Social Security, a pension booster, faces shortfall

July 17, 2017

Retirees who receive federal Social Security in addition to their California state and local government pensions got mixed news last week.

Social Security trustees project a 2.2 percent increase for recipients next year after little or no increase the last two years. And the Social Security trust funds are projected to run out of money by 2034, triggering a 23 percent cut unless Congress takes corrective action.

Benefits could be reduced (extend the retirement age or cap cost-of-living adjustments) or revenue increased (raise the payroll tax or raise the $127,200 cap on wages taxed). But the Trump administration is not advocating direct action to solve the growing problem.

“To help make these programs sustainable into the future we should focus on strengthening the economy today,” U.S. Treasury Secretary Steven Mnuchin said last week. “Compounding growth will help ease projected short-falls. To this end, it is essential for us to implement tax and regulatory reform.”

If the trust funds run dry in 2034, Social Security payments would be cut (a projected 23 percent) to an amount low enough to be paid by the Social Security payroll tax, currently 12.4 percent, split equally between employer and employee, 6.2 percent each.

About 40 percent of California state and local government workers have Social Security in addition to pensions, according to the Public Plans Data website maintained by three nonprofit organizations.

In a higher estimate of coverage, a report by the watchdog Little Hoover Commission in 2011 said “nearly half of all public employees in California, including teachers, police and firefighters, remain outside of the federal supplemental program.”

The influential Little Hoover report (quoted in a key pension-cut appeals court decision awaiting a Supreme Court hearing) also explained why the original reduction in the CalPERS pensions of government employees who receive Social Security went awry.

Legislation in 1961 allowing state workers to begin receiving Social Security made an offsetting cut in state pensions. The final pay used to set pensions was reduced by a third of the Social Security payroll tax, resulting in a 24 percent pension cut for high-income employees.

But the law making the cut used a dollar amount, $133.33, instead of a percentage of monthly pay. Now the 1961 dollar reduction is still the law, even though its percentage of final pay plummeted over the decades.

“With rising benefit levels, a rank-and-file state worker who retires at age 63 with 30 years of service now can expect to receive 107 percent of pre-retirement income, when adding in full Social Security benefits (available at age 67),” said the Little Hoover report.

“Without the $133.33 reduction in the benefit calculation, the worker’s pension would equal almost the same pay, about 109 percent of pre-retirement salary.”

In 1982, the last state budget proposed by Gov. Brown during his first eight years in office said state workers could retire at age 62 and receive more than 100 percent of their final salary from CalPERS and Social Security.

Brown proposed lower pensions for new hires, arguing that 70 percent of final salary is a “common standard” for maintaining a standard of living in retirement that is similar to the one when working.

He signed a budget in 1982 calling for a “two-tier” system giving new hires a lower pension, but it was not enacted. After returning to office nearly three decades later, Brown did get pension reform legislation that gives new hires in CalPERS and county systems lower pensions.

Employees hired on or after Jan. 1, 2013, when the reform took effect, can still receive Social Security. And the final pay used to set their lower pensions is not subject to the $133.33 reduction.

The Social Security trust funds grew to $2.8 trillion during several decades, roughly 1990 to 2010, when the payroll tax revenue was higher than payments to recipients, as this chart from the Committee for a Responsible Federal Budget shows.

After payment costs began exceeding tax revenue around 2010, the shrinking trust funds are expected to run out of money and trigger a 23 percent payment cut in 2034, when a person now age 50 reaches the normal retirement age of 67.

Meanwhile, trust fund assets have been loaned to the rest of government through special bonds, called a “raid” by some. In their calculations, the fund trustees assume the loan will be repaid with interest, costing the rest of government about $4.4 trillion through 2034.

“Many argue that these Social Security surpluses masked other deficits in the rest of the government, and thus allowed policymakers to enact more deficit-financed tax cuts or spending increases,” said the Committee for a Responsible Federal Budget.

Delaying a solution adds to the cost or benefit reduction, said the committee. To make Social Security solvent, for example, the 12.4 percent payroll tax would need to increase to 15 percent today, 16.4 percent if delayed until 2034.

Social Security and California public pensions differ in a number of ways. The federal program is intended to be a modest supplement, not a full retirement plan, and it provides a relatively larger payment for low-income persons.

It’s a pay-as-you-go program, not expecting like California retirement systems to get nearly two-thirds of the money needed to pay pensions from investments that can be risky and unpredictable.

Social Security costs are shared equally by employer and employee. In California plans, only the employer pays the debt or “unfunded liability” (usually from investment earnings shortfalls). So, the rate paid by employers is usually much larger than the employee rate.

While Social Security recipients face cuts, members of California plans are protected by the “California rule,” a series of state court rulings that the pension offered at hire becomes a vested right, protected by contract law, that can only be cut if offset by a new benefit.

Congress, unlike the California Legislature, has taken a dim view of adding Social Security to pensions. Two laws can be a problem for members of the California State Teachers Retirement System, who do not receive Social Security.

The Windfall Elimination Provision reduces Social Security earned by CalSTRS members on other jobs. The cut is intended to avoid giving a more generous Social Security payment based on low income to someone who has a pension from a higher-paying job.

The Government Pension Offset reduces spousal Social Security payments by two-thirds of the pension received from a government job. The cut for surviving spouses with a pension is intended to be similar to the cut for those with Social Security.

CalSTRS in the past has given Congress a detailed analysis showing why the two Social Security laws are unfair and arbitrary, emphasizing the impact of the spousal offset on its membership that is 70 percent female with longer expected life spans.

A bill to reform or repeal the two laws, which are said to harm teacher recruitment, has been introduced in every session of Congress since 2001. None got out of committee, said a CalSTRS analysis of two current repeal bills.

Teachers in 35 states receive Social Security, putting California in the minority on the issue. Another problem is the cost of repeal, estimated by Social Security last year to be 0.13 percent of payroll over the long term.

A repeal of the two laws, rather than a reform, might revive the inequity issue and lead to calls to require Social Security for all government employees, said the CalSTRS bill analysis. Members of CalSTRS voted “almost four to one” in 1955 to remain out of Social Security.

“The (CalSTRS) board has opposed mandatory Social Security participation for CalSTRS members, citing studies that show the move would increase costs or reduce total retirement benefits,” said the bill analysis.

“Additionally, there are potential costs associated with the overlap of CalSTRS’ disability and survivor benefits and comparable Social Security benefits.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 17 Jul 17


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