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Analysis of the Jeb Bush Proposal to Reform Social Security

Andrew G. Biggs Resident Scholar American Enterprise Institute Former Florida Gov. Jeb Bush, a candidate for the Republican presidential nomination, has released a proposal to reform the Social Security program and improve the system’s finances. The following outlines the details of the plan, based upon discussions with Bush campaign staff, and uses a microsimulation model of the Social Security program to project how the plan might affect the system’s financial health and benefit payments were it to be implemented.

Background on the Social Security program Social Security, or technically the Old Age, Survivors and Disability Insurance (OASDI) program, pays benefits to retirees, the survivors of eligible workers, and workers who become unable to work through disability. Benefits are calculated as a progressive replacement of lifetime coverage earnings, with the inclusion of spousal benefits and adjustments for the age at which the participant claims benefits. The program is financed principally through a 12.4 percent tax on wages up to $118,500, with the tax split evenly between employers and employees. In addition to payroll taxes, Social Security receives revenue from income taxes levied on Social Security benefits. Social Security also has a trust fund, whose value as of the beginning of 2015 was $2.8 trillion. The special-issue Treasury bonds held in the trust fund can be redeemed to enable the program to maintain the payment of full benefits even when the program’s benefit obligations exceed its tax revenues. As with any government bond, repayment of trust fund’s bonds poses a financial obligation on the non-Social Security portion of the federal government’s budget. According to the Social Security Trustees and the Social Security Administration’s actuaries, Social Security’s trust fund is projected to remain solvent through 2034 and the program as a whole will run an actuarial deficit of 2.68 percent of taxable payroll over the next 75 years. The Congressional Budget Office performs similar projections, estimating that Social Security would remain solvent through 2028 and run an actuarial deficit of 4.4 percent of payroll over 75 years. Once Social Security’s trust funds are exhausted, the program would reduce benefits to the level payable through the program’s dedicated tax revenues. This would involve a roughly one-

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fifth reduction in benefits in the year of insolvency, with larger reductions over time as the program’s dedicated tax revenues fell increasingly short of scheduled benefit payments.

Modeling background Gov. Bush’s proposal is analyzed using a suite of models developed and maintained by the Policy Simulation Group.1 The PSG models simulate a sample of the U.S. population on an individual and household basis and project that population into the future. Using this population, the models simulate participation in the Social Security program and employer-sponsored pensions. Only the Social Security provisions of Gov. Bush’s proposals are analyzed here. Details of the provisions of the plan are based upon discussions with Bush campaign staff. The PSG models have been used by the Social Security Administration, the Government Accountability Office and the Department of Labor and produce outcomes very similar to those generated by the Social Security Trustees and the Social Security Administration’s Office of the Chief Actuary.

Summary of Social Security Provisions Gov. Bush’s proposal includes a number of provisions designed to balance Social Security’s finances, improve incentives to delay retirement, and provide a stronger safety net for long-term low-earning workers. These provisions include: Increase the normal and early retirement ages. Social Security’s Normal Retirement Age (currently 66) will under current law increase to 67 for individuals turning age 62 in 2022. Under the reforms proposed by Gov. Bush, the normal retirement age would continue to increase at a rate of one month per year, such that over the following 36 years the normal retirement age would rise to 70. In addition, Social Security’s Early Entitlement Age (commonly referred to as the early retirement age) would increase by one month per year beginning in 2022 and reach 65 for individuals turning 62 in 2058. Increase benefit adjustment for individuals who delay retirement. Social Security awards increased benefits to individuals who delay claiming benefit after the early retirement age of 62. These adjustments are accomplished via the Actuarial Reduction Factor, which applies to benefits claimed prior to the Normal Retirement Age, and the Delayed Retirement Credit, which applies to benefits claimed after the Normal Retirement Age. Under current law, the Actuarial Reduction is equal to 6.7 percent per year that benefits are claimed prior to the Normal Retirement Age. The Delayed Retirement Credit increases benefits by 8 percent for each year that claiming is delayed past the Normal Retirement Age. This policy increases both the Actuarial Reduction Factor and the Delayed Retirement Credit to 9 percent, beginning in 2022. These changes are designed to encourage individuals to delay claiming Social Security benefits

1 Details of the models are available at www.polsim.com.

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and extend their work lives. However, the modeling assumes that individuals claim benefits as they would under current law. Eliminate the Retirement Income Test. The Retirement Earnings Test reduces benefits for some individuals who continue to work while claiming benefits prior to the Normal Retirement Age. In 2015, benefits are reduced on a 1-for-2 basis for each dollar of earnings in excess of $15,720; in the year an individual reaches the Normal Retirement Age, the earnings threshold is increased to $41,880. At the Normal Retirement Age, benefits are adjusted to account for any reductions that took place prior to the Normal Retirement Age. Under Gov. Bush’s proposal, the retirement income test would be eliminated beginning in 2018. Eliminate the employee portion of the Social Security payroll tax for workers over the age of 67. Beginning in 2018, Gov. Bush’s proposal would eliminate the 6.2 percent employee share of the Social Security payroll tax for individuals aged 67 and above. Establish a minimum benefit for long-term low-wage workers. The proposal would establish a benefit equal to 125 percent of the federal poverty threshold for individuals with 30 years of earnings. The benefit would be scaled for individuals with between 10 and 30 years of earnings. This policy would begin in 2022. Adjust Social Security benefit formula. Social Security’s current benefit formula replaces 90 percent of Average Indexed Monthly Earnings up to $826, 32 percent of earnings between $827 and $4,980, and 15 percent of earnings between $4,981 and the contribution and benefit base, currently $9,975 per month. Between 2022 and 2040, the proposal would increase the first replacement factor from 90 percent to 93 percent, reduce the second factor from 32 percent to 21 percent, and reduce the top factor from 15 percent to 5 percent. Calculate COLAs using Chained CPI. Beginning in 2018, the proposal would use the Chained Consumer Price Index for All Urban Consumers to calculated annual Cost of Living Adjustments for Social Security benefits. It is assumed that the Chained CPI produces COLAs that are 0.3 percentage points lower on an annual basis than would be calculated using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which is currently used to calculate COLAs.

Financing results The plan is analyzed under the assumptions used in the 2015 Social Security Trustees Report. As noted above, the 2015 Report projected that the combined Social Security Trust Funds would remain solvent until 2034 and over 75 years the program would run an actuarial deficit equal to 2.68 percent of taxable payroll. Analyzed using the PSG models, Gov. Bush’s proposal would generate a 75-year actuarial balance of 0.0 percent of payroll, meaning that the program would be expected to be almost

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precisely balanced over 75 years. In practice, changes in the factors that affect Social Security’s finances could cause the program to be over- or under-funded over time. The combined Social Security trust funds are projected to remain solvent throughout the 75-year period. The ratio of trust funds balance to annual benefit outlays (the “trust fund ratio”) is a common shorthand measure of funding health. This ratio is projected to be rising toward the end of the 75 year period, indicating so-called “sustainable solvency” in which the program could be expected to remain solvent following the end of the 75-year period. Figure 1 shows projected annual Social Security income and costs under Gov. Bush’s proposal. Income is composed of payroll tax revenues and income taxes levied on Social Security benefits, while costs are composed of benefit outlays and administrative costs. Costs currently exceed income and would continue to do so for several decades, during which time Social Security would continue to rely upon Treasure securities held in the combined trust funds to maintain full benefit payments. By mid-century, benefit costs would fall below revenues and the program is projected to run very modest payroll tax surpluses in following years. Figure 1.

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Projected Social Security Annual Income and Cost Under Gov. Bush Proposal

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Conclusion In coming months, I will use the PSG models to simulate both system financing and the level and distribution of benefits under a number of proposed reforms to the Social Security program.