History Social Security and Operations

Who benefits? Social Security has achieved its goal of providing widespread protection against financial risks associated with retirement, disability, and survivorship. Coverage is virtually universal, with 152 million workers (over 95 percent of the workforce) and their families included in the program. In February 2001, monthly benefits were paid to over 45 million persons, including almost 29 million retired workers; nearly 5 million surviving aged widows and widowers; 400,000 surviving mothers and fathers; 5 million disabled workers; and 3 million children under eighteen, mostly survivors or dependents of disabled workers.

Social Security’s benefits bridge the generations. The main source of survivor and disability protection for America’s families, for a ‘‘typical’’ twenty-seven year old couple with two children under age four, Social Security is the equivalent of a term life insurance policy in excess of $300,000 and a disability policy in excess of $200,000. The only pension protection available to six out of ten working persons in the private sector, it provides the equivalent of $12.1 trillion dollars in life insurance protection, more than the entire value ($10.8 trillion) of all the private life insurance protection in force (Ball, 1998). Even retirement benefits have clear cross-generational value. Assuming that one accepts the view that the United States government cannot renege on its commitment to provide benefits to future retirees, then, by making Social Security payroll tax contributions, younger workers earn the right to benefits when they retire. Also, by providing benefits to today’s elderly persons, Social Security frees up resources that allow the adult children of retirees to invest more in the education of their own children (or their own retirements), rather than in the financial support of their aged parents.

Social Security has transformed old age in America. While government employee pensions and private pensions, annuities, assets, and earnings provide important sources of cash income for many elderly persons age sixty-five and older, Social Security remains the heart of the retirement income system. In part, because of the progressive nature of the benefit formula, more than 70 percent of the income going to aged households in the bottom 60 percent of the elderly income distribution comes from Social Security (see Table 1). Only for those in the highest 20 percent of the elderly income distribution do other sources of income, such as earnings and assets, eclipse Social Security in terms of their aggregate contribution to household income (U.S. Department of Health and Human Services, 2000). Occupational pensions make significant contributions to the aggregate incomes going to households in the three highest quintiles, but this source of income falls well short of Social Security for these households. While not unimportant, the aggregate contribution of cash welfare benefits (9.8 percent) to the 4.9 million aged units with less that $8,792 in annual income in 1998 was substantially less than that of Social Security (82.1 percent). Moreover, without Social Security, the poverty rate among Social Security beneficiaries age sixty-five and older would jump from 9 percent to 48 percent; for unmarried older beneficiaries, it would jump from 15 percent to 58 percent; and for older African-American beneficiaries the poverty rate would rise from 24 percent to 75 percent.

Financing and administering Social Security. Retirement, survivor, and disability protections are earned through the payment of payroll taxes by working persons and their employers. Today, most people know that their payroll taxes do not go into a special savings account earmarked for particular workers and their families. Current benefits are funded largely from the taxes paid by current workers, with the promise that the current workers will themselves receive benefits when they become eligible for them. Additional revenues come from treating a portion of Social Security benefits as taxable income and from the interest earned from investing the growing OASDI trust fund assets in government bonds. Social Security financing is held together primarily by the taxing power of the government Table 1 Importance of various sources of income to elderly households (aged units), 1998* (all members over age 65) SOURCE: U.S. Department of Health and Human Services, Social Security Administration, Office of Policy Office of Research, Evaluation and Statistics, Income of the Population 55 and Over and the public’s (and hence politicians’) strong interest in maintaining the program.

The Social Security Administration maintains a record of the earnings on which workers have paid payroll taxes. This record provides the basis for establishing eligibility to program benefits and determining the size of those benefits. Interestingly, each year less than 1 percent (0.9 percent) of trust fund revenues is spent on the administration of OASDI.

Employed persons contribute 6.2 percent of their earnings (with an equal employer match) up to a maximum taxable ceiling ($76,200 in 2000) into two trust funds—one for Old-Age and Survivors Insurance (OASI) and one for Disability Insurance (DI)—which are often referred to as the combined OASDI trust fund. Self-employed persons make contributions equivalent to those made by regularly employed persons and their employers. The maximum taxable ceiling is adjusted each year for changes in average wages. Another 1.45 percent payroll tax goes to Medicare’s Hospital Insurance (HI) trust fund.

Social Security benefits. Elaborate rules link contributions to benefits. Four general rules are worth keeping in mind. First, persons who have worked for ten years or more (that is, earned credit for forty quarters) in covered employment are almost always eligible to receive retirement benefits at age sixty-two or later and their survivorship protections are in force. One credit for a quarter is actually given (a maximum of four per year) for having $830 of earnings in covered employment. Second, for disability protections to be in force, workers generally need to have worked for five out of the previous ten years. Third, there are exceptions to these basic rules. Younger workers, for example, are subject to far less restrictive eligibility requirements for survivorship and disability protections.

The fourth basic rule is that, in keeping with the program’s goal of providing widespread and adequate protection, the Social Security benefit formula works to assure that long-term, low-wage workers receive a proportionately larger benefit (relative to their contributions) than high-wage workers. The increased payroll tax contributions of high-wage workers is recognized by a larger monthly benefit, but such workers receive a proportionately smaller benefit. This is done through a benefit formula that replaces a smaller percentage of covered earnings as a worker’s average covered earnings rise. For example, for workers retiring at age sixty-five in January 2001, Social Security replaces about 28 percent of earnings for those with earnings consistently at the maximum taxable ceiling, compared to about 58 percent for those whose earnings were consistently at 45 percent of median wages, and 42 percent for those with average earnings. The monthly retired workers benefit for this maximum earner would be $1,538 compared to $637 for the low earner and $1,051 for the average earner.

Nearly all covered workers are eligible to accept actuarially reduced early retirement benefits at age sixty-two or full benefits at the normal retirement age—in 2002, age sixty-five and scheduled to gradually increase to age sixty-seven by 2027. Workers electing to postpone benefits past the normal retirement age receive credits that permanently increase the value of their monthly benefits. The surviving spouses of retired workers may receive reduced survivor benefits at age sixty (or age fifty if severely disabled) or full benefits at age sixty-five or later. Severely disabled workers are also eligible to receive monthly benefits if their condition meets the disability eligibility criteria. Other dependents of retired, deceased, or disabled workers (even, in some cases, financially dependent grandchildren, divorced spouses caring for dependent children, or adult children who were disabled prior to age nineteen) may also be eligible for monthly benefits. (Note: additional benefit information can be found by accessing the Social Security Administration’s Web site: www.ssa.gov.)