A Paper Prepared for The Commission
on the Social Security 'Notch' Issue
by James
W. Kelley
Former Staff Director, Subcommittee
on Social Security, House Ways and Means Committee
and
Joseph R. Humphreys
Former Professional Staff Member,
Senate Finance Committee
TABLE OF CONTENTS
OVERVIEW
I INTRODUCTION
WHAT IS THE NOTCH?
CONGRESSIONAL INTENT
II THE LEGISLATIVE ROOTS OF THE NOTCH
BENEFIT INCREASES PRIOR TO THE AUTOMATIC COST OF LIVING ADJUSTMENTS
1. Legislative action in 1969
2. Legislative action in 1970
3. Legislative action in 1971
4. Legislative action in 1972
III DEFECTS IN THE AUTOMATICS APPEAR
ACTUARIAL STATUS IN 1972
1973 UNEXPECTED INFLATION
1974 TRUSTEES REPORT INDICATES A PROBLEM
FIRST HSIAO PANEL CONFIRMS A VERY SEVERE FINANCING PROBLEM
1974 ADVISORY COUNCIL RECOMMENDS WAGE INDEXED FORMULA
SECOND HSIAO PANEL RECOMMENDS PRICE INDEXED APPROACH
IV LEGISLATIVE ACTION
FORD ADMINISTRATION PROPOSAL
PRESIDENT CARTER'S RECOMMENDATIONS
DIFFERENCE IN ADMINISTRATION BILLS CONCERNING THE NOTCH
HOUSE ACTION IN 1977
SENATE ACTION IN 1977
FINAL CONGRESSIONAL ACTION
1979 CONGRESSIONAL HEARING ON THE NOTCH
V CONCLUSIONS
OVERVIEW
The 1970's were tumultuous years
for the Social Security System. In 1972, legislation was enacted
designed to automatically keep benefits up to date with inflation
while at the same time assuring adequate financing to support the
program into the long-range future. In addition, the 1972 legislation
provided a one-time increase of 20% in Social Security benefit levels.
Almost immediately economic conditions dramatically worsened with
serious consequences for the Social Security program. Rapid inflation
caused Congress to add additional ad hoc benefit increases. The
unexpectedly high inflation also interacted unfavorably with the
new automatic benefit formula, and caused benefit costs to eat into
the trust fund reserves. During this same period, it became clear
that other factors such as disability experience and long-range
fertility trends were developing in ways that would undermine the
program's financing. By 1977, the long-range actuarial situation
of the Social Security system was enormously out of balance and,
in the short-range, trust fund reserves were facing exhaustion within
a very few years. At the same time, the 1970's was a recessionary
period and the prospect of raising taxes -always unpleasant -- was
particularly unappealing.
The 1977 Social Security amendments
attempted to restore the program's financial soundness. A major
element of those amendments was a change in the formula (i.e. benefit
computation method) for Social Security benefits. Individuals born
prior to 1917 were left under the old formula. Individuals born
after 1916 were required to have their benefits computed under the
new rules. Many of those born in 1917 and the years immediately
following 1917 believe that the change unfairly discriminates against
them as compared with persons born in earlier years and also as
compared with those who come well after them.* This alleged discriminatory
impact is referred to as the notch issue.
(*Note that individuals
born on January 1 of a particular year are considered to have been
born in the previous year.)
Social Security is a complex program
having many rules which can significantly affect benefit levels.
This makes it difficult to compare the benefits payable to individuals
whose circumstances are not identical in every respect. Under either
the old law or the new law, it is possible to draw examples of individuals
who seem in many ways to be similarly situated but who get strikingly
different benefits because they are not identically situated. It
is also possible to find reasonable examples of a "reverse
notch" under which the 1977 amendments have resulted in substantially
higher benefits for persons born after 1916 compared to persons
born a few days earlier (but just prior to 1917) who have very similar
or even identical earnings histories.
Nonetheless, the basic operations
of the new and old benefit formulas do tend in many cases to create
the results cited as the notch issue. The two sides of the notch
-- the comparison with later retirees and the comparison with earlier
retirees -- arise from different decisions.
Future beneficiaries do better
than those who came on the rolls in the years just after implementation
of the 1977 amendments. The 1977 benefit formula is designed to
provide stable replacement rates -- benefits as a percentage of
preretirement earnings. Since, in most years, wages rise faster
than prices, this tends to result in each year's new cohort of beneficiaries
receiving benefits which are higher in real terms than the initial
benefits for similar retirees in previous years. Both the mechanics
of this result and the principle that it gives higher benefits for
workers m the future appear to be a conscious policy choice made
by Congress. A Congressional panel had recommended an alternative
approach of keeping initial benefits level in real terms from year
to year. One of the rationales stated for that approach in the panel's
report was that it would avoid treating the retirees in future years
better than the retirees in earlier years. This alternative approach
was considered and specifically rejected by the Congress.
The other, and more widely discussed,
side of the notch issue is the differential in benefits between
those in the prenotch years (born prior to 1917) and those born
in the notch years (the 5 to 10 years after 1916). In general terms,
it can be said that the result is consistent with the overall objective
that Congress intended to achieve which was to restore the solvency
of the program by a combination of increased revenues and constrained
benefits -- and in particular by adopting a new benefit formula
that was less generous (particularly in times of high inflation)
than the old law benefit formula.
In the 1977 Social Security amendments,
therefore, Congress acted to restore the solvency of the program
by a variety of measures aimed primarily at cutting costs and raising
revenues. The most significant cost cutting item was the adoption
of a new benefit formula that was intentionally set at a level which
represented a rollback from the levels attained by the old formula.
In implementing any new system, a decision has to be made as to
when and how it will be applied. Congress chose to make the new
formula effective for those who would attain retirement age starting
about a year after the law was enacted, that is, those born in or
after 1917, who would reach age 62 in or after 1979.
The fact that Congressional intent
was to implement a less generous benefit formula is, in a general
way, consistent with the result that those in the notch years receive
lower benefits than those in the prenotch years. However, there
is no evidence that Congress directly focused on the question of
comparative benefits for the two groups. The legislation did include
a transition clause for individuals reaching age 62 in the first
five years after implementation, but this provision was aimed at
protecting the benefit expectations of those individuals rather
than at providing any type of parity with those born in other years.
In the hearings on the legislation, one witness did submit with
his testimony (before the Senate and House Committees) an addendum
which clearly and specifically identified the notch issue, but there
is no evidence of any follow up to this testimony.
Why did Congress not focus on this
issue? The ability to analyze the impact of the 1977 benefit formula
was constrained in a number of ways. There were a large number of
major issues competing for attention including novel and controversial
financing schemes and other difficult benefit rule changes. For
most of the period of Congressional consideration, there were multiple
contenders for the role of new benefit formula each of which would
have affected the comparison in different ways. Also, the complexity
of the Social Security system makes it difficult to construct truly
typical examples.
Nonetheless, examples could have
been constructed to address the question of benefit differentials
between those coming under the new law and those remaining under
the old law. Had such examples been constructed, they would have
shown much smaller differentials than those which actually materialized
because the assumptions underlying the 1977 amendments did not foresee
the unprecedented inflation of the following several years.
It can only be a matter of conjecture
as to how Congress would have reacted if the notch issue had been
clearly framed at the time of the 1977 amendments. If Congress had
wanted to change the policy, it could have done so. The notch, in
fact, would not have occurred under the legislation originally submitted
by the Administration in 1976 since it would not have permitted
those born before 1917 to use post-1978 wages in an old-law computation.
For reasons unrelated to the notch issue, this restraint was dropped
when the new Administration resubmitted the legislation in 1977.
The notch could also have been lessened by allowing those in the
transition years (born 1917-1921) to use post-age-62 earnings, as
apparently envisioned by the 1974 Advisory Council or by a transition
clause involving a blending of old and new law benefit computations,
as recommended by the Hsiao panel. Other approaches also might have
been developed for Congressional consideration. If Congress had
addressed the issue, the overwhelming concern to restore program
solvency would logically have leant support to the approach of limiting
benefit growth for those remaining under the old-law, rather than
raising benefit levels for those qualifying for benefits under the
new benefit formula.
I INTRODUCTION
This report was undertaken at the
request of the Commission on the Social Security "Notch"
Issue with a view to examining the legislative background of that
issue and, insofar as possible, the Congressional intent underlying
the legislation involved.
What is the Notch?
In the Social Security Amendments
of 1977, Congress changed the formula for computing Social Security
benefit amounts. The change in law was made effective for individuals
reaching age 62 (the age of first eligibility for Social Security
retirement benefits) in 1979 or later. Persons born in 1916 or earlier
remained eligible for benefits under the old formula and were not
allowed to use the new formula. Persons born in 1917 or later were
required to use the new formula. They were not allowed to use the
old-law formula, but a special "transitional" formula
was provided as an alternative for those reaching age 62 in the
first five years of the new law: 1979-1983.
The new formula, in its first year
of applicability (1979), was designed to produce benefit levels
averaging about 5% lower than those that would have resulted from
the old formula.(1) However, under the transition formula, persons
reaching eligibility age
and retiring in 1979 were guaranteed a benefit at least
equal to the benefit the old law formula would have produced.
For persons reaching age 62 after
1978, the new formula generally produced lower benefits than would
have been available under the old formula. Both the old and new
formulas were automatically adjusted in a way that results in increasing
benefit levels from year to year. However, the growth rate in benefit
levels under the old formula was higher than the growth rate under
the new formula. Consequently, persons who could continue to use
the old formula (i.e., persons who were born prior to 1917) and
who worked beyond 1978 tended to receive benefits that were higher
(in many cases significantly higher) than persons with comparable
earnings who were required to use the new formula (i.e. persons
born after 1916).(2)
For those born from 1917 through
1921, the transition clause provided a guarantee that their benefits
would be no lower than what they would have qualified for under
the old law formula as of 1979. However, the old law formula was
applied for these persons without adjustment for inflation between
1978 and the year of first eligibility (age 62) and without the
use of earnings after age 62. Both of these elements--inflation
adjustments and post-62 earnings--tended to heavily influence the
growth of benefit levels under the old law formula. Consequently,
the transition formula often did little or nothing to lessen the
differential between benefit levels for those born in and after
1917(3) compared with those born earlier.
(1) Conference
report on 1977 amendments (House Report No. 95-837) as printed in
U.S. Congress, Congressional Record, (Permanent Edition), v. 128,
p. 38943. (December 15, 1977).
(2) It was,
however, quite possible for some
individuals to receive significantly higher benefits under the new
benefit formula than what was payable to persons with similar earnings
records who were born prior to 1917 and thus required to use the
old law formula. An example would be two women, one born in December
1916 and the other in January 1917. If both had maximum earnings
from 1951 through 1965 (age 35 through 49) and then dropped out
of the work force to care for an elderly parent, the woman born
in 1917 (a notch year) would qualify in January 1979 for a benefit
of $241.80 while the pre-notch woman (born a few days earlier but
in 1916) would have a benefit of $200.40. In other words, with the
same earnings record and a birth date a few days apart, the notch
years retiree would get a 20 % higher benefit than the pre-notch
retiree.
(3) There is
no universally accepted definition of what constitutes the "notch
years''. It clearly begins with those born in 1917 -- the first
category permitted and required to use the new wage indexing formula.
The birth year ending the notch period is most commonly considered
to be either 1921 or 1926.
While most discussions of the notch
issue focus particular attention on the noticeably lower benefit
level for many of those born in and after 1917 compared with the
benefit level for those born earlier, there is also an issue related
to comparative benefits for those in the notch years and those who
came on the rolls after the notch years. The very term "notch"
implies a "V" or "U" shaped cut in which the
area cut out is lower than the areas on either side of the cut.
Because initial dollar benefit levels do grow from year to year
under the new formula, individuals reaching eligibility age well
after the 1979 changeover year will receive higher benefits than
those who came before them. This is true even if benefit levels
are adjusted for inflation.
Thus the notch category - those
born in the first few years after 1916 -- did in many cases receive
benefits which can be characterized as lower than the benefits for
those who came before them and lower than the benefits for those
who came after them. Benefits were lower than for those who came
before them because the new benefit formula was intended to produce
lower benefits than the prior law formula. Benefits were lower than
for those who came after them because the new benefit formula is
designed to provide each year's cohort of retirees with benefits
which, in real terms, are higher than the benefits payable to comparable
workers who reached retirement age in earlier years.
Congressional Intent
Congressional intent is sometimes
clearly delineated in the legislation itself or in the Committee
reports and floor debates accompanying the consideration of a measure.
This is not the case with respect to the notch issue.
The legislative record contains
some discussion, as noted later in this paper, of the fact that
the new benefit formula provided lower real benefits for those reaching
retirement age in any given year compared with those who would retire
in later years. On the more prominent aspect of the notch issue,
however, there is no outright statement in the "official"
legislative history to indicate that Congress focused its attention
on the question of whether those reaching eligibility in the first
several years after enactment would receive substantially different
benefits from those coming before them. Consequently, there is also
no clear and obvious indication of whether such a result would or
would not have been acceptable to the Congress at the time of enactment.
In the absence of any clear statements
of intent, this paper attempts to provide an indirect analysis of
Congressional intent by examining the context surrounding the 1977
amendments in addition to the official legislative history. What
were the main objectives addressed by the legislation and how is
the notch result consistent or inconsistent with those objectives?
What alternatives did Congress consider and not adopt and how would
those alternatives have affected the outcome of this issue? Since
the 1977 legislation was designed in large part to remedy problems
with the 1972 legislation, what was Congress trying to achieve in
1972 and to achieve better in 1977? What were the purposes of the
1977 transition clause, and how did it achieve, or fail to achieve,
those purposes? What were the economic expectations underlying the
1977 amendments, and how did those expectations and the actual economic
results affect the notch issue?
II THE LEGISLATIVE
ROOTS OF THE 1972 AND 1977 BENEFITS FORMULA
Benefit Increases
Prior to the Automatic Cost of Living Adjustments
When the Social Security programs
was enacted in the Social Security Act of 1935, it provided for
benefit payments only to workers in "commerce and industry"
when they retired from employment at age 65 or later. The system
then established has been expanded in the intervening years both
in coverage and in the types of economic protection afforded to
workers and their dependents.
The major subsequent laws which
broadened the system included benefits for dependents and survivors
of covered workers enacted in 1939; coverage for additional types
of workers, largely in the 1950's, 1960's, and 1970's; benefits
for disabled workers enacted in 1956; and the creation of the Medicare
program, financed in part by employment taxes, enacted in 1965.
The automatic cost of living adjustments
were enacted in 1972 following a three-year period of intense Congressional
action dealing with proposed changes to a broad range of Social
Security Act programs. These included: the enactment of the Supplemental
Security Income (SSI) program which federalized the state administered
adult public assistance programs; reforms to the Aid to Families
with Dependent Children (AFDC) program including the Nixon Administration's
proposed Family Assistance Plan, which failed of enactment; numerous
Medicare and Medicaid amendments; and major amendments to the unemployment
compensation program. During the same period, the House Ways and
Means Committee and Senate Finance Committee were also occupied
with major trade and tax legislation.
The focus of this section is limited
to the history of Social Security benefit increases that preceded
the benefit formula provisions of the 1977 amendments, which resulted
in the enactment of the "notch." Only those prior amendments
that had some relationship to benefit increases will be mentioned.
The automatic cost-of-living benefit
adjustments enacted in 1972 were based, in principle, on the same
approach used in designing all of the ad hoc benefit increases that
were enacted in prior years.
Prior to the 1972 amendments "static"
economic assumptions were used to determine the long-range future
cost of the Social Security program. The application of these static
assumptions was a deliberately conservative approach to financing
the program. In brief, the static assumptions held that wages and
prices would not increase in the future but would remain at the
same level they had attained at the time of the estimate.(5)
(4) The Social
Security Act of 1935 also contained separate titles to create additional
programs for the needy and the unemployed which have developed independently.
References in this paper to the Social Security program are to the
Old-Age, Survivors, and Disability Insurance program (OASDI) which,
in the 1935 legislation, was the Old-Age Insurance program.
(5) See discussion
of financing methodology in U.S. House of Representatives, Reports
of the 1971 Advisory Council on Social Security, House Document
No. 92-80, Washington, U.S. Government Printing Office, pp. 64-66.
The application of static economic
assumptions resulted in periodic surpluses in the Social Security
trust funds as wages levels increased providing additional Social
Security tax income to the program. These surpluses, augmented by
legislated changes in Social Security (FICA) tax rates and the amount
of annual earnings subject to tax (the wage base), were used to
finance ad hoc benefit increases and other program liberalizations
prior to the adoption of the automatics in the 1972 amendments.
The following table of benefit increases and price increases indicates
that, except for the period prior to 1950(6) and in the case of
the 1973 Amendments(7), Congress enacted ad hoc benefit increases
that exceeded increases in the CPI, prior to the first scheduled
operation of the automatics in June 1975.
(6) Social Security
benefits were not paid until January 1940
(7) The 1973 amendments
provided earlier benefit increases in 1974 that would not have occurred
under the automatics until June of 1975.
HISTORY
OF PERCENTAGE INCREASES IN BENEFITS AND PRICES
|
|
Across-the-Board
Increase in Benefits |
Increase
in CPI (1) |
Act
|
Date
of Enactment |
Effective
Date |
Each
Amendment |
Cumulative
Since Amendments of 1939 |
Between
Effective Dates |
Cumulative
Since Amendments of 1939 |
1939
|
8/10/39
|
1/40
|
-----
|
-----
|
-----
|
-----
|
1950
|
8/28/50
|
9/50
|
77.0%
(2) |
77.0%
|
75.5%
|
75.5%
|
1952
|
7/18/52
|
9/52
|
12.5
(3) |
99.1
|
9.3
|
91.8
|
1954
|
9/1/54
|
9/54
|
13.0
(4) |
125.0
|
0.5
|
92.8
|
1958
|
8/28/58
|
1/59
|
7.0
(5) |
140.8
|
8.0
|
108.2
|
1965
|
7/30/65
|
1/65
|
7.0
|
157.6
|
7.9
|
124.7
|
1967
|
1/2/68
|
2/68
|
13.0
|
191.1
|
9.2
|
145.3
|
1969
|
12/30/69
|
1/70
|
15.0
|
234.8
|
10.8
|
171.8
|
1971
|
3/17/71
|
1/71
|
10.0
|
268.2
|
5.2
|
185.9
|
1972
|
7/
1/72 |
9/72
|
20.0
|
341.9
|
5.9
|
202.8
|
1973
|
12/31/73
|
6/74
|
11.0
(6) |
390.5
|
16.4
|
252.5
|
1973
|
Automatic
|
6/75
|
8.0
|
429.7
|
9.3
|
285.3
|
1973
|
Automatic
|
6/76
|
6.4
|
463.7
|
5.9
|
308.0
|
1973
|
Automatic
|
6/77
|
5.9
|
496.9
|
6.9
|
336.1
|
1973
|
Automatic
|
6/78
|
6.5
|
535.7
|
7.4
|
368.4
|
1973
|
Automatic
|
6/79
|
9.9
|
598.6
|
11.1
|
420.4
|
1973
|
Automatic
|
6/80
|
14.3
|
698.5
|
14.2
|
494.3
|
1973
|
Automatic
|
6/81
|
11.2
|
788.0
|
9.5
|
550.8
|
1973
|
Automatic
|
6/82
|
7.4
|
853.7
|
7.1
|
597.0
|
1973
|
Automatic
|
12/83
|
3.5
|
887.1
|
3.9
|
624.2
|
1973
|
Automatic
|
12/84
|
3.5
|
921.6
|
3.5
|
649.5
|
1973
|
Automatic
|
12/85
|
3.1
|
953.3
|
3.6
|
676.5
|
1973
|
Automatic
|
12/86
|
1.3
|
967.0
|
0.7
|
681.9
|
1973
|
Automatic
|
12/87
|
4.2
|
1011.8
|
4.5
|
717.1
|
1973
|
Automatic
|
12/88
|
4.0
|
1056.3
|
4.4
|
753.1
|
1973
|
Automatic
|
12/89
|
4.7
|
1110.6
|
4.5
|
791.5
|
1973
|
Automatic
|
12/90
|
5.4
|
1176.0
|
6.1
|
845.9
|
1973
|
Automatic
|
12/91 |
3.7
|
1223.2
|
2.8
|
872.4
|
1973
|
Automatic
|
12/92
|
3.0
|
1262.9
|
2.9
|
900.6
|
1973
|
Automatic
|
12/93
|
2.6
|
1298.3
|
2.5
|
925.6
|
(1)
1967=100 CPI-W
(2) Average increase
of about 77%--from 100% at lowest to 50% at highest level.
(3) Greater of 12.5%
or $5
(4) Guarantee of 7%
or $3
(5) Guarantee of 7%
or $4
(6) 11% increase in
benefits effective June 1994, with 7% of this amount payable March
1974. SOURCE: Social Security Administration
Following is a brief summary of
legislative actions taken from 1969 through 1972 on ad hoc benefit
increases and on the adoption of the automatic provisions
1. Legislative
action in 1969
On September 25,1969, President
Nixon sent his Social Security recommendations to Congress and they
were introduced by Minority Leader Gerald Ford as H.R. 14080.(8)
The bill contained a 10% benefit
increase and automatic benefit increases based on future increases
in the cost-of-living plus additional amendments relating to benefit
categories.
The House Ways and Means Committee
started public hearings on September 30, 1969, on H.R. 14080, together
with H.R. 14173, President Nixon's proposed welfare reform amendments.
The hearings continued until November 13. The Committee went into
executive session on November 19 to consider both the Social Security
and the welfare reform proposals.
On December 8, the Ways and Means
Committee unanimously reported a separate bill (H.R. 15095) which
was introduced by Chairman Wilbur D. Mills and ranking Minority
member John Byrnes on December 4. The bill provided a 15% benefit
increase effective for January 1970 and numerous modifications to
the President's proposals. The bill did not contain any financing
amendments since the OASDI trust funds had a favorable actuarial
balance of 1.16% of payroll.(9) Following floor debate, the House
approved the bill by a 398 to 0 vote on December 15.
Meanwhile H.R. 13270, the-proposed
Tax Reform Act of 1969, was being considered in the Senate. The
Senate attached several Social Security amendments to the bill,
including a 15% benefit increase effective for January 1970, and
an increase in the minimum benefit from $55 to $100/month, and an
increase in the taxable earnings base to $12,000 beginning in 1973.
H.R. 13270 passed the Senate by a vote of 69 to 22 and it was sent
to a Senate-House conference committee on December 11,1969, which
considered the differences between the two bills. The conference
committee agreed to the 15% benefit increase, approved by both Houses,
omitted the Senate financing provisions and settled the differences
on the other provisions of the bill. The conference committee bill
was agreed to by both the House and the Senate on December 22 and
the President signed the bill as Public Law 91-172 on December 30,1969.
2. Legislative
action in 1970
The Ways and Means Committee carried
on extensive executive sessions in the early months of 1970 and
further considered the Administration's Social Security, Medicare,
and Medicaid proposals. On May 11, 1970, Chairman Mills and Congressman
Byrnes introduced H.R. 17550, containing the Committee's decisions.
The bill contained an additional 5% benefit increase, effective
for January 1971 but did not include the Administration's automatic
benefit increase proposal.
H.R. 17550 also contained many
additional amendments to the OASDI program and to the Medicare and
Medicaid programs, along with financing provisions to maintain the
fiscal integrity of the payroll-financed OASDI and Medicare (Hl)
programs.
(8) Weekly Compilation
of Presidential Documents, vol. 5, no. 39, pp. 1319-1324.
(9) The long-range
solvency of the Social Security program is usually stated in terms
of percentages of taxable payroll. Roughly speaking, a long-range
deficit of l% of taxable payroll means that the actuarial projections
of the income and outgo of the trust funds over the next 75 years
show that outgo will exceed income and that income could be made
to equal outgo by increasing the combined employer/employee tax
rate by l percentage point (or by making other changes of an equivalent
magnitude to the income or outgo of the program). Similarly a surplus
of 1% of taxable payroll could be used to decrease the tax rates
by a combined 1 percentage point or to make program changes with
comparable costs.
While being debated in the House,
H.R. 17550 was ordered recommitted with directions to report the
bill back to the House with the Administration's recommendation
for automatic adjustment of benefits, the wage base, and the retirement
test. As so amended, the bill passed the House on May 21, 1970,
by a vote of 344 to 42.
The Senate Committee on Finance
began public hearings on H.R. 17550 and on H.R. 16311, the proposed
welfare reform amendments on June 17 and went into executive session
to consider the two bills on September 29. The Finance Committee
bill was reported on December 9 with major modifications.
In place of the 5% benefit increase
in the House passed bill, the Finance Committee bill provided a
10% increase. The minimum benefit would be increased to $100, rather
than $67.20 which would have been payable under the 5% increase
passed by the House. The Finance Committee bill also differed from
the House bill with regard to financing the automatics. The House
bill assumed that the program would be adequately financed from
the additional revenues generated by automatic increases in the
wage baseCthe maximum amount of annual earnings subject
to Social Security tax. The Senate Finance committee bill would
have required an actuarial evaluation of program finances each time
a benefit increase was triggered. On the basis of that evaluation,
program financing would be increased to the full extent necessary
to cover the additional costs. One-half of those costs would be
financed from increases in FICA tax rates and one-half from increases
in the wage base.
Numerous other OASDI and HI amendments
in the Finance Committee bill either were the same as modifications
or deletions of, or additions to the provisions of the House passed
bill.
The Finance Committee bill also
would have created a new Federal program of catastrophic health
insurance for all persons under age 65 who were insured for or entitled
to Social Security, their spouses, and dependent children. The health
services would have been the same as those provided under the Medicare
program and would have been available after family health care expenses
exceeded defined limits. Also included in the bill were provisions
related to international trade and veterans benefits.
With regard to welfare changes,
the Finance Committee considered H.R. 16311 the Administration's
welfare reform proposal and, with major modifications, included
its provisions in H.R. 17550. These modifications would have eliminated
the House passed provisions to federalize the adult public assistance
programs and establish a federal Family Assistance Plan in place
of the State-run AFDC program, but the bill included a number of
other modifications to the adult assistance programs and to the
AFDC program.
During floor debate the Senate
voted to recommit the bill to delete the catastrophic health insurance
program and certain other provisions of the bill. As so amended,
H.R. 17550 was passed by a vote of 81 to 0 on December 29.
The Senate requested a conference
and appointed conferees. The House declined the request since Congress
had set January 2, 1971, as final adjournment day. Chairman Mills
declared his intention to make Social Security legislation the first
order of business for the Ways and Means Committee in the about-to-convene
92nd Congress.
3. Legislative
action in 1971
When the 92nd Congress convened
on January 21, 1971, Chairman Mills and Representative Byrnes jointly
introduced H.R. 1, the Social Security Amendments of 1971. The bill=s
provisions were, for the most part, the same as those contained
in H.R. 17550 as passed by the House in 1970 (but they did not include
the automatic benefit increase provisions). The bill also included
the welfare reform proposals passed by the House in H.R. 16311 in
1970.
The Committee on Ways and Means
held executive sessions from February through May 1971 to consider
H.R. 1.
During this same time, action was
required on a bill to increase the public debt limit. When the public
debt bill (H.R. 4690) was before the Senate, several Social Security
amendments were adopted during floor debate. The principal amendment
was a 10% Social Security benefit increase, including family maximum
benefits, effective for January 1971. The conference committee on
the debt limit bill deleted two of the Senate amendments (one providing
for a $100 minimum and one providing for an increase in the retirement
test (10) annual exempt amount to $1200), but accepted the remaining
Senate amendments, including the 10% increase in benefits and family
maximum benefits.(11)
The President signed H.R. 4690
into law (Public Law 92-5) on March 17, 1971.
Also during March 1971 the Advisory
Council on Social Security(12), which had been appointed in 1969,
issued its report. Its recommendations included most of the major
changes in the OASDI program that were contained in H.R. 1. It also
recommended changing from static to dynamic economic assumptions
in estimating the costs of the OASDI program, and it endorsed the
principle of current cost financing by which trust fund revenues
and expenditures would generally be kept in balance with sufficient
reserves to maintain funds to assure annual benefit payments.
The Ways and Means Committee reported
H.R. 1 to the House on May 26, 1971. The reported bill provided
a 5% Social Security benefit increase effective for June 1972. The
OASDI, Medicare, and Medicaid provisions remained essentially patterned
after H.R. 17550 but with additional modifications along the lines
of Senate amendments to H.R. 17550 in 1970.
H.R. 1 as reported in the House
also contained welfare reform provisions which differed considerably
from those contained in H.R. 16311 of the previous Congress.
H.R. 1 passed the House by a vote
of 288 to 132 on June 22 and was sent to the Senate. The Senate
Finance Committee held public hearings in July and August of 1971
but took no further action on H.R. 1 during the remainder of 1971.
(10) The retirement
test or earnings limit is the provision of law under which Social
Security benefits are reduced when an individual to whom the test
applies has earned income above a certain amount, referred to as
the exempt amount. The test now generally applies to beneficiaries
under age 70.
(11) It is of interest
to note that in dealing with the l0% increase in the family maximum
the amendment eliminated "notches" that had accrued for
families affected by the family maximum under prior benefit increases.
Such earlier benefit increases went only to families on the rolls
on the effective date of a benefit increase, but not to families
coming on the rolls in the future. This resulted because family
maximum benefits were previously determined as a percentage of a
worker's average monthly wage, which remained constant regardless
of any benefit changes. The family maximum was, in effect, redefined
by being stated as a percentage of a worker's primary insurance
amount (PIA) which is the basic figure that is used to determine
all individual benefits. As thus redefined, benefit increases were
made applicable to family maximum benefits regardless of when a
family became subject to the maximum. Since then, all benefit increases
have applied to current and future families limited by the family
maximum.
(12) Section 706 of
the Social Security Act provided for the appointment every four
years by the Secretary of Health Education and Welfare of a 13-member
Advisory Council whose "members, shall to the extent possible,
represent organizations of employers and employees in equal numbers
and represent self-employed persons and the public." Legislation
enacted in 1994 establishes a permanent advisory board and eliminates
the requirement for quadrennial advisory councils.
4. Legislative
action 1972
The Senate Finance Committee held
additional public hearings on H.R. 1 in January and February of
1972 followed by executive sessions which lasted through June.
On February 23, 1972, while hearings
on H.R. 1 were being conducted by the Senate Finance Committee,
Chairman Mills introduced a bill (H.R. 13320) to provide a 20% Social
Security benefit increase, effective for June 1972. The bill's financing
provisions provided for increases in the wage base to $10,200 in
1972 and to $12,000 in 1973, and automatic increases in the wage
base thereafter, and for reductions in the tax rates in the early
years according to the following table showing rates for current
law, H.R. 1 as passed by the House and for H.R. 13320.
OASDI
CONTRIBUTION RATES (EMPLOYEE AND EMPLOYER, EACH)
(In percent) |
Year
|
Current
law (1) |
H.R
. l (2) |
H.R.
13320 (3) |
1972
1973-74
1975
1976
1977-2010
2011 and after |
4.60
5.00
5.00
5.1
5.15
5.15 |
4.2
4.2
5.0
5.0
6.1
6.1 |
4.6
4.6
4.6
4.6
4.9
6.1 |
(1) $9,000 contribution
and benefit base for 1972 and after.
(2) $10,200 contribution
and benefit base for 1972 with automatic adjustments to increases
in earnings levels thereafter.
(3) $10,200 contribution
and benefit base for 1972 and $12,000 for 1973 with automatic adjustments
to increases in earnings levels thereafter.
In introducing H.R. 13320, Chairman
Mills explained that it was possible to finance a 20% benefit increase
and the provisions in H.R. 1 and at the same time lower tax rates
during the early years by applying the dynamic economic assumptions
and the current-cost financing that had been recommended by the
Advisory Council on Social Security and endorsed by the boards of
trustees of the Social Security trust funds and by the Nixon Administration.(13)
Mr. Mills' bill met with an uncharacteristic
questioning of its soundness. Employer interests and the conservative
press and Congressional critics expressed concerns relative to the
risks the system would assume if the finely-tuned economic assumptions
on which financing of the Mills' bill was based failed to occur.(14)
Action on the 20% benefit increase
and the automatics followed an unusual and unpredictable path in
the Senate. This legislative course bypassed consideration by the
legislative committees in both Houses of the 20% increase and the
shift from static to dynamic assumptions.
(13) U.S. Congress,
Congressional Record, (Permanent edition), pp. 5269-5272, Feb. 23,
1972.
(14) See statement
of Congressman Conable at U.S. Congress, Congressional Record, (Daily
edition), p. H1429, Feb. 24, 1972.
When the Senate was debating a
bill (H.R. 15390) to extend the public debt limit, Senator Frank
Church on June 28, 1972, offered a floor amendment to the bill that
was essentially the same as H.R. 13320 but with a later effective
date for the 20% benefit increase (September rather than June) and
a one year delay in the wage base increases (to $10,800 in 1973
rather than 1972, and to $12,000 in 1974 rather than 1973).
H.R. 15390, with these and other
technical amendments, was passed by both the Senate and the House
on June 30 and signed by the President on July 1, the date by which
final action on the debt limit was mandatory. (Public Law 92-336,
92nd Cong.)
Such was the highly charged legislative
environment in which the automatic (COLA) provisions were enacted.
The Senate Finance Committee resumed
consideration of H.R. 1 in September 1972 and reported the bill
on September 26 with numerous amendments to the Social Security,
Medicare/Medicaid, and welfare programs.
The Senate debated H.R. 1 from
September 26 to October 6, again adding additional amendments, and
passed the bill by a vote of 68 to 5.
The conference committee met on
the bill on October 10 through October 14. The conference report
was adopted by the House on October 17 by a vote of 305 to one and
on the same day by the Senate by a vote of 61 to zero. On October
30, 1972, the President signed the bill into law as Public Law 92-603.
III DEFECTS IN
THE AUTOMATICS APPEAR
Actuarial Status in
1972
In 1972, when the automatic benefit
increase provisions were adopted, inflation rates seemed to be declining
from the unusually high levels (averaging 5% annually) of the past
five years. For 1972, the inflation rate was 3.2%.(15) Near the
end of 1972, the Finance Committee reported that the Social Security
program of Old-age, Survivors, and Disability Insurance had a positive
actuarial balance. The future cost of the system assumed an average
annual inflation rate of 2.75% and a wage growth rate of 5%. For
the first 37 years (through 2010), a safety factor of 0.375% was
added so that the assumed real wage differential was 1.875% (5%
wage growth minus 2.75% inflation. minus 0.375% safety factor).
The first two automatic benefit increases were projected to take
place in 1975 (5.1%) and 1977 (5.5%). (16)
1973 - Unexpected
Inflation
By early 1973, it was clear that
inflation would be much higher than had been expected in 1972. Instead
of waiting for the first automatic increase to take effect in January
of 1975, Congress passed Public Law 93-66 in July 1973 providing
an ad hoc increase of 5.9% to become effective in June of 1974.
This was a "down payment" on the January 1975 automatic
increase which was then expected to be about 8%.
As inflation continued to mount,
Congress again passed legislation in the closing days of the session
to provide a two-step increase - an 11% increase effective for June
1974, 7% of which was payable in April. The previously adopted 5.9%
increase was absorbed into this increase.
(15) Economic Report
of the President, U.S. Government Printing Of lice, Washington,
1992., p. 361.
(16) Committee on
Finance, U.S. Senate, Social Security Amendments of 1972 (Senate
Report 92-1230 to accompany H.R. 1), U.S. Government Printing Of
lice, Washington, 1972, pp. 341-344. Under the 1972 law, inflation
would have to increase by at least 3 % since the last increase in
order to trigger an automatic benefit adjustment. Under subsequent
amendments, there is now an annual increase without regard to any
such minimum.
Action on this legislation began
with the introduction of H.R. 11333. The bill was favorably reported
by the House Ways and Means Committee on November 9, 1973 (House
Report No. 93-627). The bill, as it was reported and as it passed
the House on November 15, provided for a two-step increase. A "flat"
7% payable for March 1974 and another increase payable for June
1974 which, together with the 7% increase, would equal a combined
11% increase.
The Senate acted on this increase
as an amendment to H.R. 3153, a lengthy technical amendments bill
to eliminate minor drafting errors in the Social Security law. The
1974 two-step benefit increase in the Senate amendment differed
from the House provision in H.R. 11333 in three respects: first,
the interim 7% increase would be for the month in which the bill
was enacted rather than for March 1974 as in H.R. 11333; second,
additional financing was provided in the form of increases in Social
Security tax rates and in the taxable wage base; third, the interim
7% increase would be a "refined" increase rather than
a "flat" increase as in H.R. 11333.(17)
A conference committee began to
meet on H.R. 3153 in late December but no conference report was
issued. Instead, by unanimous consent, floor action was taken in
the House on December 20 and in the Senate on December 21. Both
houses approved H.R. 11333 with the two-step 11% increase along
the lines of the Senate amendment to H.R. 3153. The bill was signed
on December 31, 1973, as Public Law 92-233.
In its report on the legislation
which would become Public Law 92-233, the Senate Finance Committee
indicated that it would leave the Social Security program with a
long-range actuarial deficit of 0.56% of taxable payroll and a short-range
situation in which end-of-year balances would grow from $44 billion
in 1973 to $52 billion in 1978. (Although the Committee report did
not point this out, the size of the short range fund balances relative
to annual outgo were
projected to decline over that period.) (18)
1974 Trustees Report
Indicates a Problem
While the Finance Committee report
in 1973 showed no great concern over the financial status of the
program, the situation changed dramatically in 1974. Inflation,
which, in the years since 1950, had never reached as much as 5%
came in at 6.2 % for 1973 and continued to accelerate to nearly
twice that rate in 1974. When the Social Security Board of Trustees(19)
issued its annual report on the financial status of the program
at the end of May, it revealed a startling actuarial imbalance of
2.98 % of taxable payroll. For the program to meet its benefit obligations
over the 75-year estimating period, tax rates would have to be increased
by some 27 percent. (20)
(17) Briefly, a "flat"
increase involves applying the percentage increase to actual benefit
amounts paid to beneficiaries rather than to the primary insurance
amount (PIA) on which benefits are normally based and on which a
"refined" benefit increase is based. The use of the former
gives rise to more difficult administrative problems than the latter.
(18) Committee on
Finance, U.S. Senate, Social Security Amendments of 1973 (Senate
Report 93-553 to accompany H.R. 3153), U.S. Government Printing
Office, Washington, 1972, pp. 10-16
(19) By law, the OASI
and Dl trust funds each have a board who are required to make an
annual report on the status of the funds. In 1974, the Board of
Trustees was composed of the Secretary of Treasury, the Secretary
of Health, Education, and Welfare, and the Secretary of Labor, with
the Commissioner of Social Security acting as secretary to the Board.
(20) U.S. House of
Representatives, 1974 Annual Report of the Board of Trustees of
the Federal Old-Age and Survivors Insurance and Disability Insurance
Trust Funds, House Document 93-313, Washington, U.S. Government
Printing Office June 3, 1974, p. 36. The primary reason assigned
by the trustees for the worsening of the financial condition of
the funds was a change in population projections.
First Hsiao Panel
Confirms a Very Severe Financing Problem
The Senate Committee on Finance
responded to the Trustees' report by recommending a Senate Resolution
calling for the appointment of a panel of actuaries and economists
to provide a second opinion or, in the words of the resolution,
"an expert independent analysis of the actuarial status of
the Social Security system." The resolution was adopted by
the Senate In of 1974, and a panel, headed by William C. L. Hsiao
was convened.(21)
The Hsiao panel issued its report
in January of 1975. The panel not only confirmed the Trustees' findings
that the program was badly out of actuarial balance but also concluded
that the deficit was roughly twice as bad as indicated in the Trustees'
report. Where the trustees had indicated that tax rate increases
of 27% would be needed for the program to meet its benefit obligations
over the long-range estimating period, the Hsiao panel found that
restoring solvency would require a 55% increase in tax rates (or
other changes to benefits and financing with an equivalent impact).(22)
The Hsiao panel attributed the
long-range financing problems of the Social Security program about
equally to two main causes: demographics (a lower fertility rate
than had previously been projected so that there would be fewer
workers to pay taxes to support the program) and the nature of the
benefit formula. The panel also examined the various factors which
have an impact on program solvency and found that those factors
with the highest impact (fertility, wage patterns, and inflation)
were also the factors that are hardest to predict accurately.(23)
With respect to the benefit formula,
the panel found that the formula adopted in 1972 "responds
irrationally to changes in the rate of inflation, and can produce
patterns of replacement ratios inconsistent with the generally understood
purpose of the Social Security system." The panel recommended
"That the benefit structure be changed to eliminate its irrational
response to changes in the rate of inflation. This is essential
to achieve financial soundness. The first step should be a prompt
thorough study of several possible changes in the benefit structure."(24)
1974 Advisory Council
Recommends Wage Indexed Formula
A new Social Security advisory
council had been appointed to meet in 1974 under the chairmanship
of W. Allen Wallis, Chancellor of the University of Rochester. The
advisory council devoted its primary attention to the need to correct
problems with the benefit formula adopted in 1972. Its report issued
in March 1975 noted that "the method used for automatic cost-of-living
adjustments has the side-effect of making replacement ratios (benefits
as a proportion of earnings just before retirement) subject to unpredictable
variations caused by changes in wage and price levels, an effect
that presumably was not intended."(25)
(21) Committee on
Finance, U. S. Senate, Report of the Panel on Social Security Financing
pursuant to S. Res. 350, 93rd Congress. Committee Print, U.S. Government
Printing Office, Washington, 1975, p. 1 (cited hereafter as Hsiao
I).
(22) Hsiao I., p.
2.
(23) Hsiao I., pp.
2-6.
(24) Hsiao I., pp.
3-4.
(25) U.S. Congress,
Reports of the Quadrennial Advisory Council on Social Security,
House Document 94-75, U.S. Government Printing Office, Washington,
1975, p. l 30. Hereafter cited as Advisory council (74). Note: This
quotation and some of the others in this paper come from an appendix
to the advisory council report which was prepared by a panel of
consultants to the council. Since the Advisory Council chose to
incorporate their finding in its report and indicated no disagreement
with them, this paper treats that appendix as part of the report.
The Hsiao panel had characterized
the problem with the 1972 automatic benefit adjustment mechanism
as one of "overindexing."(26) The advisory council report
described it as a "coupled" system.(27) Both of these
terms were widely used in discussions and documents at that time.
They referred to the fact that initial benefit levels increased
from year to year as a result of two separate indexing mechanisms.
Initial benefit levels were computed by applying a formula to the
retiree's average wages under Social Security. Under the 1972 legislation,
the factors in the formula were periodically increased by the percentage
increase in the Consumer Price Index.(28) The average wages to which
this formula was applied also tended to increase as wage levels
in the economy grew from year to year (and the 1972 legislation
facilitated this impact by indexing for wage growth the maximum
amount of annual earnings that could be counted in determining the
average wages to which the benefit formula was applied). Thus, initial
benefit levels were automatically increased by a mechanism which
"coupled" the impact of price growth through an explicit
indexing of the benefit formula and the impact of wage growth through
the use of average wages. This "coupling" of the two factors
made the increase in year to year benefit levels extremely difficult
to predict since the increase would be based on both the absolute
values and the interrelationship of inflation and wage growth. The
result, under the revised economic assumptions of the mid-1970's
was that benefit levels were increasing more rapidly than the financing
of the system could sustain. Consequently, the "coupled"
system adopted in 1972 was resulting in "overindexing"
of benefits.(29)
The advisory council recommended
that the situation be corrected by replacing the "coupled"
mechanism for increasing initial benefit levels with a "decoupled"
system which would rely entirely on wage indexing. Under the advisory
council approach, the 1972 system in which the percentages in the
benefit formula were indexed to the CPI each year would be dropped.
A new formula would be adopted in which the percentage factors would
not change from year to year. Instead of indexing the formula for
price inflation, the new mechanism would index the wages to which
the formula was applied. A retiree's creditable wages for each year
would be adjusted to reflect wage growth in the economy between
the year in which they were earned and the year of retirement. The
benefit formula would then be applied to the average of those indexed
wages.(30) Once individuals had their initial benefit levels computed
at retirement, those benefits would be kept up to date through price
indexing.
Although differing in some details,
the wage indexing approach recommended by the advisory council,
was essentially the approach ultimately enacted in the 1977 amendments.(31)
(26) Hsiao I., p.
17
(27) Advisory council
(74), pp. 130-131.
(28) Strictly speaking
there was no actual formula. Rather the law contained a benefit
table which prescribed the full-rate benefit payable for workers
at each level of average earnings. When benefits increased by a
given percentage, all the benefit amounts in the table were increased
by that percentage and, if the law also increased taxable wages,
the table was
extended to prescribe
benefit amounts at the resulting higher average wage levels. For
all practical purposes, however, the result was the same as if there
had been a benefit formula and all the factors in the formula were
increased by the specified percentage.
(29) There was no
"official" definition of the term "coupling,"
and it was somewhat confusingly used in two different meanings.
As described here, it referred to the fact that the mechanism for
adjusting initial benefits combined elements of price indexing with
elements of wage indexing. It was also sometimes used in reference
to the fact that the 1972 law used
the same mechanism--price
indexed benefit formula factors--to increase initial benefit levels
and to adjust benefits for those already on the benefit rolls. (A
proposal described as "simple decoupling" would have eliminated
price indexing for the factors in the benefit formula as it related
to initial benefit levels but continued price indexing as it applied
once an individual was on the benefit rolls.)
(30) The Social Security
program weights the benefit formula to the advantage of lower income
individuals. The benefit formula provides a higher percentage return
on the lower part of an individual's average earnings than on the
higher part. The "bend points" -- the levels of earnings
at which the percentage in the formula changes -- were also to be
indexed for wage growth in the economy under the advisory council
proposal. Advisory council (74), p. 17.
(31) The advisory
council proposed formula was 100 % of the first "A" dollars
of average indexed monthly earnings (AIME) plus "B" %
of AIME above "A" dollars. Instead of this 2-step formula,
the actual 1977 legislation created a 3-step formula starting with
90% of the first "A" dollars. Advisory council (74), p.
17.
The question of how the change
from the old to the new system would affect benefit levels in the
years following the changeover was addressed in the advisory council
report to some extent:
THE
PHASING-IN PROCESS
The consultants have no intention
of reducing benefits when the new formula produces a lower result
than the old one. It is clearly important that the new beneficiary
of year y
actually receive the greater of the new-formula PIA(32) and the
old-system PIA. For those becoming beneficiaries after year y the
same comparison is to be made and the greater benefit granted; with
the understanding, however, that the old-system benefit table will
not be updated for CPI changes after year y. As
time goes on, the new-formula result (dynamic with average wages)
will be greater than the PIA from the old system (static at the
year y level) for a larger and larger percentage
of the new beneficiaries, and the old system will be slowly phased
out. The young-age death and disability cases will likely be the
last to be payable on the new formula.(33)
In connection with the notch issue,
there are several important points to be noted about the above quotation
from the 1974 advisory council report.
The phase in described by the advisory
council report matches the transition provision actually adopted
in the 1977 legislation with 2 important exceptions. The actually
enacted transition provision prohibits the use of wages earned in
or after the year of reaching age 62 in computing a benefit under
the old law formula. The benefit level differentials which give
rise to the notch issue would have been less striking if the transition
clause had permitted the use of post-age-61 wages.(34)
While the advisory council phase-in
clearly anticipated that there would be no differential between
old-law and new-law benefits for individuals retiring in the year
the change became effective ("year y@), the above quotation shows that the report
did recognize that the old-law benefits would for some time be higher
for some beneficiaries than what would be payable under the new
system. This finding, however, relates solely to a comparison of
what the same individual would qualify for under the two approaches.
There is no indication that the advisory council was aware of or
addressed in any way the actual notch issue; that is, a differential
in actual benefit levels payable to individuals subject to the new
system and individuals who continued to be eligible under the prior
system.
A second notable difference is
that the Advisory Council Transition would have been available to
all future retirees rather than only to those reaching retirement
age in the first five years of the new formula. As the Council pointed
out, however, the new formula would increasingly provide higher
benefits than the static transition formula.
(32) The term "PIA"
is an abbreviation for "Primary Insurance Amount". This
is the "basic" benefit amount for an insured worker. For
a retiree, it represents the amount that would be payable if the
individual began receiving benefits at age 65. The actual benefit
payable may differ, for example, because of reduction for early
retirement.
(33) Advisory council
(74), p. 130.
(34) For persons born
in 1917, allowing post-6l wages to be used in an old-law computation
would have eliminated any notch effect since such individuals were
not affected by the other part of the notch, the rule that cost-of-living
increases would not apply after 1978 and before the year of attaining
age 62.
Second Hsiao Panel
Recommends Price Indexed Approach
In April of 1975, the Congressional
Research Service of the Library of Congress, on the basis of a request
from the Senate Finance Committee and the House Ways and Means Committee,
appointed a consultant panel of actuaries and economists to "examine
the various ways in which the benefit structure could be revised
to correct the problem of any overreaction to changes in price levels."(35)
William Hsiao once again was selected as project director for this
study. The panel submitted its report to the Congressional Research
Service in April of 1976. The report was subsequently printed as
a joint committee print in August, 1976. By the time the report
was printed, the Ford administration had submitted legislation proposing
a switch to a wage indexed mechanism along the lines of the recommendations
made by the 1974 advisory council.
The Hsiao II panel looked at 5
alternatives to the 1972 benefit adjustment mechanism: a flat benefit
formula, a money purchase plan, a "high-5" plan, a wage-indexed
formula, and a price-indexed formula.(36) For the most part, however,
the report concentrated on the price and wage indexing alternatives.
The panel recommended a price indexing approach. This would have
operated in the same way as the wage indexing proposals except that
wages would have been adjusted for price inflation between the year
of earnings and retirement instead of being adjusted for wage growth.
The price indexing approach recommended
by the Hsiao II panel was expected to result in lower program costs
than wage indexing.(37) The panel argued that price indexing would
maintain the real, inflation-adjusted value of benefit levels while
preserving a greater degree of control and flexibility for Congress
to determine whether benefit increases in excess of inflation were
appropriate. A second argument was that the price indexing approach
involved a substantially lower long-range cost. The panel's third
argument was that the price indexing approach would allow Congress
to provide real increases in benefits for those already on the rolls:
- In contrast to this, the wage-indexing
method provides a sharp tilt in favor of workers retiring in
the future. The increases in benefits for workers already retired
are limited to increases in the rise in the Consumer Price Index.
Yet workers who retire five years later will receive increments
due to both price changes and increases in real wages. The difference
in retirement benefits can be substantial.(38)
This last argument corresponds
to that part of the notch issue which is based on the contention
that those in the notch years received benefits which were lower
than those paid to later retirees.
The Hsiao II panel also dealt with
the issue of transition. They recommended that persons born in 1917
or earlier remain subject to the old law regardless of when they
retired. For those born during the 4 transition years 1918-1921,
the panel recommended the payment of a blended benefit comprised
of an increasing percentage (20,40,60, and 80 percent) of the new
law benefit and a decreasing percentage of the old-law benefit.
Like the advisory council, the Hsiao II panel did not directly address
the question of discrepancy between benefits for those born before
1918 and those born after 1917.
(35) Committee on
Finance, U.S. Senate, and Committee on Ways and Means, U.S. House
of Representatives, Report of the Consultant Panel on Social Security
to the Congressional Research Service. Joint Committee Print, U.S.
Government Printing Office, Washington, 1976, p. 1. (cited hereafter
as Hsiao II)
(36) Hsiao II, p.
15.
(37) As it turned
out, during the first few years during which the 1977 amendments
were effective, price inflation outpaced wage growth so that costs
of price indexing during that period would have been greater than
the costs of the wage indexing system which was enacted. Over the
long run, however, the price indexing approach would have cost significantly
less.
(38) Hsiao II, p.
9.
IV LEGISLATIVE
ACTION
As described under the preceding
heading, during the period between the enactment of the 1973 ad
hoc increase and the
1977 amendments, concerns over the financial integrity of the Social
Security system mounted. Although no legislation to deal frontally
with the financing problems was enacted during that period the legislative
committees of both Houses maintained continuing oversight and acted
to lay the groundwork for the 1977 corrective legislation.(39)
Ford Administration
Proposal
The newly formed House Social Security
Subcommittee(40) conducted eight days of hearings beginning on May
7, 1975 and ending on June 19, 1975.(41) During these hearings,
testimony was received from representatives of the Ford Administration,
the 1974 Advisory Council, and employer, labor and beneficiary organizations.
The Ford Administration took the
position in 1975 that the long-range financing issues required further
study and stated that a long-range financing bill would be submitted
in 1976.
The House Subcommittee on Social
Security conducted seven additional days of hearings from February
5th through 19th, 1976. The Secretary of Health, Education, and
Welfare testified on the opening day of the hearings. The Secretary's
testimony dealt only with the broad outlines of an Administration
proposal, stating that an Administration bill would be drafted and
submitted at a later date. He also suggested that the first order
of business should be the short-range financing issues together
with several program modifications that were being developed by
the Administration.
The Ford Administration's proposal
for changing the benefit formula was not submitted until June 17,
1976. It was introduced by Representative James A. Burke, the Chairman
of the Social Security Subcommittee, as H.R. 14430, the Social Security
Indexing Act of 1976.
The major features of H.R. 14430
were:
- wage indexing of a worker's
earnings through the second year before entitlement to retirement
benefits, disability, or death;
- a new benefit formula that would
approximate the benefit levels of existing law at implementation
and stabilize future replacement rates;
- a 10-year transition guarantee
that benefits would be no lower for those affected than benefits
at implementation under previous law.
The House Social Security Subcommittee
held three days of hearings on the Administration bill on June 18,
July 23, and July 26 of 1976. The Subcommittee held markup sessions
on the bill on August 5, 9, and 10, but ceased working on the legislation
when it became apparent that there was insufficient time to complete
action in the House and Senate on such complicated and controversial
issues before a scheduled October final adjournment for the Fall
elections.
(39) For example,
the staff of the Ways and Means Committee conducted a two-year study
of the disability insurance program and produced a report in 1974
warning of the potential costs resulting from administrative practices
in the disability determination process. U.S. House of Representatives,
Committee on Ways and Means, Committee Staff Report on the Disability
Insurance Program, July 1974, 447 p.
(40) The Committee
on Ways and Means did not maintain legislative subcommittees before
1975. The Legislative Reorganization Act of 1974 required all House
Committees to establish subcommittees beginning in 1975.
(41) U.S. Congress,
House of Representatives, Committee on Ways and Means, Hearings
Before the Subcommittee on Social Security, 94th Congress, on Financing
the Social Security System.
President Carter's
Recommendations
President Carter announced his
proposals to stabilize the Social Security benefit structure and
reestablish the financial integrity of the system on May 9, 1977.
The proposals were aimed at both the short-term and long-term financing
problems.
The proposals also related to other
issues that had been under discussion for some time including providing
equal treatment for men and women, the retirement test, coverage
of Federal, State, and local governmental employees and employees
of non-profit organizations, and correcting weaknesses in the disability
insurance determination process. While this paper discusses only
those proposals directly related to financing and the notch issue,
it is important to note that all of these other issues had to be
dealt with and, to that extent, may have reduced the capacity of
the Congress to analyze fully the narrower issue of implementing
the change in the benefit formula.
The Carter Administration recommended
that the Social Security benefit structure be "decoupled"(42)
with future replacement rates stabilized at approximately the levels
applicable under prior law for workers retiring in January 1979.
The decoupled benefit structure, like that recommended in 1975 by
the Advisory Council and by the Ford Administration would be based
on indexing earnings to changes in average earnings over the individual's
working years and indexing benefits to increases in prices (as measured
by the Consumer Price Index) after the worker reached the age of
eligibility (or became disabled or died in the case of disability
and survivorship benefits).
The mayor elements of the Carter
Administration short-term financing recommendations included:
- eliminating the ceiling on the
amount of annual earnings subject to the employer tax by 1981
with interim increases in the employer tax base to $23,400 in
1979 and to $37,500 in 1980(43);
- increasing the wage base for
employees and the self-employed by $600 in each of four yearsC1979,
1981, 1983, and 1985, in addition to the increases resulting from
the automatic increases under the provisions of the existing law;
- providing for "countercyclical"
use of general revenues to compensate for Social Security revenue
losses attributable to unemployment rates above 6 % in 1975 through
1978;
- reallocating part of the Hospital
Insurance tax rate increases scheduled in current law to the OASI
and DI trust funds;
- advancing the one percentage
point tax rate increase then scheduled to go into effect in the
year 2011 so that a 0.25% increase would go into effect in 1985
with the remaining 0.75% increase going into effect in 1990;
- restoring the self-employment
tax rate (which had been frozen at 7 % in 1973) to its historic
relationship of one and one-half times the employee rate.
Difference in Administration
Bills Concerning the Notch
In terms of the not&in issue,
there was a very important difference between the Ford and Carter
Administration bills which apparently has not been widely noticed
up to now.
The Carter bill, as submitted and
as ultimately enacted, essentially drew a strict dividing line between
those born prior to 1917 and those born after 1916. Those born prior
to 1917 and eligible for retirement benefits prior to 1979 were
not only permitted but also required to use the old-law formula
for determining benefits. They were not given the option of using
the new wage-indexed formula even if it would result in a higher
benefit. Those persons on the other side of the dividing line (i.e.,
those born after 1916) were not given the option to use the old-law
benefit formula. They were required to use the new wage indexing
formula or, if a higher benefit would result, a truncated version
of the old-law formula which did not allow the use of earnings after
the year of attaining age 61 and did not provide for cost-of-living
increases after 1978 and prior to the year the individual reached
age 62. (This alternative use of a truncated version of the old-law
formula was available only to individuals born prior to 1922.)
(42) See footnote
29 for a discussion of "decoupling."
(43) In 1977, for
both employer and employee, the tax base was $16,500.
The Ford Administration bill had
not drawn this sharp distinction between the two groups. Individuals
in either category could use the wage indexing formula and (in the
case of individuals born before 1927) either group could use the
truncated old-law whichever was more advantageous. However, neither
group would be permitted to include earnings after 1978 in computing
a benefit under the old-law formula.
If the Ford Administration approach
had been adopted, the notch issue would not have arisen. Benefits
for individuals in the notch years would be the same as under existing
law, but the inflated benefits payable to those born in the years
just prior to 1917 would have been avoided since they would have
been unable to apply their post 1978 earnings to the old-law formula.
This significant difference between
the Ford and Carter bills appears not to have been recognized either
at the time or since. According to the recollections of Social Security
Administration officials(44) the change appears to have come about
in an attempt to close what seemed at the time to be an undesirable
loophole. The old law formula bases benefits on an average of actual wages. The new formula bases benefits on
an average of wages which have been inflated
from their nominal value by a factor representing the growth of
earnings in the economy since the year those wages were earned.
Individuals already on the benefit rolls at the time of enactment,
particularly those whose benefits were based largely on earnings
many years earlier, might have qualified for a sudden large increase
in benefits if they had been permitted to switch to the new wage-indexed
benefit formula. This would have been possible under the bill as
submitted by the Ford Administration.(45) In order to preclude this
seeming windfall, the Carter Administration modified the bill so
that individuals born before 1917 could not use the new, wage-indexed
formula. The Carter bill was also changed to allow these same individuals
to use wages earned after 1978 in computing benefits under the old-law
formula. This latter change may have seemed necessary as a matter
of fairness since, without it, any earnings after 1978 by persons
born prior to 1917 would have been excluded from use under any formula.
This is the cause of the "Notch".
House Action in 1977
The House Social Security Subcommittee
began hearings on President Carter's recommendations on May 10,
1977 with testimony from Secretary of Health, Education, and Welfare
Joseph A. Califano and other Administration witnesses.
Legislation embodying the Administration's
proposals was submitted to Congress on July 11, 1977 and introduced
as H.R. 8218(46) by Subcommittee Chairman James A. Burke on the
following day. Public hearings were held on the Administration's
proposals and other pending financing bills during the following
two weeks on July 18-22 end duly 26-27.
On July 29,1977, the Social Security
Subcommittee met to plan for markup sessions on the financing and
decoupling issues. In view of an expected mid-October final adjournment
date, the subcommittee considered bifurcating the short-range and
long-range financing issues, acting on the former in the 1977 session,
and deferring action on the more complex and controversial long-range
financing issues until 1978. The subcommittee concluded, however,
that enactment of comprehensive legislation was possible in 1977
and scheduled markup sessions for September 12, the earliest date
available following an August recess.
(44) As related to
the authors of this paper in informal conversations.
(45) The individuals
affected would have been required to have some earnings in a year
after 1978 to trigger a recomputation, but even a very small amount
of earnings would have met this requirement.
(46) A companion bill
(S. 1902) was introduced on July 21 by Senator Gaylord Nelson, Chairman
of the Social Security Subcommittee of the Senate Committee on Finance.
The subcommittee began markup on
the scheduled date and continued through September 22, concentrating
on the provisions of H.R. 8218 and a "Republican Alternative"
C a comprehensive package proposed by the
minority members of the subcommittee. The Republican alternative
was not introduced in bill form. The major features of the Republican
plan included: wage indexing of automatic benefit increases with
replacement rates about 10 % lower than those anticipated in 1979
under existing law; freezing the minimum benefit; a gradual increase
from age 65 to age 68 in the age of eligibility for full (unseduced)
benefits; coverage of Federal employees under Social Security; meeting
financing needs by tax rate increases rather than wage base increases,
and elimination of the retirement test.
The subcommittee decided on September
22, in view of the limited time to complete legislative action in
1977, to refer its recommendations to the full Ways and Means Committee
without formally reporting a bill. This permitted the subcommittee
staff to continue putting the subcommittee decisions into legislative
language for consideration by the full committee at the earliest
possible date.
The subcommittee's recommendations
were introduced in bill form as H.R. 9346 by Representative Al Ullman,
Chairman of the Ways and Means Committee, on September 27.
With regard to long-range financing
issues, H.R. 9346 followed the lines of the Administration's decoupling
proposal with the following modifications:
- indexing a worker's earnings
and the benefit formula(47) to reflect annual increases in average
wage levels up to the second year before eligibility (age 62,
disability, or death) rather than the second year before entitlement(48);
- stabilizing replacement rates
at approximately 5 % below the January 1979 replacement rates
then expected under existing law;
- guaranteeing for 10 years (rather
than 5) that retirement benefits would not be lower than benefits
under existing law as of December 1978 (without using post-1978
and pre-age 62 cost of living increases and without using post-age
61 earnings).
With regard to the short-range
financing issues, H.R. 9346 provided for:
- increasing the wage base for
workers and employers to $20,900 in 1979, to $24,400 in 1980,
and to $27,900 in 1981, with automatic increases thereafter;
- in lieu of "countercyclical"
general revenue contributions recommended by the Administration,
providing standby authority for loans from general revenues to
the OASI and DI trust funds whenever the assets of a fund at the
end of a year dropped below 25 % of outgo for that year, with
automatic repayment when assets in a fund at the end of a year
reached 40 % of that year's outgo.
- a reallocation of part of the
scheduled increase in the HI tax rate for years after 1977 to
OASDI and an adjustment of the tax rates so that the ultimate
OASDHI tax rate for 1990 and after would be 7.45 % each for employers
and employees.
- re-establishment of the self-employment
OASDI tax rate at one and one half times the employee rate.
The full Ways and Means Committee
began markup on September 28, the day following the introduction
of H.R. 9346. The Committee markup session continued through October
12, when H.R. 9346, as amended by the Committee, was reported to
the House, with the following changes from the Subcommittee bill:
- increase in the wage base beginning
in 1978 (instead of 1979) to $19,900, to $22,900 in 1979, to $25,900
in 1980, and to $27,900 in 1981, with automatic increases thereafter;
- modification of OASDI and HI
tax rates to improve slightly the reserve ratios in each of the
funds;
- revision of the standby loan
authority so that, if triggered, there would under certain conditions
be an automatic tax rate increase of 0.10 percentage points for
employers and employees (each) and of 0.15 percentage points for
the self employed.
(47) The benefit formula
percentages did not change. However, the amount of average indexed
monthly earnings to which each percentage was applied was indexed
by the growth of wages. These levels of average earnings at which
a different percentage began to be applied are frequently referred
to as the "bend points' of the formula.
(48) A worker, for
example, might elect not to apply for and become entitled to benefits
until age 64, 65, or later, even though he would be eligible to
do so at age 62.
Another Committee amendment that
had a significant impact on early year financing related to the
coverage of Federal, State, local, and nonprofit employees, for
whom the subcommittee had provided mandatory Social Security coverage
effective in 1980. The full Committee bill extended coverage to
the same groups of employees effective in 1982 (rather than 1980)
and directed that the Department of Health, Education, and Welfare
and the Civil Service Commission engage in a joint study and report
to Congress with recommendations on how to coordinate civil service
retirement with the Social Security program.
Before consideration by the House
Rules Committee, H.R. 9346 was referred to the Post Office and Civil
Service Committee which had jurisdiction over the Civil Service
Retirement system. On October 13, that Committee ordered H.R. 9346
reported with an amendment to delete coverage for Federal employees
and to substitute a two-year study on the feasibility and advisability
of covering Federal workers under Social Security.
On October 18, the Rules Committee
granted a "modified open rule" (as requested by the Ways
and Means Committees(49)) to govern House floor debate on the bill.
The rule allowed for the offering of the Post Office and Civil Service
Committee amendment and eight other amendments to which the Ways
and Means Committee had indicated its consent that they be brought
up as floor amendments.
The House debated H.R. 9346 on
October 26 and 27. During the debate, the provisions extending coverage
to government and nonprofit workers were eliminated. The resulting
early year revenue loss was balanced by an additional tax rate increase
of 0.1 percentage points (employer and employee, each) in 1982 and
by an increase in the wage base in 1981 to $29,700 (rather than
$27,900 in the Committee bill). Also this amendment required a study
on the feasibility and desirability of covering Federal, State,
and local government employees. This study was to be undertaken
jointly by the Departments of Treasury and of Health, Education,
and Welfare and by the Civil Service Commission and the Office of
Management and Budget.
Also during the debate, the bill's
provisions relating to the retirement test were modified with regard
to the years before 1982 and by elimination of the retirement test
in 1982. An additional tax rate increase was required to finance
this amendment.
The House of Representatives passed
H.R. 9346 on October 27 by a vote of 275 to 146 and the bill was
sent to the Senate. Since the Finance Committee was ready to report
its version of the legislation to the Senate, the House bill was
not referred to that Committee but was placed on the Senate Calendar.
(49) The Committee
traditionally had requested a closed rule for major Social Security
and tax bills. A closed rule would allow for no amendments and only
one motion to recommit the bill.
Senate Action in 1977
At the start of the 95th Congress
in January of 1977, the Senate Finance Committee found itself faced
with a variety of pressing issues. With a new Administration coming
in, the Committee had to deal with a number of Cabinet and subcabinet
level nominations in the Departments of Treasury and Health, Education,
and Welfare. As a result of a continuing recession, early attention
was also required to tax legislation designed to provide economic
stimulus and to the continuation of an emergency unemployment compensation
system. The financial situation of the Social Security program,
however, also required prompt action by the Committee.
The Carter Administration Social
Security proposal was announced in May of 1977. The Finance Committee
scheduled 5 days of hearings on this matter in June and July. On
July 27, the Committee met to begin consideration of the matter
and "agreed that it would prefer to finance such system through
means other than the use of general revenues."(50) Further
consideration of Social Security financing did not take place until
after the August recess. During September and October, the Finance
Committee met frequently to markup several legislative initiatives
including a National Energy Tax Act, welfare legislation, black
lung legislation, numerous trade bills, and Social Security financing.
Altogether, from July 27 through November 1, the Committee held
markup sessions on Social Security financing on 10 occasions. On
November 1, 1977, the Finance Committee ordered the Social Security
legislation reported, filed its report on the bill with the Senate,
and took the legislation up on the Senate floor.
In dealing with the Social Security
legislation, the Finance Committee faced a range of difficult and
complicated questions. While the revision of the benefit formula
was a very major element of the legislation, it primarily affected
the long-range viability of the system. By 1977, the program was
facing severe short-range problems. The reserves in the cash benefits
trust funds would ideally have been equal to a full year's benefits.
In 1977 they had dropped to less than half that level with rapid
declines projected for the next few years and total depletion within
5 years.(51) The need for immediate short-range financing was complicated
by the recessionary economic situation so that the "normal"
financing method of raising the Social Security tax rates seemed
undesirable.
The Carter Administration attempted
to meet the program's immediate financing needs by two unusual mechanisms.
It proposed to introduce some general fund financing under a provision
which would have used general revenues to substitute for the loss
in payroll tax revenues attributable to the recession. It also proposed
to depart from the traditional equal employer and employee contributions
by increasing the maximum amount of annual earnings on which employers
were required to pay taxes while leaving unchanged the tax base
for the employee tax. Both of these Carter Administration proposals
proved highly controversial and, ultimately, neither of them was
included in the enacted legislation. They did, however, occupy a
great deal of the Committee's attention during the consideration
of the bill.
In addition to financing and the
benefit formula, the 1977 Social Security legislation included several
other difficult issues including a proposal to limit payments of
benefits to dependents that was necessitated by a potentially costly
Supreme Court decision allowing non-dependent husbands and widowers
to qualify for spousal benefits. (52)
(50) U.S. Congress,
Congressional Record, (Permanent Edition), v. 128, p. D650.
(51) Committee on
Finance, U.S. Senate, Social Security Amendments of 1977 (Senate
Report 95-572 to accompany H.R. 5322), U.S. Government Printing
Office, Washington, 1977, Table 1, p. 10. Hereafter cited as 77
Senate Report.
(52) A court decision
in 1977 (Califano v. Goldfarb, 430 U.S. 199) would have allowed
a husband or widower to qualify for benefits as a spouse of a woman
worker on the same basis that a similarly situated woman was allowed
to receive benefits as a wife or widow of a male worker, that is,
without a requirement of proving dependency on the worker. This
decision appeared likely to involve substantial additional cost
just as Congress was grappling with the serious underfunding of
the program, and almost all of the new beneficiaries were expected
to be men who were not actually dependent spouses but rather had
retirement income in the form of a pension from governmental employment.
The Carter administration proposed to require that women also prove
dependency in order to qualify. Congress opted instead to reduce
benefits payable as a spouse by the amount of any governmental pension
the wife, widow, husband, or widower had earned in employment that
was not subject to Social Security. While the need to act in this
area was clear, it also involved a reduction in benefits, and Congress
devoted considerable attention to the question of how to accomplish
this objective in a way which would minimize the loss to women who
were near retirement age and had counted on receiving the benefits.
While all of these issues required
considerable attention and many of them were controversial, the
benefit formula was clearly the most complicated matter. The task
before the Committee was not just the implementation of a new approach
that commanded a clear consensus. Rather it was faced first with
a choice among many different alternative approaches. A staff document
prepared for the Committee markup of the legislation outlined half
a dozen alternative ways in which the 1972 automatic benefit increase
mechanism might be modified. These included the wage indexing approach
proposed by the 1974 advisory council and the Ford and Carter Administrations,
the price indexing approach proposed by the Hsiao II panel, "simple
decoupling" (eliminate indexing of initial benefit levels),
a so-called "combination proposal" (wage indexing to 1995,
with subsequent increases reduced by half the gains in real earnings),
wage indexing after a reduction in the existing replacement rates,
and a continuation of the existing formula but with indexing limited
to no more than 55% of wage increases. For present law and for each
of these alternatives, the staff document included tables, prepared
by actuaries of the Social Security Administration, showing the
financial implications of the proposal and the projected benefits
amounts and replacement rates that would result in future years.
These projections went out to the year 2050 at 5 or 10 year intervals.(53)
The hearings held by the Committee
in June and July received testimony from the Administration and
from a wide variety of interested parties. Most of the testimony
focused on the major issues: the choice of a benefit formula to
replace the 1972 mechanism and the questions of taxes, general revenues,
and financing generally. At committee hearings, witnesses typically
make a brief oral presentation and then respond to questions from
the Committee. A longer formal statement, sometimes accompanied
by attachments, is often submitted and printed in the hearings record.
As far as can be determined from the printed hearing record, the
oral presentations and committee questions did not get into any
discussions directly relevant to the notch issue apart from some
discussion on the length of the transition clause which had been
10 years in the Ford proposal and was only 5 years in the Carter
bill. However, one witness did address the notch issue very directly
in an attachment to his printed testimony.
Robert J. Myers submitted with
his testimony on behalf of the American Council of Life Insurance
an addendum entitled "Recommended Minor Policy Changes and
Legislative Drafting Points With Regard to S. 1902" This addendum
included the following paragraph:
- The bill would provide considerably
different treatment as to computation of retirement benefit
amounts for persons eligible before 1979 (i.e., generally who
had attained age 62 before 1979) than for those who become eligible
after 1978 (page 19, lines 16 and after). The latter can use
the new indexed method and, if eligible before 1984, the frozen
present new-start formula (or, strangely enough, the old-start
method regardless of when eligible even if after 1983). Those
eligible before 1979 can never use the new indexed method, but
rather use the present new-start formula not frozen, but rather
going on in the present coupled basis for all future years (it
is not clear how, if at all, the old-start formula is used for
this category). The result is certainly an undue discrimination
between the two generation groups--it is not clear which way
the discrimination goes or who it favors. There should be identical
treatment for these two categories, so that both can use both
the old formula frozen and the new indexed method.(54)
(53) Committee on
Finance, U.S. Senate, Staff Data and Materials on Social Security
Financing Proposals. Committee Print, U.S. Government Printing Office,
Washington, 1977.
(54) Committee on
Finance, Subcommittee on Social Security, U.S. Senate, Social Security
Financing Proposals. Hearings, U.S. Government Printing Office,
Washington, 1977, p. 345. Mr. Myers, a former official of the Social
Security Administration (Chief Actuary and subsequently Deputy Commissioner)
is a member of the Commission for which this paper is being prepared.
He also testified before the House Ways and Means Committee in 1977
and included an essentially identical addendum to his testimony
there. (Committee on Ways and Means, Subcommittee on Social Security,
U.S. House of Representatives, President Carter's Social Security
Proposals, Part I. Hearings, U.S. Government Printing Office, Washington,
1977, p.l45.)
On November 1, 1977, the Committee
on Finance reported the 1977 Social Security amendments to the Senate.
The reported bill replaced the benefit formula adopted in 1972 with
a new formula based on the wage indexing model. There were some
similarities between the old and new formulas. Both, for example,
based benefits on average earnings over the same number of years.
However, the new formula utilized quite different percentages and
was applied to the average of earnings that had been indexed for
wage growth as compared with the old formula which was applied to
the average of actual earnings. Individuals who under the old law
might have had identical average earnings and get the same benefit
amount might well have different indexed earnings and qualify for
quite different benefits under the new law. It was, therefore, not
possible to construct a new benefit formula which, in the year of
implementation, would provide all retirees in that year with the
same benefits they would have received under the old law. Instead,
the new benefit formula was created in a manner which was designed
to produce benefit levels which on
average would duplicate
the benefit levels under the old law. (Because of the need to address
a financing crisis in the program and because the old system had
caused benefit levels to increase more rapidly than had been intended,
the Finance committee bill actually used a new benefit formula which,
when implemented in 1979, was designed to provide benefits at 1976
levels.)(55)
The Finance Committee bill followed
the Carter Administration approach of allowing and requiring that
those born before 1917 would continue to use the old law benefit
formula. The committee report does not state any rationale for choosing
this approach but it does explicitly point out that benefits for
such individuals will be "computed-and recomputed under the
provisions of present law even if they work in covered employment
after 1978.(56)
The report of the Finance Committee
on the 1977 amendments includes a table showing, by 5 or 10 year
periods, the projections out to 2050 of the benefits and replacement
rates under present law and under the committee bill. Nothing in
the report shows (or indicates that the Committee gave any consideration
to) the specific issue of how benefit levels would compare as between
those remaining under the old law and those retiring under the new
rules in the years immediately following implementation. However,
the table in the report does fairly clearly indicate that there
would be a substantial difference in benefit levels between the
old and new systems within a short time after implementation. For
a worker with average earnings retiring at age 65 in 1985 (6 years
after the effective date), the table shows a reduction in benefits,
after adjustment for inflation, exceeding $600 per year.(57)
(55) 77 Senate Report,
p. 19.
(56) 77 Senate Report,
p. 25.
(57) 77 Senate Report,
p. 20
The Finance Committee bill adopted
the transition clause as proposed in the Administration bill. Individuals
born from 1917 through 1921 would receive the higher of the benefit
computed under the new wage indexing formula or a benefit computed
under the benefit formula in effect in 1978 without the use of any
wages earned after age 61 and without any cost-of-living increases
after 1978 and prior to the year in which the retiree reached age
62.
For a worker retiring at age 62
in 1979 with no significant earnings after 1978, the transition
formula guaranteed the same benefit as prior law (or a higher benefit
if the wage indexing formula produced such a benefit). However,
workers with earnings after age 61 or workers reaching age 62 after
1979 would find the transition clause increasingly less useful as
an alternative to the new wage-indexed formula.
The committee report describes
the purpose of the transition clause as being "to protect the
benefit rights of people who are now approaching retirement and
whose retirement plans have taken Social Security benefits
into account."(58) This rationale
does not seem to address the notch issue, that is how the benefits
for those under the new system compare with benefits for those who
remained under the old system. Rather, the transition clause appears
designed to address the expectations issue. A person quite near
retirement age may have already figured out how much he or she could
expect to get under the old law benefit formula. In an individual
case, it is possible that the use of the new formula could result
in a much smaller benefit. This would be true, for example, for
individuals with unusual wage patterns. The transition clause would
narrow that differential. For those right at the point of retirement,
i.e., those who would retire in the year of implementation (which
was a bit more than a year after enactment), the transition clause
would guarantee the full anticipated old-law benefit. For those
retiring in the next four years, the guarantee was roughly based
on what they could have expected on the basis of their earnings
up to the point of enactment without any adjustments for subsequent
inflation (until they reached retirement age).
While the Finance Committee reported
the Social Security legislation to the Senate on a voice vote,(59)
the Committee was not unanimous. The committee report includes minority
views, signed by four Senators, opposing the bill's financing approach,
which relied on a substantial increase in the amount of annual wages
subject to the employer tax.(60) The committee report also included
two sets of "additional" views. The "additional views"
of Senator John C. Danforth criticized several of the basic committee
decisions including the choice of wage indexing and raised rather
specifically that part of the notch issue which relates to a comparison
between notch year benefit levels and benefit levels for later retirees.:
- I oppose this method of indexing
because it is very expensive and because it draws invidious
and unjustified distinctions between retirees of today and retirees
20 years from today. Thus, under wage indexing, a worker who
retires today will receive a smaller benefit in real dollars
than a worker with an identical wage history who retires 20
years from now even though both may be alive and drawing benefits.
Under wage indexing, the current retiree is excluded from sharing
in the real growth of our Nation's productivity.
I favor price indexing. It
protects workers against the erosion of benefits as a result
of inflation. At the same time, while wage indexing only cuts
the long-range deficit in half, price indexing reduces the
deficit totally, placing the system in long-range actuarial
balance. In this way, it makes unnecessary additional rate
increases of 1.45 % which will be required if wage indexing
is adopted. Finally, it provides Congress with the flexibility
to make appropriate adjustments in the level of benefits which
will benefit not only present workers, but also those who
have already retired.
The Senate took up the Social Security
bill on the same day it was reported and debate continued for four
days. More than 20 floor amendments were offered and there were
a dozen roll call votes. The debate did not, however, focus on issues
related to the notch. On November 4, the Senate passed the legislation
by a vote of 42 to 25. On the same day, the Senate requested a conference
with the House and appointed its conferees.
(58) 77 Senate Report,
p. 24
(59) Because the House
was still considering H.R. 9346 at the time the Finance Committee
was preparing to report its recommendations, the Finance Committee
attached its proposals to a minor tariff bill (H.R. 5322, dealing
with tariffs on istle). The Finance Committee amendments were then
offered as a floor amendment to the House bill H.R. 9346.
(60) 77 Senate Report,
p. 169- 172. The committee bill would have increased the annual
wages subject to the employer Social Security tax to $50,000 in
1979 (compared with $18,900 under prior law) and to $75,000 in l
985. Much smaller increases in the employee tax base were provided
through 1985 by which time the employee base was expected to be
$30,300. Thereafter the employee wage base would continue to rise
(as under prior law) by an index based on average wages, the employer
tax base would remain at $75,000 until such time as the employee
base reached the $75,000 level. Thereafter both bases would be indexed.
(61) 77 Senate Report,
p.176-177.
Final Congressional
Action
The House of Representatives agreed
to a conference and appointed conferees on November 30. The conferees
met on December 1, 5, 11, and 14. While there were a number of contentious
issues in the conference, they did not include issues directly related
to the notch. Both the Senate and House bills had adopted the wage
indexing approach with an effective date which allowed prenotch
individuals to use the old-law formula without constraint and required
notch year individuals to use either the wage indexing formula or
a transition formula without pre-age-62 inflation increases and
without post-age-61 wages.
The last day of the 1977 Congressional
session was December 15, and, on that date, both the Senate and
House approved the conference agreement which had been reached on
December 14. The Senate acted first, approving the conference report
on a vote of 56 to 21. The House first voted on a rule governing
debate on the conference agreement. The rule was agreed to by a
vote of 178 to 175. The conference agreement itself was approved
by a vote of 189 to 163. President Carter signed the 1977 Social
Security amendments into law (Public Law 95-216) on December 20.
1979 Congressional
Hearing on the Notch
The Subcommittee on Social Security
of the House Ways and Means Committee held a brief hearing on the
notch on September 27, 1979. This hearing also took testimony on
another developing problem relating to the payment by employers
of the FICA tax liabilities of their employees.(62)
(62) Hearing before
the Subcommittee on Social Security, House Ways and Means Committee,
Employer Payment
of Social Security Taxes; Benefit Formula Differential,
September 27, 1979 (Serial 96-45).
The subcommittee's hearing on the
notch issue was not held in response to a groundswell of beneficiaries'
concerns, but to consider recommendations proffered by Social Security
technicians, including Professor Robert J. Myers, to avoid or alleviate
its effects.
Testimony on the notch problem
was given, in addition to Professor Myers, by only two other witnesses:
The spokesmen for the Social Security Administration, and the American
Association for Retired Persons (AARP).
Mr. Lawrence H. Thompson, Acting
Associate Commissioner, presented the position of the Social Security
Administration. After discussing general approaches to modify the
transitional provisions of the 1977 Amendments, the SSA prepared
statement concluded that no legislative action be taken:
- "We believe that the
schedule for transition from the old computation system to the
new computation system which was adopted by the Congress in
1977 was a reasonable one. We do not believe that the schedule
should be slowed down, as the first of these options would do.
We believe that there are serious disadvantages in either of
the propesed methods of accelerating the schedule for the transition,
as the other two options would do. Finally, there is clearly
not sufficient time between now and the end of the year to enact
and administratively implement one of these taco options. Therefore,
we urge that no change be made in the present transition provisions."
Professor Robert J. Myers' recommendation
at the time of the 1979 hearing proposed that the transition provision
of the 1977 Amendments be modified to provide that individuals attaining
age 62 before 1979 not be allowed to have their post-age 62 earnings
included in their benefit computations under the old law unindexed
method which continued to give them the benefit of the flawed windfall
effects of the 1972 Amendments. But rather, the benefit computations
for such individuals should apply the new law benefit computation
procedures of the 1977 Amendments applicable to earnings in 1979
or later. The SSA actuary estimated that this Myers' proposal would
result in a five-year (1980 through 1984) savings of $34 billion
under the 1979 intermediate economic assumptions.
The only other witness at the 1979
hearing who discussed the notch issue was James Hacking, speaking
for the National Retired Teachers Association and the American Association
of Retired Persons. This witness expressed opposition to the Myers'
proposal because of its deliberalizing effect. He endorsed an amendment
that would extend the transition period from five to ten years and
gradual phase out of the old law benefit computation. The precise
details of accomplishing this result were not addressed by the witness.(64)
V CONCLUSIONS
The 1977 Social Security amendments
changed the way of computing benefits for persons reaching age 62
in or after 1979. Congress clearly was aware that the new benefit
formula would usually be less generous than the formula it replaced.
Congress was also aware that benefit levels for future retirees
would tend to grow faster than inflation. In at least a general
way, therefore, it might be reasonable to conclude that Congress
"intended" the result that those who came on the rolls
in the years just after implementation would fare less well than
those who immediately preceded them and than those who came after
them. These results were consistent with the major policy choices
which Congress made. Congress had concluded that the benefit formula
enacted in 1972 had gone awry and was producing benefits far too
generous for the financing of the program to support. It chose to
substitute on a prospective basis a benefit formula that was less
generous. Because of concern over the financial problems of the
system (caused in part by the 1972 benefit formula, but also by
other problems), Congress consciously adopted an initial benefit
formula for the new system which represented a rolling back of benefit
levels. Congress explicitly chose wage indexing over price indexing,
knowing that it would cause initial benefit levels to grow so that
each year's cohort of retirees would do somewhat better in real
terms than the retirees of prior years.
On the other hand, it is not correct
to conclude that the notch was an inevitable result of the policy
choices made in 1977.
To begin with, the original Ford
Administration bill submitted in 1976 would have accomplished the
same policy objectives without creating the most significant of
the benefit level differentials that gave rise to the notch issue.
It would have done so by requiring those born prior to 1917 to use
the new wage indexing formula if they wanted to have a benefit computed
using wages earned after 1978. This would have eliminated the notch
issue by holding down the growth in benefit levels for those in
the pre-notch period. Benefits for those in the notch years would
have been computed in the same manner as under present law. When
the new Administration resubmitted the legislation in 1977, this
provision had been changed. Individuals born prior to 1917 were
not given the option of using the wage indexing formula but were
permitted to use post-1978 wages in the old-law formula. It appears
that the change was made to address a totally different issue (avoiding
a potential windfall for certain beneficiaries who might do much
better under wage indexing than under the 1972 benefit formula.)
It seems likely that alternative ways of addressing that issue could
have been found.65 There is no indication however, that Congress
focused any attention on this change, and certainly no indication
that Congress was aware of its implications for what would become
the notch issue.
(63) 1979 Hearings
at pp. 25 through 31.
(64) Ibid. pp. 32
through 40.
A second missed opportunity for
avoiding the notch was the addendum to testimony submitted to both
the Ways and Means and Finance Committees by Robert Myers. In this
addendum, Mr. Myers explicitly identified the problem of differential
benefit levels for the two categories of beneficiaries and proposed
a way to avoid it. If greater attention had been paid to this testimony,
it is at least possible that Congress would have modified the legislation
along the lines he suggested and that the notch issue would not
have arisen.
The blended transition approach
recommended in the Hsiao II report would also have lessened the
notch differentials. While Congress might not have accepted such
an approach in view of the financial difficulties faced by the program,
it does illustrate that a range of alternatives were available.
Given that it was possible for
the notch problem to have been avoided, the question arises as to
why it was not avoided. Why did not Congress examine and compare
the benefit levels that would be payable to the old and new law
retirees? Why was the transition clause not drawn in such a way
as to minimize the differentials? Why was so little attention paid
to the Myers addendum, to the differences in the two Administration
bills, and to the blended transition approach in the Hsiao II report?
While there is no entirely satisfactory
answer to these questions, the context in which the legislation
was considered may provide some degree of explanation. The Social
Security program had undergone massive changes in 1972. Benefits
were increased by 20 per cent and a new, automatic system for increasing
both benefits and program revenues was adopted with assurances that
the revised program was soundly financed. Almost immediately thereafter,
economic developments and revised projections of other factors (such
as fertility) created a situation in which the solvency of the program
was seriously undermined. As the 1970's progressed, the situation
worsened and, by 1977, Congress found that the Social Security program
had a truly massive long-range deficit and also was also facing
rapid short-term fund depletion. By the time the Congressional Committees
were considering the reported legislation, the long-range deficit
was estimated at 8.2 % of taxable wages. In other words, the combined
employer-employee tax of 9.9 % would have to have been increased
to 18.1 % to solve the problem with a tax rate increase. In the
short run, fund reserves, ideally at least equal to 12 months' benefits
were below half that level at the start of 1977 and were projected
to decline to total exhaustion within 5 years.
To address this major financing
problem, Congress considered a variety of proposals. The need to
adopt a new benefit formula was clear, but which formula to adopt
was not so clear. An advisory council and the Administration recommended
the wage-indexing approach. A congressional appointed panel recommended
a price indexing approach. Several other approaches were also under
serious consideration.
At the same time, Congress was
considering various different (and controversial) proposals to provide
added revenue to the program and was also considering ways to reduce
program outgo through benefit rule changes such as the government
pension offset.
(65) For example,
those in the prenotch years could have been allowed to use their
post- 1978 wages in a wage indexed recomputation but with the benefit
limited to no more than would have been produced by the old-law
formula. Such a restriction would, of course, have created to some
extent the ''reverse notch" which exists under present law
in certain cases (like the one described in footnote 2) to the disadvantage
of those born prior to 1917.
The capacity to analyze the detailed
impact of changes on individual benefit levels was limited by both
the complexity of the new, indexed benefit formulas and by the number
of alternatives under consideration. Even so, the Committees did
ask the actuaries to provide fairly extensive comparisons of benefits
for low, average, and maximum earners under prior law and each of
the alternative proposals. The tables produced, however, did not
clearly illustrate what came to be known as the notch issue. They
were designed primarily to deal with what then appeared to be the
major issue of comparative replacement rates.
The design of the transition clause
appears from the legislative history to have been aimed at the question
of preserving individual expectations rather than at avoiding differentials.
Even if Congress had developed
examples illustrating benefit differentials among different categories
of recipients, they would not have shown as great differentials
as actually developed. To a significant extent, the notch results
from the impact of inflation on the old-law benefit formula. At
the time the 1977 amendments were considered, inflation rates were
expected to return to more "normal" levels. The trustees'
report issued a few months after the 1977 amendments became law
projected that Social Security benefit increases would decline from
6.5 % in 1978 to 5.0 % in 1982.(66) In fact, inflation rates were
about to reach historically high levels. The average
benefit increase over that 5-year period turned out to be 9.9 %
with a 1-year high of 14.3 % in 1980.
It is not at all clear what kind
of examples Congress would have asked for if it had decided to address
the benefit differential question. Comparisons of benefits for persons
born in different years are not easy to make because, even under
prior law, there were factors which provided advantages on the basis
of birth date. At the time of the 1977 amendments, the length of
time over which earnings were averaged was gradually increasing.
For persons reaching age 62 in 1976, earnings would be averaged
over 20 years. For a person reaching age 62 in 1977, earnings would
be averaged over 21 years and so forth. With the same total wages,
the older person would receive a higher benefit because those wages
would be averaged over fewer year. On the other hand, if the comparison
were based on benefits payable for retirement at a given age, e.g.
age 65, the younger person might get some advantage from having
had an additional year of earnings when maximum creditable earnings
were high enough to increase average wages even when averaged over
an additional year.
A comparison of benefits payable
to beneficiaries with different birth years is thus complex and
likely to be confusing. Quite different results would be shown depending
on the particular characteristics of the two individuals compared.
As was noted earlier, examples can even be drawn showing a "reverse
notch" under which certain notch year retirees fare substantially
better than approximately identical retirees born in the pre-notch
period (see footnote 2).
(66) U.S. House of
Representatives, 1978 Annual Report of the Board of Trustees of
the Federal Old-Age and Survivors Insurance and Disability Insurance
Trust Funds, House Document No. 95-336, Washington, U.S. Government
Printing Office, May 16, 1978.
One possible approach would have
been to compare the benefits actually payable to "typically
individuals born in a given year under the new formula with the
benefits which would have been payable under the old-law formula
to those same "typical" individuals. While this would
not be a comparison across different age cohorts, it would have
shown the potential for such disparities in a way which zeroed in
on the impact of the 1977 legislation and filtered out differentials
attributable to other aspects of the program. The following table
illustrates this approach by comparing the old and new law benefits
for individuals born in the notch years. Two comparisons are shown.
The left side of the table shows the benefit levels that would have
been projected under the economic assumptions that the Congress
used in crafting the 1977 amendments. The comparison on the right
hand side of the table shows the benefits that would have resulted
under the actual economic situation that developed after enactment.
The flaw that the new formula was trying to correct was an overreaction
to inflation. Since inflation turned out to be higher than expected,
the benefits under the inflation-sensitive old law formula grew
much more rapidly than the benefits under the revised formula.
As the left side of the table shows,
a projection in 1977 of benefits for average earners retiring at
age 65 would have shown a 10 % ($50 monthly) differential in benefit
amounts for the first group affected Chose born in 1917) if they
continued to work after enactment until they retired at age 65 (in
1981). The differential increases to 13 %($70) for the second group
and then to 14 % for all subsequent groups.
It is possible (though not at all
certain) that the availability of the projections shown on the left
side of the table under the 1977 assumptions might have led Congress
to consider a somewhat smoother transition. It seems less likely
that it would have aroused substantial concern over the benefit
disparities it implied between the notch year workers shown in the
table and prenotch workers who would continue to benefit from the
old law formula.
(67) Most of the examples
used to illustrate benefits in 1977 (and later) are based on "typical"
workers who have steady earnings at specific levels such as the
average wage or the maximum wage creditable for Social Security.
The difficulty in finding truly typical examples is described in
the following excerpt from the Finance Committee print which was
prepared for the use of the Committee in its consideration of the
1977 amendments:
- The wage-indexed
formula is designed to accommodate an earnings pattern in which
an individual's earnings start at a low level and rise at a
rate approximating the changes in average covered earnings.
The Hsiao panel points out, however, that this may not be the
normal pattern and that for a significant part (and perhaps
the major part) of the population there is considerable variation
with maximum earnings at some point considerably earlier than
retirement. Others have wages which go up in one period, fall
in another, rise in another, and so on. In addition to cases
of disability, for example, there are persons who have varying
wage levels as they move from job to job, persons (such as married
women) who may be out of the labor force for some extended periods
of time, persons who may work in non-covered employment (such
as employment abroad or for a Governmental agency) for some
part of their career. Depending on the particular circumstances
involved, such irregular coverage patterns could result in greatly
different benefits under an indexed system than under existing
law. For some individuals, the difference could be quite favorable
and for others it could be quite unfavorable. (U.S. Senate,
Committee on Finance, Staff Data and Materials on Social Security
Financing Proposals, U.S. Government Printing Office, Washington,
September 1977, p. 61-62.) Nonetheless, the steady earner (presumably
for lack of a better alternative) was and continues to be used
as a proxy for a "typical" individual.
Old
vs New Law -- Benefit Differentials for Worker with
Average Earnings Retiring at Age 65 (68) |
Birth
Year |
|
Under
1977 projections |
Under
actual conditions |
|
Old Law |
New Law |
Difference
in % |
Difference
in $ |
Old Law |
New Law |
Difference
in % |
Difference
in $ |
1917 |
492
|
443
|
-10% |
-50
|
614
|
535
|
-13%
|
-79
|
1918 |
530
|
460
|
-13%
|
-70
|
682
|
553
|
-19%
|
-129
|
1919 |
569
|
489
|
-14%
|
-79
|
733
|
542
|
-26%
|
-191
|
1920 |
605
|
522
|
-14%
|
-83
|
775
|
548
|
-29%
|
-227
|
1921 |
642
|
554
|
-14%
|
-88
|
816
|
576
|
-29%
|
-240
|
1922 |
681
|
587
|
-14%
|
-94
|
841
|
593
|
-29%
|
-248
|
1923 |
721
|
620
|
-14%
|
-101
|
894
|
626
|
-30%
|
-268
|
1924 |
763
|
655
|
-14%
|
-108
|
943
|
668
|
-29%
|
-275
|
1925 |
807
|
693
|
-14%
|
-114
|
1004
|
720
|
-28%
|
-284
|
1926 |
853
|
733
|
-14%
|
-121
|
1075
|
751
|
-30%
|
-324
|
The disparities which the right
side of the table illustrates under the actual (but then unanticipated)
conditions of double digit inflation are far more compelling. The
first group of retirees (born in 1917) had a 13% differential and
by the fourth year the differential had grown to 29% with a dollar
amount of $227. Thereafter the differential remained in the range
of 28-30 % reaching a dollar amount in excess of $300 by the 10th
year. It is certainly possible that differentials of this magnitude,
if they had been known in 1977, would have raised questions about
the appropriateness of making a sharp break between the old law
rules for workers born before 1917 and the new law rules for workers
born in and after 1917.
The numbers on the left side of
the table could have been provided to the Congress in 1977. There
would have been no basis for providing the much more substantial
(and, as it turned out, accurate) numbers on the right hand side.
The question of how Congress would have reacted to either set of
these numbers can only be speculation. However, if one assumes that
Congress would have reacted by trying to lessen the implicit differential
between the notch and prenotch groups, some reasonable conjectures
can be made from the legislative history and context.
First of all, there was a solution
at hand. Both the Ford Administration proposal and the testimony
of Robert Myers (whose views were accorded great deference by the
Ways and Means and Finance Committees) provided the same solution;
namely, prohibit persons in the prenotch group from using post-1978
wages in an old-law computation. Moreover, since the major task
faced by Congress was restoring solvency to the system, the Ford
Administration / Myers solution would have recommended itself on
the grounds that it would have helped reduce the cost of the program.
By contrast, a solution which would have increased benefits for
individuals in the notch years would have exacerbated the problems
Congress was facing in financing the program. In particular, had
Congress projected anything like the actual inflation experience
that gave rise to the differentials shown on the right side of the
table, it would have been under even greater pressure to hold down
benefit costs.
On the other hand, it should be
pointed out that Congress did include in the 1977 legislation some
provisions which increased benefit costs. Consequently, whether
and how Congress would have addressed the issue must remain a matter
of speculation. Apart from the apparently overlooked addendum to
the Myers testimony, we have found no indication of any effort at
that time to bring up the notch issue for closer Congressional scrutiny.
The attention of Congress was focused on other Social Security issues
such as the choice among several alternative benefit formulas and
among alternative and highly controversial methods for increasing
program revenues.
(68) The benefit amounts
in this table were computed by the Office of the Actuary of the
Social Security Administration in a memorandum of July 14, 1994
prepared by Richard S. Foster entitled, "Anticipated Versus
Actual OASDI Replacement Rations and Monthly Benefit Amounts under
Social Security Amendments of 1917." This memorandum was prepared
in response to a request from the Commission.
(69) For example,
the 1977 legislation eased the retirement test so that it would
no longer apply to individuals aged 70 or overCcompared with aged 72 or over under
prior law. (This change was to be effective in 1982, but legislation
enacted in 1981 deferred it until 1983.) Liberalizations were also
included in the benefit rules for remarried widows and divorced
spouses. |