The 1935 Social Security Act mandated coverage for most workers in commerce and industry, which at that time comprised about 60 percent of the workforce. State and local government employees were excluded because they had their own retirement systems and there was concern over the question of the federal government’s right to impose a tax on state governments. Subsequently, the Congress extended mandatory Social Security coverage to most of the excluded groups, including state and local employees not covered by a public pension plan. The Congress also extended voluntary coverage to state and local employees covered by public pension plans. Since 1983, however, public employers have not been permitted to withdraw from the program once they are covered. SSA estimates that 96 percent of the workforce, including 70 percent of the state and local government workforce, is now covered by Social Security. Social Security provides retirement, disability, and survivor benefits to insured workers and their dependents. Insured workers are eligible for full retirement benefits at age 65 and reduced benefits at age 62. Social security retirement benefits are based on the worker’s age and career earnings, are fully indexed for inflation after retirement, and replace a relatively higher proportion of the final year’s wages for low earners. Social Security’s primary source of revenue is the Old Age, Survivors, and Disability Insurance portion of the payroll tax paid by employers and employees. The payroll tax is 6.2 percent of earnings each for employers and employees, up to an established maximum. SSA estimates that 5 million state and local government employees, excluding students and election workers, are not covered by Social Security. SSA also estimates that annual wages for noncovered employees total about $132.5 billion. Seven states—California, Colorado, Illinois, Louisiana, Massachusetts, Ohio, and Texas—account for more than 75 percent of the noncovered payroll. A 1995 survey of public pension plans found that police, firefighters, and teachers are more likely to occupy noncovered positions than other employees. specified benefit rate for each year of service and the member’s final average salary over a specified time period, usually 3 years. For example, plans with a 2-percent rate replace 60 percent of a member’s final average salary after 30 years of service. In addition to retirement benefits, a 1994 Department of Labor survey found that all members have a survivor annuity option, 91 percent have disability benefits, and 62 percent receive some cost-of-living increases after retirement. As part of our study, we examined nine state and local defined benefit plans covering over 2 million employees. For those plans, employer contributions ranged from 6 to 14.5 percent of payroll and employee contributions ranged from 6.4 to 9.3 percent of payroll. (See the appendix.) Extending mandatory Social Security coverage to states and localities with noncovered workers would reduce the trust funds’ long-term financial shortfall, increase program participation, and simplify program administration. SSA estimates that mandatory coverage would reduce Social Security’s financial shortfall by about 10 percent—from 2.19 percent of payroll (a present discounted value of $3.1 trillion) to 1.97 percent of payroll (a present discounted value of $2.9 trillion)—over a 75-year period. Figure 1 shows that mandatory coverage would also extend the program’s solvency by about 2 years, from 2032 to 2034. As with most other elements of the reform proposals put forward by the 1994-1996 Social Security Advisory Council, such as raising the retirement age, extending mandatory coverage to newly hired state and local employees would resolve only a part of the trust funds’ solvency problem. A combination of adjustments will be needed to extend the program’s solvency over the entire 75-year period. Council stated that mandatory coverage is basically “an issue of fairness.” The Advisory Council report stated that “an effective Social Security program helps to reduce public costs for relief and assistance, which, in turn, means lower general taxes. There is an element of unfairness in a situation where practically all contribute to Social Security, while a few benefit both directly and indirectly but are excused from contributing to the program.” Mandatory coverage would also simplify program administration in the long run. SSA’s Office of Research, Evaluation, and Statistics estimates that 95 percent of noncovered state and local employees become entitled to Social Security as either workers, spouses, or dependents. SSA’s Office of the Chief Actuary estimates that 50 to 60 percent of noncovered employees will be fully insured by age 62 from covered employment. The Congress has established the government pension offset and windfall elimination provisions to reduce the unfair advantage that workers who are eligible for pension benefits based on noncovered employment might have when they apply for Social Security benefits. The earnings histories for workers with noncovered earnings may appear to qualify them for the higher earnings replacement rates that Social Security assigns to lower earners, when in fact they have substantial income from public pension plans. With some exceptions, the government pension offset and windfall elimination provisions require SSA to use revised formulas to calculate benefits for workers with noncovered employment. However, a separate GAO study for the Chairman of this Subcommittee indicates that SSA is often unable to determine whether applicants should be subject to the government pension offset or windfall elimination provisions. We estimate that failure to reduce benefits for federal, state, and local employees caused $160 million to $355 million in overpayments between 1978 and 1995. In response, SSA plans to perform additional computer matches with the Office of Personnel Management and the Internal Revenue Service (IRS) to get noncovered pension data in order to ensure that these provisions are applied. Mandatory coverage would reduce benefit adjustments by gradually reducing the number of employees in noncovered jobs. Eventually, all state and local employees, with the exception of a few categories of workers, such as students and election workers, would be in covered employment. Additionally, in 1995, SSA asked its Inspector General to undertake a review of state and local government employers’ compliance with Social Security coverage provisions. In December 1996, SSA’s Office of the Inspector General reported that Social Security provisions related to coverage of state and local employees are complex and difficult to administer. The report stated that few resources were devoted to training state and local officials and ensuring that administration and enforcement roles and responsibilities are clearly defined. The report concluded that there is a significant risk of sizeable noncompliance with state and local coverage provisions. In response, SSA and IRS, which is responsible for collecting Social Security payroll taxes, initiated an effort to educate employers and ensure compliance with legal requirements for withholding Social Security payroll taxes. If all newly hired public employees were to receive mandated Social Security coverage, they would have the income protection afforded by Social Security. Also, they and their employers would pay the combined Social Security payroll tax of 12.4 percent of payroll. Each state and locality with noncovered workers would decide how to respond to the increase in retirement costs and benefits. They could absorb the added cost and leave current pension plans unchanged or eliminate plans completely. From discussions with state and local representatives, however, we believe states and localities with noncovered workers would likely adjust their pension plans to reflect Social Security’s costs and benefits. To illustrate the implications of mandatory coverage to employers and employees, we examined three possible responses: States and localities could maintain similar benefits for current and newly hired employees. This response would likely result in an increase in total retirement costs and some additional benefits for many newly hired employees. States and localities could examine other pension plans that are already coordinated with Social Security and provide newly hired employees with similar benefits. This response would also likely increase costs and benefits for newly hired employees. States and localities could maintain level retirement spending. This response could require a reduction in pension benefits. According to pension plan representatives, each of these responses to mandatory coverage would result in reduced contributions to current plans, which could affect long-term financing of the plans. States and localities with noncovered workers could opt to provide newly hired employees with Social Security and pension benefits that, in total, approximate the pension benefits of current employees. Studies indicate that such an option could increase retirement costs by 7 percent of new-employee payroll. Using SSA’s data and its assumption that mandatory coverage would start January 1, 2000, a 7 percent of payroll increase in retirement costs for newly hired employees would mean additional costs to states and localities with noncovered workers of about $9.1 billion over the first 5 years. A 1980 study of the costs of providing Social Security coverage for noncovered workers provides support for the estimated 7 percent of payroll increase. The Universal Social Security Coverage Study Group developed options for mandatory coverage of employees at all levels of government and analyzed the fiscal effects of each option. The study group used two teams of actuaries to study over 40 pension plans. The study estimated that costs, including Social Security taxes and pension plan contributions, would need to increase an average of 2 to 7 percent of payroll to maintain level benefits for current and newly hired employees. The study assumed that most newly hired employees would have salary replacement percentages in their first year of retirement that would be comparable to those provided to current employees. For example, employees retiring before age 62 would receive a temporary supplemental pension benefit to more closely maintain the benefits of the current plan. Since Social Security benefits are fully indexed for inflation and many pension plans have limited or no cost-of-living protection, total lifetime benefits for many newly hired employees would be greater than those provided to current employees. Existing pension plan disability and survivor benefits were also adjusted to reflect Social Security disability and survivor benefits. example, a December 1997 study for a plan in Ohio indicated that providing retirement and other benefits for future employees that, when added to Social Security benefits, approximate benefits for current employees would require an increase in contributions of 6 to 7 percent of new-employee payroll. A 1997 study for a pension plan in Illinois indicated the increased payments necessary to maintain similar total benefits for current and future employees would be about 6.5 percent of new-employee payroll.