Social Security Reform: Issues for Disability and Dependent Benefits
Released: 2007-11-26T00:00:00

Letter

Background

Social Security is one the largest federal programs in the United States, providing about $546 billion in benefits in 2006 to over 49 million beneficiaries. Although the majority of Social Security benefits are paid to retirees, Social Security does much more than provide retirement income. Social Security Disability Insurance (DI) pays monthly cash benefits to nearly 7 million workers who, due to a severe long-term disability, can no longer remain in the workforce. Additionally, Social Security provides benefits to over 11 million dependents, including payments to widows and widowers as well as surviving parents and children under Survivors’ Insurance (SI), plus benefits to dependent spouses and children of retired and disabled workers paid from the Old Age Insurance (or Old Age) and DI trust funds. Social Security benefits often represent a significant source of income for their recipients, providing an average of $1,051 a month (as of July 2007) to retired workers, $995 a month to widows and widowers, and $979 a month to disabled workers. Although disabled workers and dependents receive slightly lower average monthly benefits than retired workers, benefits could be particularly important to these individuals. These beneficiaries may face considerable hardships; for example, a disabling condition may make work and other activities of daily living more difficult. As a result, these beneficiaries may have financial difficulties planning and preparing for death or disability in the way one might plan for retirement. Social Security was never intended to provide an adequate income by itself, but instead serves as an income base on which to build. In fact, the Social Security program balances the goals of income adequacy with individual equity, i.e., that lower income beneficiaries should receive higher benefits relative to wages than higher income beneficiaries (adequacy), and beneficiaries with higher lifetime income receive higher benefits in accordance with their income/lifetime contributions (equity).

History and Development of DI and Dependents’ Benefits

Although Social Security had originally been envisioned to include disability and survivors’ insurance, the 1935 Social Security Act created only a retirement program. Over the next 40 years, the program expanded both the size and type of its benefits, introducing benefits for dependents and disabled workers (fig. 2). The first new type of benefits went to dependents, as the 1939 amendments offered payments to elderly dependent wives and widows, as well as dependent children. (Some husbands and widowers were allowed to receive these same benefits after 1950). Creating these benefits was not only seen as socially desirable, but also offered additional protections for workers and their families from risk and spent down surpluses created by the system. Disability Insurance, which had been recommended by the 1938 and 1948 advisory councils, was established in 1956 to provide cash benefits to permanently disabled workers over the age of 50. The DI program was later expanded to include disabled workers under the age of 50 as well. In 1961, widows benefits increased from 75 to 85 percent of their deceased spouse’s benefits, and then to 100 percent in 1972. In addition, eligibility was extended to divorced spouses as well as to the spouses and children of disabled workers. Furthermore, benefit levels for retirees, dependents, and disabled worker beneficiaries grew during this time period. However, facing solvency crises, legislative efforts to control the size of the Social Security program were made in the mid 1970s and early 1980s.

In order to maintain trust fund solvency, major changes were enacted to reduce the growth of Social Security benefit levels from the mid1970s to the early 1980s. Additionally, a number of legislative changes to the DI and dependents’ programs eliminated or reduced certain benefits and tightened the eligibility standards for receiving other benefits. However, despite ongoing fiscal concerns, eligibility for a few dependents’ and disability benefits has been expanded since 1975, suggesting an interest in protecting some vulnerable populations who may rely on Social Security for a significant portion of their monthly income. Although recent reform proposals have focused on elements intended to improve solvency, there continues to be some interest in protecting some or all DI and dependents’ benefits from potential benefit reductions. Figure 3 shows how Old Age, Survivors, and Disability Insurance (OASDI) has grown financially and in terms of beneficiaries over time.

Development of a Single Benefit Formula

Although the 1935 act did not provide for disability and dependents’ benefits, those benefits were later built upon the existing Social Security structure, and today all benefits continue to be calculated from a common formula. Dependents’ benefit levels were set as fractions of the benefits owed to the person upon whom beneficiaries depended. For example, under the 1939 legislation, a widow would receive 75 percent of her deceased husband’s benefits, and dependent children or spouses would receive 50 percent of the retired worker’s benefits. When Congress created the DI program in 1956, it provided a lower retirement age (50) for those who were permanently and totally disabled. The same benefit formula used in computing OASI benefits was adopted for disability benefits because the original DI program treated disabled workers as being forced into premature retirement. In 1960, when Congress expanded the DI program by eliminating the requirement that disabled workers had to be 50 years old, the same benefit formula applied. Because benefit types shared a common formula, automatic indexing provisions implemented in 1972 and 1977 applied across the board.

The OASDI programs are tightly linked in other ways as well. These programs are financed through a common mechanism—payroll taxes; receipts from the payroll tax are deposited into the OASI and DI trust funds which, like the two programs, are separate but often combined in discussion and analysis of Social Security’s solvency and sustainability. Furthermore, beneficiaries can receive multiple types of benefits over their lifetimes, moving into, out of, and among Social Security programs at different life stages. When disabled workers reach the full retirement age (FRA), for example, they begin to receive retirement benefits from the Old Age program, in place of DI benefits; the common benefit formula keeps such individuals’ benefit levels stable. In another case, a recent widow(er) might have her (or his) retirement or spousal benefits replaced with survivors’ benefits based on the relative earnings of the deceased spouse. Because parents, children, or spouses may be eligible for dependents’ benefits through the Old Age, Survivors, and Disability Insurance programs, a person can collect several types of Social Security benefits over a lifetime, although generally not simultaneously. The many linked pieces of Social Security could make developing a single, comprehensive reform package challenging because such a package would need to take into account all of these pieces.

Benefits under Current Law

Under current law, Old Age benefits are generally calculated through a four-step process in which a progressive yet earnings-based formula is applied to an earnings history, and then updated annually through a cost- of-living adjustment (COLA). For those who receive retirement benefits, this earnings history is generally based on the 40 years in which credited earnings were highest, with the 5 lowest-earning years dropped out (leaving the highest 35 years of indexed earnings to be included in the initial benefit calculation). Dependents’ benefit levels are determined as a given percentage of Old Age benefit levels. Eligible children and spouses can receive up to 50 percent of a worker’s benefit; widow(er)s can be given up to 100 percent; and surviving parents or children can collect up to 75 percent, subject to a family maximum.

DI benefits are calculated similarly to Old Age benefits, but are generally based upon a shortened work history. (For more detail on how benefits are calculated, refer to app. II.) To be eligible for benefits, individuals must have a specified number of recent work credits under Social Security when they first become disabled. Individuals must also demonstrate the inability to engage in substantial gainful activity by reason of a physical or mental impairment that has lasted or is expected to last for twelve continuous months or to result in death. If not eligible on medical grounds, SSA must also consider age, education and past work history. In particular, medical eligibility criteria for DI are less stringent for applicants over the age of 55.

Based on prior work, GAO has designated modernizing federal disability programs (including the DI program) as a high risk area because of challenges that continue today. For example, GAO found that federal disability programs remain grounded in outmoded concepts that equate medical conditions with work incapacity. While SSA has taken some actions in response to prior GAO recommendations, GAO continues to believe that SSA should continue to take a lead role in examining the fundamental causes of program problems and seek the regulatory and legislative solutions needed to modernize its programs so that they are aligned with the current state of science, medicine, technology, and labor market conditions. Moreover, SSA should continue to develop and implement strategies to better manage the programs’ accuracy, timeliness, and consistency of decision making.

Social Security’s Financing Social Security is currently financed primarily on a pay-as-you-go basis, in which payroll tax contributions of current workers are used primarily to pay for current benefits. Since the mid1980s, the Social Security program has collected more in taxes than it has paid out in benefits. However, because of the retirement of the baby boomers coupled with increases in life expectancy, and decreases in the fertility rate, this situation will soon reverse itself. According to the Social Security Administration’s 2007 intermediate assumptions, annual cash surpluses are predicted to turn into ever-growing cash deficits beginning in 2017. Absent changes to the program, these deficits are projected to deplete the Social Security DI trust fund in 2026 and the OASI trust fund in 2042, leaving the combined system unable to pay full benefits by 2041. Reductions in benefits, increases in revenues, or a combination of both will likely be needed to restore long- term solvency. A number of proposals have been made to restore fiscal solvency to the program, and many include revenue enhancements, benefit reductions, or structural changes such as the introduction of individual accounts as a part of Social Security. Because many reforms to the benefit side of the equation would reduce benefits through changes in the benefit formula, they could affect DI and dependents’ benefits as well as Old Age benefits. Unless accompanied by offsets or protections, these reforms might reduce the income of disabled workers and dependents. This situation could be challenging for these beneficiaries as they may have relatively low incomes or higher health care costs and rely heavily on Social Security income. Many disabled workers and dependents may also have trouble taking on additional work and accumulating more savings and, thus, have difficulty preparing for Social Security benefit reductions.

Certain Benefit- Reducing Reform Elements Could Have a Substantial Impact on Disabled Workers and Dependents

Many reform elements could have a substantial impact on the benefits of Social Security recipients, including those of disabled workers and dependents. We considered six such elements that have been included in reform proposals to improve trust fund solvency. These reform elements take a variety of forms and would change either the initial benefit calculation or the growth of individual benefits over time. Our projections indicated that most of these elements would reduce benefits from currently scheduled levels for the majority of both disabled workers and dependents. That is, most would reduce median lifetime benefits for these beneficiary types—some more substantially than others. Many of these beneficiaries would also experience a reduction in total lifetime benefits; the extent of which would depend on the reform element and individual.

Benefit-Reducing Reform Elements Take Different Forms

We considered six different reform elements that could help control costs and improve Social Security solvency by reducing benefits. Five would change how initial benefits are calculated, and one would limit the growth of an individual’s benefits over time.

We considered several ways to improve solvency: Longevity indexing would lower the amount of the initial benefit in order to reflect projected increases in life expectancy. Such indexing would maintain relatively comparable levels of lifetime benefits across birth years by proportionally reducing the replacement factors in the initial benefit formula.

Price indexing would maintain purchasing power while slowing the growth of initial benefits. This would be accomplished by indexing initial benefits to the growth in prices rather than wages, as wages tend to increase faster than prices.

Progressive price indexing, a form of price indexing, would control costs while protecting the benefits of those beneficiaries at the lowest earnings levels (in terms of career average earnings). It would continue to index initial benefit levels to wages for those below a certain earnings threshold and employ a graduated combination of price indexing and wage indexing for those above this threshold. Increasing the number of years used in the benefit calculation would also control program costs. For example, initial benefits could be based on the highest 40, rather than 35, years of indexed earnings. This could be done either by eliminating the 5 years normally excluded from the calculation or by increasing the total number of years factored in from 40 to 45 years. In either of these cases, the initial Old Age benefit would be calculated using the highest 40 years of indexed earnings. (For more information on these reform elements and how we incorporated them into our microsimulation model, see app. I.)

Raising the age at which people are eligible for full retirement benefits could change the amount and/or the timing of initial benefits. Increasing the full retirement age would improve solvency by generally increasing the number of years worked, reducing the number of years benefits are received and increasing revenue to the system through payroll taxes in the additional years worked. Further, those who retire early would have their benefits actuarially reduced.

Though it would not generally affect initial benefit amounts, a change to Social Security’s cost-of-living adjustment (COLA) could also control costs and improve solvency by limiting the growth of an individual’s benefits over time. The COLA adjusts benefits to account for inflation by indexing benefits to price growth annually, using the Consumer Price Index (CPI). Setting the COLA below the CPI would limit the nominal growth of an individual’s benefits over time, and as such those who receive benefits for a prolonged period of time would see the largest reductions.

Most of the Social Security Reform Elements We Considered Would Reduce Benefits for Virtually All Beneficiaries

According to our projections for the 1985 cohort, four of the five reform elements that we analyzed would reduce total lifetime benefits for more than three-quarters of disabled workers and dependents, relative to currently scheduled benefits. Table 1 shows the proportions of disabled workers and dependents affected by each of the reform elements. For three of the elements—reducing the COLA by one percentage point, price indexing and progressive price indexing—the percentage of disabled workers affected is very similar to the percentage of dependents affected. Moreover, for these three reform elements, more than 99 percent, or virtually all, disabled workers and dependents would see their benefits reduced. In contrast, progressive price indexing differs from other reform elements in its impact: fewer beneficiaries are affected, and the percentage of disabled workers affected varies from that of dependents. While an estimated 87 percent of dependents would experience a reduction in lifetime benefits under progressive price indexing, an estimated 77 percent of disabled workers would do so.

While the COLA reduction, longevity indexing and price indexing are all designed in such a way that they affect virtually all beneficiaries, the COLA, which has a greater impact on solvency than longevity indexing, affects relatively fewer disabled workers and dependents. This is because the COLA reduction would first affect benefits one year after the initial benefit payment was made, whereas both longevity indexing and price indexing affect the initial benefit amount. Our simulations indicated that 1.11 percent of disabled workers died within the first year of receiving benefits, while only 0.35 percent of dependents did so. Most such beneficiaries would not have received a COLA.

Reform Elements Reduce Median Lifetime Benefits for Disabled Workers and Dependents to Varying Degrees

According to our simulations each of the reform elements we selected would reduce median lifetime benefits for both disabled workers and dependents relative to currently scheduled benefits (figs. 4 and 5). However, our projections also indicated that these reductions would vary by reform element. Price indexing would have the largest impact on disabled workers and dependents, reducing median lifetime benefits by more than 25 percent. Median lifetime benefits would fall from $473,960 to $343,350 for disabled workers and from $351,910 to $244,745 for dependents. Progressive price indexing, on the other hand, would create the smallest reduction in median lifetime benefits, with median lifetime benefits falling by 7 percent for disabled workers and 8 percent for dependents.

Additionally, increasing the full retirement age and increasing the number of computation years would likely reduce median lifetime benefits for dependents. Since dependent benefits are linked to those of the primary worker, an increase in the full retirement age could shorten the period of time over which they both receive benefits. Alternatively, some workers may decide not to adjust their retirement plans in response to the increase in the FRA. Those who maintain their original retirement plans, retiring prior to the new FRA, will also receive reduced benefits relative to current law. (See app. II for a discussion of how benefits are adjusted for early retirement.) Thus, under both scenarios, total lifetime benefits would be reduced, and so, too, would median lifetime benefits. A similar outcome results from increasing the number of computation years by which initial benefits are calculated. By increasing the number of computation years, a worker’s earnings history is expanded to include years of possibly lower indexed earnings. As a result, total benefits for some retired workers, and therefore, their dependents, would likely be reduced, as would median lifetime benefits.

Disabled and Dependent Beneficiaries Are Not Uniformly Affected by Reform Elements

Our projections suggest that, while lifetime benefits would be reduced for virtually all disabled workers and dependents, such reductions would not be uniform across individuals. Figures 6 and 7 compare beneficiaries’ total lifetime benefit reductions by each reform element, for disabled workers and dependents, respectively. If the COLA were reduced by one percentage point, our projections show that approximately 58 percent of disabled workers experienced lifetime benefit reductions of 10 percent or less, while about 42 percent of disabled workers experienced lifetime benefits reduced by 10 to 25 percent. Almost no disabled workers would see benefits fall by more than 25 percent.

Certain reform elements would create reductions in total lifetime benefits for the vast majority of disabled workers and dependents. These reductions may create new hardships for certain beneficiaries, such as disabled workers, who may not be able to easily replace lost income. According to our projections, price indexing would result in the greatest benefit reductions for the largest percentage of beneficiaries, with decreases in lifetime benefits of between 25 percent and 50 percent for almost 70 percent of disabled workers and about 90 percent of dependents. Both price indexing and longevity indexing have a greater effect on initial benefit amounts the longer the reform is in place. As such, people who leave the workforce early may experience a smaller reduction in lifetime benefits than those who leave at full retirement age. For example, as shown in figures 6 and 7, longevity indexing could reduce lifetime benefits for about 86 percent of disabled workers and about 96 percent of dependents by 10 to 25 percent.

Progressive price indexing may have a more moderate effect on the benefits of disabled workers and certain dependents because it is designed to protect benefit levels for low earners and gradually apply benefit reductions to beneficiaries with higher earnings. Because of shorter earnings histories, some disabled workers would be in the low end of the earnings distribution. Thus, under progressive price indexing, a greater proportion of disabled workers would be likely to have benefits adjusted by wage indexing. According to our projections, progressive price indexing would reduce total lifetime benefits by 5 percent or less for 46 percent of disabled workers and 35 percent of dependents.

Options Protecting the Benefits of Disabled Workers and Dependents Could Mitigate the Effects of Benefit-Reducing Reform Elements

Various options are available to protect benefits in different ways, including accelerating the growth of an individual’s benefits, modifying current constraints on benefit levels, and exempting certain populations from reforms. Options can also target certain types of beneficiaries. We analyzed some of these protections and found they could be structured to mitigate the effects of benefit reductions for varying lengths of time. In addition, we found that specific options to protect dependent benefits could be targeted to certain vulnerable beneficiaries, such as widows and dependent children.

Many Options Exist for Protecting Social Security Benefits, Including Full and Partial Exemptions

We found a wide range of options exist for protecting disabled workers and dependents from benefit-reducing reforms. Table 2 provides a summary of the options. The protection options may be very specific in terms of whom they protect and how, or broader in scope. For example, while two protection options focus specifically on disabled adult children (DAC), others, such as partial exemptions could apply to any vulnerable population. In addition to each option having its own strengths and weaknesses, the options could interact with each other and with the various reform elements. When implementing a protection option, all of these factors could influence its impact.

There are several protection options that could be applied to all disabled workers and dependents. Under a full exemption, beneficiaries would not be subject to a reform and their benefits would remain unchanged. Under a partial exemption, beneficiaries would not be subject to a reform until a certain point in time. For example, disabled workers could be exempt from benefit changes until they are converted to the Old Age program at the full retirement age. At this point, their benefit amount would be recalculated to reflect the reform in proportion to the years they spent working. In addition, a super COLA could help protect the benefits of disabled workers and dependents. A super COLA would mitigate some of the effects of a benefit-reducing reform by annually increasing benefits at a rate above the consumer price index—which is currently used to index benefits.

Some protection options could cover all dependents by increasing the percentage of the worker’s benefit that the dependent receives. (See app. II for more detail on how dependent benefits are calculated.) For example, a number of proposals have called for increasing the percentage of the worker’s benefit that widow(er)s receive. Another option that could protect the benefits of a wide range of dependents would be to raise the maximum benefit that families can receive based on one worker’s earnings record. Other protection options, such as caregiver credits, could focus on protecting particular groups of dependents. Several reform proposals have, in fact, called for providing caregiver credits to individuals who spend time out of the workforce to care for their dependents or to those with reduced or low earnings while attending to care-giving responsibilities. Some proposals assign caregivers a specified level of earnings for each year the caregiver received zero or low earnings compared to prior years. Other proposals exclude zero-earning care years from the initial benefit calculation. Another option specific to a certain type of dependent would be to increase benefits for aged survivors, since they are more likely to rely on Social Security to stay out of poverty and could have fewer opportunities, such as returning to work, to respond to benefit-reducing reforms.

Increasing the early retirement age could offer some protection for survivors. If the early retirement age were raised—for example, from 62 to 64—then workers who take early retirement would receive actuarially adjusted benefits for a shorter period of time under the new early retirement age, and thus their monthly benefits would be relatively higher than the monthly benefits they would have received if they had retired at the current early retirement age. Since a dependent’s benefit is linked to the worker’s initial benefit amount, an increase in the worker’s benefit would also increase the dependent’s benefit, mitigating some of the negative effects of other reforms. Similarly, raising the FRA coupled with a partial exemption from a benefit reduction could offer some additional protection for disabled worker benefits. With an increase in the FRA, disabled workers would receive (exempted) DI benefits for a longer period of time because the age at which their disability benefits are converted to retiree benefits would rise with the new FRA.

Some Benefit Protections Could Restore Benefits to Levels near Those Scheduled under Current Law

In general, the reform elements we examined reduce median lifetime benefits for disabled workers and dependents. Because disabled workers may not have the financial resources—especially earnings related income—to adjust to benefit reductions, we explored the interaction of reform elements and certain options to offset them.

According to our projections, protections from a reduction in the COLA could restore benefits of disabled workers to levels close to those scheduled under current law. Reducing the COLA by one percentage point would result in about a 10 percent decrease in median lifetime benefits for workers who become disabled before age 60. To offset such a decrease, they could be partially or fully exempted. With a COLA reduction, a partial exemption would mean that the Social Security Administration would increase a disabled worker’s benefits annually as scheduled under current law (i.e., using the full COLA) until the worker reached the full retirement age. At that point, the disabled worker’s benefits would grow annually by the reduced COLA (1 percentage point lower than what it would be under current law). Our projections showed that a partial exemption as described above would raise median lifetime benefits from their reduced levels by 7 percent (up to 96 percent of scheduled levels under current law). In contrast, a full exemption would allow annual COLA adjustments in line with current law until death (fig. 8).

In addition to a decrease in the COLA, we analyzed options for protecting the benefits of disabled workers under three reform elements that have an impact on the initial benefit amount a disabled worker receives—price indexing, longevity indexing, and progressive price indexing. There are several protection options for mitigating the effects of these reform elements, including full and partial exemptions. In the case of price indexing initial benefits, we projected that the median lifetime benefits of disabled workers would be about 75 percent of the median benefits under current law (fig. 9). A full exemption for disabled workers would raise the benefits of those disabled workers who exclusively receive DI benefits to the currently scheduled levels. However, a partial exemption from price indexing would restore the median lifetime benefit to 89 to 90 percent of scheduled levels, depending on how the partial exemption is implemented. One type of partial exemption (Type I) uses price indexing to calculate the portion of the benefits based on the years a person is out of the workforce and receiving DI benefits. In contrast, the other type of partial exemption (Type II) uses wage indexing to cover the same time period. (For more details, please see app. I.) The difference between the two partial exemptions becomes more substantial the earlier one becomes disabled, as the difference between wages and prices increases over time. While offering some protection from benefit reductions, both types of partial exemptions involve a recalculation of benefits at the full retirement age. This recalculation would result in lower benefits for the DI recipient and could create a potential problem if that individual relied on the prior benefit amount and had limited options for replacing the lost income. (See figs. 10 and 11 for longevity indexing and progressive price indexing, respectively.)

Another protection option would be to allow disability benefits to grow at a greater rate than other benefits. For example, disabled workers could be explicitly included in the scope of the reform, and receive reduced initial benefits. However, instead of receiving annual increases based on the current-law COLA, disabled workers could have their benefits increased by a “super COLA”—one that is set above the Consumer Price Index. In this case, benefits for the disabled would grow at a faster rate than they would under current law and could approach or even exceed current law levels. Variations on the super-COLA could include an “age-indexed super COLA” which would be greater for those disabled at younger ages. For those workers who become disabled near the full retirement age the COLA would be closer to that used for retirees. These protections could be particularly beneficial for disabled workers who receive benefits for a prolonged period of time.

Protections for Dependent Benefits Could Be Targeted to Certain Vulnerable Beneficiaries, Including Survivors

While protections for disabled workers would generally cover all such beneficiaries, the options for protecting dependent benefits could be more targeted to specific dependents and not necessarily applied to the full range of dependents, which includes spouses, divorcees, widow(er)s, and child survivors. The circumstances around which a person becomes a dependent vary greatly, as does the role of Social Security benefits in their lives. For some, Social Security may be the primary source of support; for others, it may be only a small proportion of their income.

Protections could target children, who make up about 8 percent of Social Security beneficiaries, receiving benefits as the survivors or dependents of disabled or retired workers. Table 3 shows the number of children who receive benefits in each category and the average monthly benefit for these children. One way to protect the benefits of children would be to exempt them from any reform, keeping their benefit calculation tied to current law. Another way to protect their benefits to some degree would be to raise the maximum benefit a family could receive on a single worker’s earnings record.

The majority of experts with whom we spoke told us that increasing the maximum amount that a family could receive from one worker’s earnings record could help protect child and other dependent benefits. Such an increase could help those dependents who are constrained by the family maximum. A family may have several people receiving benefits based on one worker’s record. The sum of the family members’ benefits may exceed the specified maximum, which is calculated as a percentage of the worker’s benefit amount. Thus, any reform that would result in a decrease in the primary benefit amount would also result in a decrease in the amount that each eligible family member would receive and a corresponding decrease in the total amount a family would receive.

Certain options, including increased allowable benefits for widows or partial exemptions, could be designed to protect the benefits of widow(er)s or others who may have fewer resources available to them. Under current law, widows and widowers can collect 100 percent of their deceased spouse’s benefits (or their own benefit—whichever is greater); a “widow’s boost” would allow them to receive up to 75 percent of the couple’s combined benefits. Widow(er)s may rely on Social Security for a large percentage of their retirement income, in part because they may live many years beyond the exhaustion of other financial resources, may find it difficult to work, or may incur large health expenses that deplete their other resources.

A reduction in the COLA may be particularly detrimental to the lifetime benefits of those who live long lives, because the effect of reducing the COLA is compounded over time. As such, it may be desirable to protect older widow(er)s—along with other individuals who receive benefits for a prolonged period of time—from the effect of a COLA reduction. For example, in our projections for the COLA reduction, we found that for the group of widows who received some benefits and who died before age 75, median lifetime benefits would be approximately 93 percent of those under current law. In contrast for those who lived past age 95, median lifetime benefits would be only 83 percent of currently scheduled levels.

Some Protection Options May Create New Costs and Unintended Incentives for the Social Security Program

The options for protecting the benefits of disabled workers and those of dependents come at a cost to the Social Security program in terms of its solvency. In addition, some protections options may create incentives for people to apply to the Disability Insurance program if DI benefits increase while retirement benefits stay stable. Further, protection options could provide disincentives for some to return to work.

Protecting the Benefits of Disabled Workers and Dependents Would Increase Costs for the Social Security Program

The Social Security reform elements we examined were designed primarily to improve program solvency. These reform elements would generally reduce benefits from their currently scheduled but underfunded levels. While protecting the benefits of disabled workers and dependents may be socially desirable, such protection would come at some cost to the Social Security program. In particular, the protections lessen the degree to which the potential reforms could restore solvency. One could counter these costs with further benefit reductions to beneficiaries considered less vulnerable than those recipients whose benefits are specifically protected. That is, reform packages with certain benefit protections for vulnerable populations may necessitate further reductions in the benefits of retired workers or increases in revenues to achieve the intended solvency effect. In addition to the effects on solvency, some of the protections discussed may also have administrative costs associated with them.

Certain Protections May Create Incentives for Individuals to Apply for Disability Benefits

Protecting the benefits of disabled workers may increase the number of people who apply for disability benefits. This may also be relevant to certain reform elements. An increase in the full retirement age coupled with the reduction in benefits for early retirement could motivate some individuals approaching the early retirement age to apply for disability benefits, if they believed that they could qualify for the now greater DI benefits. For example, before a change in the retirement age a worker who is a year away from the full retirement age, and who would qualify for DI but is unsure of that outcome, may choose to wait and only receive Old Age benefits. Once the full retirement age is raised, this worker may choose to apply for DI, rather than waiting to receive retirement benefits. The greater the benefit disparity between the two programs, the more likely it may be that DI applications and enrollment will increase. Thus, the potential for an increase in DI program costs exists with any reform elements that decrease the generosity of the Old Age component of OASDI without a corresponding decrease in that of the DI component.

Under current law, there may already be an incentive for older workers to apply for DI rather than retire early. Using individual level data from the simulation model, we analyzed the benefits of two similar individuals under current law and under price indexing with and without full and partial exemptions. Both of the simulated individuals had similar lifetime earnings, close to the median for the simulated 1985 cohort, and both would have received initial benefits at age 62. However, they differed in two significant ways: one retired at age 62, while the other was disabled at age 62, and the retiree had lower lifetime benefits under current law. The retiree, who died at age 84, had lifetime benefits of about $433,000, while the disabled worker, who died at age 82, had lifetime benefits of about $505,000—about 16 percent higher than those of the retired worker.

A full exemption for disabled workers from certain reform elements could similarly create discrepancies between the two programs, resulting in incentives to apply for the DI program. Under price indexing, the lifetime benefits of both individuals would be reduced, but the relative difference would remain at about 16 percent. However, if disabled workers were fully exempted from price indexing, the simulated disabled worker’s lifetime benefits would be back to the initial amount of $505,000, or 72 percent greater than those of the retired worker. This difference in potential benefits would likely increase the incentive to apply for the DI program. Figure 12 and table 4 show the total lifetime benefits and the average monthly benefits of these two simulated individuals under current law, price indexing, and with exemptions.

However, partial rather than full exemptions or other protections, such as an age-indexed super COLA, could provide benefit protections without substantially increasing the disparity between the programs for people approaching the early or full retirement ages. Under a partial exemption, in which the disabled worker would be exempted from the reform until full retirement age, the added incentive that could be created by a full exemption would be reduced. Such a partial exemption for the disabled worker in our example would result in lifetime benefits that are about 33 percent higher than those of the retired worker under price indexing.

Certain Protections May Affect the Work Decisions of Beneficiaries

The family maximum limits the amount that can be received off of a worker’s record. This limit is compatible with the incentive for individuals to work. Changing such a limit could affect beneficiaries’ work decisions. For example, protecting benefits of dependents by increasing the family maximum could affect an individual’s work decisions. Under the current family maximum with a benefit reduction in place, if a person chooses to work 30 hours a week, an increase in the total amount a family (or individual dependents) could receive might affect this decision and decrease the person’s time in the workforce. In such a case, the individual may find that the increase in the benefits received would allow for fewer weekly hours of work without a change in total income. In addition, protections that increase the benefits of disabled workers, such as the super COLA, can also create disincentives for such beneficiaries to return to work. As such, some individuals may continue to rely on the DI program, rather than finding a way to re-enter the workforce.

Conclusions

Social Security’s financial challenges may result in program modifications that may include benefit reductions. These benefit reductions will likely affect all beneficiaries, including vulnerable individuals who may not be able to adjust to these reductions or who rely on Social Security as their primary source of income. While protecting the benefits of vulnerable populations may be desirable, such action does come at a cost. Further benefit reductions or revenue increases would be needed to achieve program solvency. These offsets, in turn, may create new financial vulnerabilities among other beneficiaries who would bear the burden of these protections.

Few reform proposals consider the impact that benefit reductions would have on all beneficiary types, instead treating all beneficiaries similarly. However, some special consideration should be given to the effects of the reform on the benefits of the most vulnerable, especially when these individuals are disproportionately affected. If the solution to Social Security’s financing problems includes benefit reductions, then the equal treatment of all beneficiaries may need to be reconsidered, and the complex interactions of benefit reductions, protections, and direct and indirect costs to the system and to other retirees will need to be weighed carefully. Benefit protections can be a part of a comprehensive reform package and the reform debate should consider the design, inclusion, and implications of such measures to assure income adequacy. Likewise, to the extent that Social Security aligns the disability program with the current state of science, medicine, technology, and labor market conditions, such modernization should also be considered.

Matter for Congressional Consideration

Accordingly, in light of potential reform, Congress should consider the potential implications of reform on disability and dependent beneficiaries. Such a review might usefully be coordinated with any modernization of the Social Security disability program.

Agency Comments

We provided a draft of this report to SSA and the Department of the Treasury, which generally agreed with our findings. Both provided technical comments, and SSA also provided general comments, which appear in appendix III. We incorporated the comments throughout our report as appropriate.

In general, SSA concurred with the methodology, overall findings, and conclusions of the report. However, SSA felt that the report could benefit from a more direct comparison of disabled beneficiaries and retired beneficiaries (and a similar construct for dependents). While such a comparison could be beneficial and give context to the reform discussion, this report was premised on the notion that certain beneficiaries would be less able to offset benefit reductions, rather than a comparison of relative welfare.

Finally, GAO agrees that one could better assess the degree to which a reform element or protection option support the program’s goal of adequacy if benefits were compared to a standard of adequacy; however such a comparison was beyond the scope of the current study.

As agreed with your offices, unless you publicly announce its contents earlier, we plan no further distribution until 30 days after the date of this letter. At that time, we will send copies of this report to the Social Security Administration and the Department of the Treasury, as well as other interested parties. Copies will also be made available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. Please contact me at (202) 512-7215, if you have any questions about this report. Other major contributors include Michael Collins, Nagla’a El-Hodiri, Jennifer Gregory, Joe Applebaum, Melinda Cordero, Mark Goldwein, Meaghan Mann, and Dan Schwimer.

Appendix I: Methodology

To analyze the effects of individual reform elements and certain protections from these reforms on Social Security benefit levels for disabled workers and dependents, we simulated their benefits using the Policy Simulation Group’s (PSG) microsimulation models. We based our analysis on projected lifetime benefits for a simulated 1985 birth cohort. In order to have a point of comparison, we also used the microsimulation models to simulate Social Security benefits of retirees who receive benefits on their own record.

Description of Social Security Reform Elements

Longevity Indexing

To simulate longevity indexing, which links the growth of initial benefits to changes in life expectancy, we successively modified the PIA formula replacement factors (90, 32, 15) beginning in 2009, reducing them annually by multiplying them by 0.995. This specification mimics provision 1 of Model 3 of the President’s Commission to Strengthen Social Security (CSSS). The CSSS solvency memorandum notes that the 0.995 successive reductions “reduces monthly benefit levels by an amount equivalent to increasing the normal retirement age (NRA) for retired workers by enough to maintain a constant life expectancy at NRA, for any fixed age of benefit entitlement.” This provision as specified and scored—using the intermediate assumptions of the 2001 Trustees’ report—in the CSSS memo by SSA’s Office of the Chief Actuary would improve the long-range OASDI actuarial balance (reduce the actuarial deficit) by an estimated 1.17 percent of taxable payroll.

Price Indexing

We also simulated the effects of price indexing, where initial benefits would be indexed to the consumer price index (CPI) in order to limit the growth of benefits. We successively modified the primary insurance amount (PIA) formula replacement factors (90, 32, and 15) beginning in 2012, reducing them successively by real wage growth in the second prior year. This specification mimics provision B6 of the August 10, 2005, memorandum to SSA’s Chief Actuary regarding the provision requested by the Social Security Advisory Board (SSAB), which is an update of provision 1 of Model 2 of the CSSS. As noted in the CSSS’s solvency memorandum from SSA’s Chief Actuary, “his provision would result in increasing benefit levels for individuals with equivalent lifetime earnings across generations (relative to the average wage level) at the rate of price growth (increase in the CPI), rather than at the rate of growth in the average wage level as in current law.” This provision as specified and scored by OCACT in the SSAB memo would improve the long-range OASDI actuarial balance (reduce the actuarial deficit) by an estimated 2.38 percent of taxable payroll.

Progressive Price Indexing

To simulate the effects of implementing a progressive price index, we mimicked provision B7 of the August 10, 2005, memorandum to SSA’s Chief Actuary. We created a new bend point at the 30th percentile of earnings, beginning in 2012. We maintained current-law benefits for earners at the 30th percentile and below. We also maintained the lower two PIA formula replacement factors (90 and 32). We reduced the upper two PIA formula replacement factors (32 and 15) so that maximum worker benefits from one generation to the next grew by inflation rather than the growth in average wages. This provision as specified and scored by OCACT would improve the long-range OASDI actuarial balance (reduce the actuarial deficit) by an estimated 1.43 percent of taxable payroll.

Increase the Number of Computation Years Used in the Initial Benefit Calculation

In our modeling of this reform element, we gradually reduced the number of drop out years from 5 to 0, thereby extending the number of computation years from 35 to 40. The number of computation years would increase to 36 in 2007, 37 in 2008, 38 in 2010, 39 in 2012, and 40 in 2014. This specification mimics provision B2 of the August 10, 2005 memorandum to SSA’s Chief Actuary. This provision as specified and scored by OCACT would improve the long-range OASDI actuarial balance (reduce the actuarial deficit) by an estimated 0.46 percent of taxable payroll.

Reduction in the Cost-of- Living Adjustment

We also simulated a reduction in the cost-of-living adjustment (COLA) of one percentage point, beginning in 2012. This specification mimics provision A2 of the August 10, 2005, memorandum to SSA’s Chief Actuary. This provision as specified and scored by OCACT would improve the long-range OASDI actuarial balance (reduce the actuarial deficit) by an estimated 1.49 percent of taxable payroll. Some reform proposals have called for reducing the COLA by about 0.2 percent to 0.4 percent, in response to methodological concerns that the CPI for urban wage earners and clerical workers, the current CPI measure used to adjust benefits, overstates inflation. The intent of these proposals is to implement a COLA that may more accurately reflect inflation.

Options Modeled to Protect Benefits of Disabled Workers

Full Exemption

To simulate the effects of fully exempting disabled workers from the various reform elements, we modified the simulation to exclude the benefits of disabled workers from the reform elements. As such, there would be no recalculation of benefits when the exempted beneficiary reached full retirement age.

Partial Exemptions

We defined partial exemptions for disabled workers to mean that their benefit would be exempted from any simulated reform until the FRA and then would be recalculated. For the COLA reduction, we simply started the one percentage point reduction at the FRA for disabled workers. However, for the reforms that involved a change in the initial benefit amount (longevity indexing, price indexing, and progressive price indexing), we simulated the recalculation of benefits at the FRA in two different ways.

Partial Exemption Type I— Kolbe-Stenholm

The first partial exemption, which we refer to as Partial Exemption Type I, followed the Kolbe-Stenholm model of converting benefits at the FRA. The Kolbe-Stenholm model reduces benefits in proportion to the difference in the disabled-worker PIA and the retired-worker PIA at the DI-onset age. This OASI benefit amount would be indexed by the COLA to for the years between the disability onset age and age 62.

Partial Exemption Type II—Graham

)

DIC is the promised DI benefit level under current law YD is the number of years (ages 21 to 62) that the disabled worker received DI benefits OASI is the OASI benefit level, calculated by computing the PIA under the reform using the formula applicable for newly eligible retired workers in the year the converting worker reached age 62. In this case, earnings from the years prior to disability would be wage indexed. The disability freeze years would apply in computing the AIME.

Data Reliability

To assess the reliability of simulated data from GEMINI, we reviewed PSG’s published validation checks and examined the data for reasonableness and consistency.

PSG has published a number of validation checks of its simulated life histories. For example, simulated life expectancy is compared with projections from the Social Security Trustees; simulated benefits at age 62 are compared with administrative data from SSA; and simulated educational attainment, labor force participation rates, and job tenure are compared with values from the Current Population Survey. We found that simulated statistics for the life histories were reasonably close to the validation targets.

Appendix II: Calculating OASDI Benefits

Social Security offers a variety of types of benefits, and although they are all based upon the same formula, they are calculated in different ways. The methods for calculating the different types of benefits are outlined below.

Calculating Old-Age Benefits

Old Age benefits are calculated through a four-step process in order to provide retirees with progressive yet wage-based cash payments (see fig. 13).

First a worker’s Average Indexed Monthly Earnings (AIME) is calculated by indexing the worker’s past earnings to changes in average wage levels over the worker’s lifetime and then averaging them. The AIME formula considers all years in which a worker earned covered earnings. It then uses the number of elapsed years from 1950 or attainment of age 21 through the age of 62 (or death) and allows for 5 “drop-out years” so that the worker’s highest 35 years of covered indexed earnings are used in the calculation. Once the AIME is determined, a progressive formula is applied to the AIME to yield a worker’s Primary Insurance Amount (PIA). In 2007, the PIA formula had the following bend points: 90 percent of the first $680 of AIME, plus 32 percent of the next $3,420, and 15 percent of any earnings above that level (fig. 13). For example, the PIA of a worker whose AIME was $1000, the equivalent of at $12,000 annual salary, would be the sum of $612 (90 percent of $680) and $102.40 (32 percent of $320), yielding a total initial monthly benefit of around $715. Similarly, the PIA of a worker with an $8,000 AIME (the equivalent of a $96,000 annual salary) would be the sum of $612 (90 percent of $680), $1094.40 (32 percent of $3420), and $585 (15 percent of $3,900), for a total of just under $2,292. Because the formula is both wage-based and progressive, the second worker receives a much higher actual benefit than the first worker ($2,292 versus $715), but his benefits are a much lower proportion of his past earnings than the first worker’s benefits (28.6 percent versus 71.4 percent).

If a worker retires at the full retirement age, which is currently between ages 65 and 66, and legislated to reach 67 in 2027, this PIA represents the first year’s benefit (although it is adjusted for inflation through a cost-of- living adjustment (COLA)). However, workers can begin receiving reduced benefits at 62; benefits are progressively larger for each month workers postpone drawing them, up to age 70. In general, benefits are actuarially neutral to the Social Security program; that is, the reduction for starting benefits before full retirement age and the credit for starting after full retirement age are such that the total value of benefits received over one’s lifetime is approximately equivalent for the average individual. Those receiving benefits before the full retirement age will also be subject to an earnings test. If earned income is above a certain threshold, Social Security withholds one dollar of benefits for every two dollars of earning above the threshold. Each year, benefits receive a COLA to keep pace with inflation.

Calculating Disability Benefits

Similarly to Old Age benefits, disability benefits are determined by calculating a worker’s AIME, applying the progressive PIA formula to it, and then adjusting benefit levels through yearly COLAs (fig. 14).

However, because disabled workers are likely to have shorter work histories, their benefits calculation relies on fewer years of earnings. In general, the number of years of earnings used to calculate the AIME is based on the total number of years between when a worker turns 21 and when he applies for DI. If this number of years is 25 or more, a worker’s 5 lowest (or zero) earnings years will be dropped from the calculation. The number of drop-out years gradually declines as a worker applies for disability earlier in life. If the disabled worker is 60 at the time of application, for example, 38 years would have elapsed since age 21. He will receive 5 drop out years, and his AIME will be calculated based upon his 33 highest-earning years. In contrast, if a worker applies for DI at 32, he would have only had 10 elapsed years since age 21, and only be eligible for 2 drop-out years; his AIME would be calculated based upon his top 8 years. At the full retirement age, disabled workers begin receiving retirement benefits, instead of disability benefits; however, benefit levels remain the same and continue to grow through annual COLAs.

Calculating Benefits for Dependents of Retired and Disabled Workers

Spouses: In addition to being eligible to receive retirement benefits on their own earnings records as early as age 62, individuals can also receive dependents’ benefits at age 62, based on their spouse’s benefit amount or, in some cases, that of an ex-spouse (table 5). These individuals can collect these benefits regardless of whether their spouse is concurrently receiving retired or disabled worker benefits. If collection begins at full retirement age, these individuals are eligible for either one-half of their spouse’s benefit amount, or the benefits based on their own earnings record; whichever is greater. As with Old Age benefits, adjustments are made if these individuals chooses to take early retirement.

Dependent Children: Dependent children may also qualify for one- half of their retired or disabled parent’s benefit amount. This benefit is available for disabled adult children who are not working on a regular basis, children under age 18, or children still in high school and under age 19.

Like other benefits, dependents’ benefits receive annual COLAs. Dependent benefits are subject to a family maximum, whereby a family is limited in the total amount of benefits that can be received from a single individual’s earnings record. The size of the family maximum is currently between 150 percent and 188 percent of the primary beneficiary’s benefit.

Calculating Survivors’ Benefits

Widow(er)s may be eligible to receive a one-time death benefit of $255. In addition, widow(er)s, surviving parents, children under the age of 18 (19 if the child is still in school) and disabled adult children can collect benefits off of the deceased person’s earnings record. A widow(er) at full retirement age will receive 100 percent of his or her spouse’s benefits, unless his or her own benefit is higher. Younger widow(er)s (those between age 60 and the full retirement age) can receive between 71 and 99 percent of their deceased spouses’ benefits depending on how close they are to the full retirement age. Furthermore, regardless of age, a widow(er) with young children, can receive 75 percent of the deceased spouse’s benefit. Surviving parents and children can also collect up to 75 percent of their deceased family members’ benefits. All of these benefits receive annual COLA adjustments and are subject to the family maximum.

Appendix III: Comments from the Social Security Administration

Related GAO Products

Retirement Security: Women Face Challenges in Ensuring Financial Security in Retirement. GAO-08-105. Washington, D.C.: October 11, 2007.

Retirement Decisions: Federal Policies Offer Mixed Signals about When to Retire. GAO-07-753. Washington, D.C.: July 11, 2007.

Social Security Reform: Implications of Different Indexing Choice. GAO-06-804. Washington, D.C.: Sept ember 14, 2006.

Social Security: Societal Changes Add Challenges to Program Protections. GAO-05-706T. Washington, D.C.: May 17, 2005.

Options for Social Security Reform. GAO-05-649R. Washington, D.C.: May 6, 2005.

Social Security Reform: Answers to Key Questions. GAO-05-193SP. Washington, D.C.: May 2, 2005.

Social Security Reform: Early Action Would Be Prudent. GAO-05-397T. Washington, D.C.: March 9, 2005.

Long Term Fiscal Issues: The Need for Social Security Reform. GAO-05-318T. Washington, D.C. February 9, 2005.

Social Security: Distribution of Benefits and Taxes Relative to Earnings Level. GAO-04-747. Washington, D.C.: June 15, 2004.

Social Security: Program’s Role in Helping Ensure Income Adequacy. GAO-02-62. Washington, D.C.: November 30, 2001.

Social Security Reform: Potential Effects on SSA’s Disability Programs and Beneficiaries. GAO-01-35. Washington, D.C.: January 24, 2001.

Social Security: Evaluating Reform Proposals. GAO/AIMD/HEHS-00-29. Washington, D.C.: November 4, 1999.

Social Security Reform: Implications of Raising the Retirement Age. GAO/HEHS-99-112. Washington, D.C.: August 27, 1999.

Social Security: Issues in Comparing Rates of Return with Market Investments. GAO/HEHS-99-110. Washington, D.C.: August 5, 1999.

Social Security: Criteria for Evaluating Social Security Reform Proposals. GA0/T-HEHS-99-94. Washington, D.C.: March 25, 1999.