SOCIAL SECURITY:
How It Works and How to Fix
It
Jonathan Barry Forman (“Jon”)
Alfred P. Murrah Professor of Law
April 2008
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
2
How Many People Get Social
Security?
 Almost 50 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
Social Security Basic Facts, http://ssa.gov/pressoffice/basicfact.htm; National Academy of Social Insurance, Social
Security Finances: A Primer (2005)
3
Who Gets Social Security?





31.5 million retired workers
2.9 million dependents
7.1 million disabled workers
1.8 million dependents
6.5 million survivors
Social Security Basic Facts,http://ssa.gov/pressoffice/basicfact.htm
4
How Much Does Social Security Pay?
Type of Beneficiary
Average
Monthly
Benefit
All Retired Workers
$1,079
Aged widow(er), non-disabled
$1,041
Disabled worker
$1,004
Aged couple-both receiving
$1,761
Widowed mother and two children
$2,243
www.ssa.gov/OACT/COLA/colaeffect.html
5
Social Security and Poverty
 2008 Poverty Levels
 Single individuals – $10,400 ($867/month)
 Married couples – $14,000 ($1,167/month)
 With Social Security only 9% were poor
(in 2000)
 Without it, 48% would have been poor
http://aspe.hhs.gov/poverty/08poverty.shtml
6
Financing Social Security
 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
 2008 tax base is $102,000 in 2008
http://www.socialsecurity.gov/OACT/COLA/cbb.html
7
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)
8
Average Indexed Monthly
Earnings (AIME)
 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
http://www.socialsecurity.gov/OACT/ProgData/retirebenefit1.html
9
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
 The Primary Insurance Amount (PIA)
 Paid at full retirement age
10
Full Retirement Age
Year of Birth
1937 or earlier
Full Retirement Age
65
1938 - 1942
plus 2 months per year
1942 – 1954
66
1955 - 1959
plus 2 months per year
1960 and later
http://www.ssa.gov/retire2/retirechart.htm
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11
Primary Insurance Amount
(PIA)
 For a worker turning 62 in 2008,
PIA = 90% of first $711 of AIME
+ 32% of AIME from $711 to $4,228 (if any)
+ 15% of AIME over $4,228 (if any)
 $711 and $4,228 are called bend points
 PIA indexed by cost of living after 62
 Provides higher benefits relative to earnings
for lower paid
12
Primary Insurance Amount (PIA) formula
for persons turning age 62 in 2008
$2,200
$2,000
S e c ond
$1,600
$4,228
Primary Insurance Amount
$1,800
Be nd P oint
$1,400
$1,200 First
Be nd P oint
PIA
$1,000 $711
$800
$600
$400
$200
$0
$0
$1,000
$2,000
$3,000
$4,000
$5,000
Average Indexed M onthly Earnings
$6,000
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How do benefits compare to earnings?
Retired worker age 65, 2005
$90,000
$80,000
Past Wages
Benefits
$60,000
$55,400
$40,000
$35,300
$20,000
$22,500
$19,600
$15,800
$14,800
$9,000
$0
"low"
"medium"
Earnings Amount
"high"
"maximum"
14
Worker Benefits:
Increases and Decreases
 Indexed for inflation
 Actuarial decrease for early retirement
 Example: average-wage worker, 62 in 2008
 Will get $1,444.30 per month at her full
retirement age of 66
 or $1,083 per month at 62
 Actuarial increase for later retirement
 8 percent per year
 Retirement Earnings Test
 In 2008, early retirees lose $1 of benefits for
each $2 of earnings over $13,560
http://www.socialsecurity.gov/OACT/ProgData/retirebenefit2.html; http://www.ssa.gov/OACT/COLA/rtea.html
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How many people rely on Social
Security for most of their income?
 90% of people 65 and older get
Social Security
 Social Security represents 39% of the
income of the elderly
 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
16
Social Security Basic Facts, http://ssa.gov/pressoffice/basicfact.htm; National Academy of Social Insurance, Social Security
Finances: A Primer (2005);
Most elderly don’t receive pensions
Percent with Employer-Sponsored
Pensions
All age 65+
Couples
Unmarried men
Unmarried women
41%
51%
39%
32%
National Academy of Social Insurance, Social Security Finances: A Primer (2005)
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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 survivor
annuity
 Dual entitlement rule limits benefits
18
The Need for Reform
 Social Security is in financial trouble
and will not be able to meet its future
benefit commitments.
 Social Security redistributes payroll
tax revenues in many ways that are
quite simply unfair.
19
Estimates for 2007 Finances
Trust Fund income = $785 billion (taxes)
Trust Fund outgo = $595 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 2008 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)
21
Social Security Administration, 2008 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 2041.
 In 2041, reserves are projected to be
depleted. Income is forecast to cover
78% of benefits due then.
 By 2082, assuming no change in taxes,
benefits or forecasts, revenue would cover
75% of benefits due then.
23
Social Security’s Financing Problem
 2008 Trustees Report shows
 Expenses will exceed payroll tax income in 2017
 Trust funds will be out of money in 2041
 75-year deficit equals 1.70% of taxable payroll
 Immediate payroll tax increase of 1.70% needed to
restore actuarial balance
 Alternatively, immediate 11.5% across-the-board
benefit cut
 $4.3 trillion unfunded liability (over 75 years)
 About 0.6% as a share of the entire economy (GDP)
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Unfunded Obligations
(Present values as of January 1, 2008; trillions of dollars)
Present
value
Over the
infinite
horizon
Over the
next 75
years
$13.6
4.3
Social Security Administration, 2008 Trustees’ Report, Table IV.B6.
As a % of
future
payroll
3.2
1.6
As a % of
GDP
1.1
.6
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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)
26
What is that non-taxable
income?
 Income not subject to Social Security
taxes includes:
 earnings above the tax cap ($102,000 in
2008)
 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)
27
Only 3 Ways to Fix Social Security
 Raise Taxes
 Cut Benefits
 Increase Investment Returns
 Private investment
 Either government or individual
28
Second problem: Social Security
Redistributes Economic Resources
 Evaluate the program’s impact over
the course of a worker’s lifetime.
 Compare Social Security taxes paid
by a worker and expected benefits.
 Linkage between the Social Security
taxes and benefits is loose.
 Can vary dramatically depending on
such factors as family status,
income, and age.
29
Social Security favors
 Early generations of retirees over later
generations,
 Workers with low career-average earnings
over workers with high career-average
earnings,
 Married couples over singles individuals,
 One-earner couples over two-earner couples,
 Larger families over smaller families, and
 Elderly retirees over elderly workers.
30
Social Security's Transfer of Wealth Among
Generations by Each Cohort's Year of Birth
(Billions of 2003 dollars)
Congressional Budget Office, How Pension Financing Affects Returns to Different Generations (2004).
31
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%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of
Actuaries (2007); Center for Retirement Research at Boston College (2007).
93%
40%
10%
20%
32
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%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of
Actuaries (2007).
41%
32%
21%
33
Options: Increase Investment
Returns
OPTION
% of Deficit Eliminated
 Investments in equities
36% - 50%
National Academy of Social Insurance, Social Security Brief No. 18 (2005); American Academy of
Actuaries (2007).
34
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
35
First Tier: Basic Benefit
 Government guarantee of poverty-level
income
 2008 Poverty Levels
 Single individuals – $10,400 ($867/month)
 Married couples – $14,000 ($1,167/month)
 Would replace SSI and redistribution
within the current SS system
 Pay for with general revenues
36
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
37
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
38
Conclusions
 $4.3 Trillion Unfunded Liability
 Oldest baby-boomers are 62
 Social Security should provide
adequate incomes throughout
retirement
 Reform is needed
39
Sources





American Academy of Actuaries, Social Security Reform Options (2007),
http://www.actuary.org/pdf/socialsecurity/reform_07.pdf.
Jon Forman, Reforming Social Security, 76 (9) Oklahoma Bar Journal 657661 (March 12, 2005), http://jay.law.ou.edu/faculty/jforman/SS-OBJ2005.pdf.
National Academy of Social Insurance, Social Security Finances: A Primer
(2005), http://www.nasi.org/usr_doc/Financing_Social_Security.ppt.
National Academy of Social Insurance, Options to Balance Social Security
Over the Next 25 Years (Social Security Brief No. 18, 2005),
http://www.nasi.org/usr_doc/SS_Brief_18.pdf.
Center for Retirement Research at Boston College, The Social Security Fix-It
Book, http://crr.bc.edu/special_projects/the_social_security_fix-
it_book.html.

Social Security Board of Trustees, 2008 Annual Report of the Board of
Trustees of the Federal Old-Age and Survivors Insurance and Disability
Insurance Trust Funds (2008),
http://www.socialsecurity.gov/OACT/TR/TR08/tr08.pdf.
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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 jforman@ou.edu or (405) 3254779. His web page is
www.law.ou.edu/faculty/forman.shtml.
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