,000
0
5,000
1,841
37%
500
4,500
5,000
450
90%
Example if No WEP Existed
Average Indexed Monthly
Earnings
SS
SURS
Total
Larry
Mo
Curly
Benefit Benefit
if use
to
SS only Earnings
500
0
500
450
90%
5,000
0
5,000
1,841
37%
500
4,500
5,000
450
90%
Example if No WEP Existed
Average Indexed Monthly
Earnings
SS
SURS
Total
Larry
Mo
Curly
Benefit Benefit
if use
to
SS only Earnings
500
0
500
450
90%
5,000
0
5,000
1,841
37%
500
4,500
5,000
450
90%
Example if No WEP Existed
Average Indexed Monthly
Earnings
SS
SURS
Total
Larry
Mo
Curly
Benefit Benefit
if use
to
SS only Earnings
500
0
500
450
90%
5,000
0
5,000
1,841
37%
500
4,500
5,000
450
90%
What Does the WEP Do?
Reduces first factor in the formula from
90% to 40%
Reduces benefits by a maximum of $340
per month for 2007 cohort
For each year over 20 years that one has
“substantial” earnings under SS, this factor
increases by 5 percentage points
At 30 years of substantial earnings, the
offset disappears
Benefits under WEP (<20 years)
PIA
$1706
.15
$612
.32
.9
$272
.4
$680
$4,100
AIME
Example with WEP Existed
Average Indexed Monthly
Earnings
SS
SURS
Total
Larry
Mo
Curly
Benefit
Benefit
to
Earnings
500
0
500
450
90%
5,000
0
5,000
1,841
37%
500
4,500
5,000
200
40%
The Bottom Line
The WEP exists for reasons of fairness,
i.e., to avoid treating medium / high
income state and local workers as if
they were low income workers
The need for it arises from the nonlinearity of the benefit formula
If formula provided flat replacement rate
for all earnings, no adjustment would be
needed
Government Pension Offset (GPO)
The GPO affects government retirees who are eligible
for two retirement benefits:
A pension based on their own work in a Federal, State, or
local government job that was not covered by Social
Security, and
A Social Security spouse's or surviving spouse's benefit
based on their husband's or wife's work in covered
employment.
If the GPO applies, the person's Social Security
spouse's or surviving spouse's benefit is reduced
Reduction = two-thirds of the amount of the person's
government pension based on work not covered by Social
Security.
Intent of GPO
Spousal benefits intended for nonworking and/or low earning spouses
GPO provision removes the possibility
that an individual with a large public
sector pension could also get the
spousal benefit
Why WEP/GPO Won’t be Repealed
1. The White House, Treasury, Social Security
Administration, and the relevant House and
Senate committee staffs know and
understand the reason it exists
2. The CBO, GAO and SSA Actuaries
understand the reason it exists
3. It is expensive to repeal
Roughly $5 billion annually
$60+ billion over 10 year budget window
Makes 75-year solvency problem worse
Brings date of cash flow problem forward 1 year
Unintended Consequences
It may make it more likely that the problem is
addressed by folding state and local workers
into Social Security
Many argue that this would be “fair”
The low “rate of return” to SS arises in large part
from having to pay off the implicit debt to past
generations of recipients
State / local workers currently escape this burden
SURS participants would be worse off if
forced to participate in Social Security
Where to Focus from Here?
While some form of WEP has a good reason
to exist, the current adjustment is ad hoc
While it may be roughly correct on average, it
is not right for every individual
Perhaps SUAA could focus on getting the
calculation changed in a manner that might
increase fairness across SURS employees
Currently, low income SURS employee gets same
offset as high income SURS employee (if # years
outside of SURS the same)
How Change the WEP: One Idea
Since 1977, SSA has kept track of both covered and
uncovered earnings
One could compute the PIA based on total (SS +
SURS) earnings
Then calculate what fraction of total lifetime earnings
were under SS
Give the person that fraction of the revised PIA
In other words, if half your earnings were under SS,
you get half the benefit
This approach would:
Reduce inequity
Be much simpler to explain
In the Meantime: Framing
Now: “Your benefit is $1200. But
because you were under SURS, your
benefit is reduced by $300 to reduce
your windfall.”
Alternative: “Your benefit is $900.”
Summary
It is perfectly understandable why SURS
annuitants are angry with WEP/GPO
The provisions are not explained well
The annual SS benefit statements do not show
right amount for SURS participants
Even the name, “windfall,” creates a negative
climate
But some version of a WEP/GPO is good
policy, and efforts to repeal it may backfire
Perhaps better to focus on (a) how it is
calculated, and (b) education