The Social Security Windfall Elimination Provision

Prof. Jeffrey Brown, UIUCSUAA State MeetingOctober 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 1983California, Colorado, Illinois, Louisiana, Massachusetts, Ohio and Texas are only states not under SSWEP 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 non-covered employment.”

– Testimony of Robert M. Wilson, Deputy Commissionerfor 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 PIANormally, if one retires at the normal retirement age, one’s benefit is equal to the PIAThe 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 growthTake 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 …

The Benefit (PIA) Formula (2007)PIA

AIME

1st bendpoint

2nd bendpoint

.9

.32

.15

$680 $4,100

$612

$1706

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 individualsTo 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 incomeNo 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 jobsConsulting 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 earningsEx: If only 10% of lifetime income is covered under SS, one would look like a “lifetime poor,” when in fact they are notThe 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

Benefit if use

SS only

Benefit to

Earnings

SS SURS Total

Larry 500 0 500 450 90%

Mo 5,000 0 5,000 1,841 37%

Curly 500 4,500 5,000 450 90%

Example if No WEP Existed

Average Indexed Monthly Earnings

Benefit if use

SS only

Benefit to

Earnings

SS SURS Total

Larry 500 0 500 450 90%

Mo 5,000 0 5,000 1,841 37%

Curly 500 4,500 5,000 450 90%

Example if No WEP Existed

Average Indexed Monthly Earnings

Benefit if use

SS only

Benefit to

Earnings

SS SURS Total

Larry 500 0 500 450 90%

Mo 5,000 0 5,000 1,841 37%

Curly 500 4,500 5,000 450 90%

Example if No WEP Existed

Average Indexed Monthly Earnings

Benefit if use

SS only

Benefit to

Earnings

SS SURS Total

Larry 500 0 500 450 90%

Mo 5,000 0 5,000 1,841 37%

Curly 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 cohortFor each year over 20 years that one has “substantial” earnings under SS, this factor increases by 5 percentage pointsAt 30 years of substantial earnings, the offset disappears

Benefits under WEP (<20 years)PIA

AIME

.9

.32

.15

$680 $4,100

$612

$1706

.4

$272

Example with WEP Existed

Average Indexed Monthly Earnings Benefit

Benefit to

Earnings

SS SURS Total

Larry 500 0 500 450 90%

Mo 5,000 0 5,000 1,841 37%

Curly 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 workersThe need for it arises from the non-linearity 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 non-working and/or low earning spousesGPO 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 repealRoughly $5 billion annually$60+ billion over 10 year budget windowMakes 75-year solvency problem worseBrings date of cash flow problem forward 1 year

Unintended ConsequencesIt may make it more likely that the problem is addressed by folding state and local workers into Social SecurityMany 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 recipientsState / 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 hocWhile it may be roughly correct on average, it is not right for every individualPerhaps 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 IdeaSince 1977, SSA has kept track of both covered and uncovered earningsOne could compute the PIA based on total (SS + SURS) earningsThen calculate what fraction of total lifetime earnings were under SSGive the person that fraction of the revised PIAIn other words, if half your earnings were under SS, you get half the benefitThis approach would:

Reduce inequityBe 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.”

SummaryIt is perfectly understandable why SURS annuitants are angry with WEP/GPO

The provisions are not explained wellThe annual SS benefit statements do not show right amount for SURS participantsEven the name, “windfall,” creates a negative climate

But some version of a WEP/GPO is good policy, and efforts to repeal it may backfirePerhaps better to focus on (a) how it is calculated, and (b) education