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This paper, undertaken at the request of the Senate Committee on Labor and Human Resources, examines the benefits and finances of the Railroad Retirement System. Particular attention has been given to the differences between railroad retirement annuities and those typically available other private-sector employees. In keeping with CBO's mandate to provide objective and nonpartisan analysis, the study makes no recommendations.

The paper was prepared by David DelQuadro of the General Government Management staff of CBO's Office of Intergovernmental Relations, under the supervision of Stanley L. Greigg and Earl A. Armbrust. The author gratefully acknowledges the special assistance given by Sherri Kaplan, Edgar A. Peden, and staff of the Railroad Retirement Board. Johanna Zacharias edited the paper and suggested several improvements; Norma Leake typed the various drafts and prepared the paper for publication.
 

Alice M. Rivlin
Director
January 1982
 
 

SUMMARY

CHAPTER I. INTRODUCTION

• How the Benefit Provisions Work
• RRS Pensions as Wage Replacement
• Sources of RRS Revenues
• Financial Contingency Actions

CHAPTER II. RRS ISSUES--SOLVENCY, BUDGETARY COSTS, AND BENEFIT ALIGNMENT

• The Financial Condition of the RRS Trust Fund
• Federal Budgetary Costs
• RRS Compared with Other Private-Sector Retirement

CHAPTER III. ALTERNATIVE BENEFIT PROVISIONS

• Option I: Continue the Current System
• Option II: Reduce Benefits for Early Retirement
• Option III: Reduce Tier II Spouse Benefits
• Option IV: Tax Railroad Retirement Benefits
• Changing the Federal Role--A Basic Departure

APPENDIX A. SUMMARY OF CHANGES IN RAILROAD RETIREMENT BENEFITS CONTAINED IN THE OMNIBUS BUDGET RECONCILIATION ACT OF 1981

APPENDIX B. INFORMATION ON COST-OF-LIVING ADJUSTMENTS IN THE PRIVATE SECTOR
 

TABLES
S-1.	SAVINGS UNDER ALTERNATIVE MODIFICATIONS TO RAILROAD RETIREMENT
1.	BREAKDOWN OF RAILROAD RETIREMENT BENEFITS AND OUTLAYS: FISCAL YEAR 1982
2.	SOURCES OF RAILROAD RETIREMENT FINANCING: 1982 AND 1990
3.	SUMMARY OF RRS PAYROLL TAXES IN 1982
4.	ACTUAL AND PROJECTED FINANCIAL CONDITION OF RRS UNDER TWO ECONOMIC SCENARIOS: 1980-1990
5.	PROJECTED IMPACT OF RRS ON THE FEDERAL BUDGET: 1983-1987
6.	EXAMPLES OF WAGE REPLACEMENT RATES UNDER RRS AND OTHER PRIVATE SECTOR RETIREMENT: WAGE REPLACEMENT AS A PERCENT OF FINAL SALARY AFTER TAXES
7.	ESTIMATED ANNUAL SAVINGS FROM RRS MODIFICATIONS

 

The Railroad Retirement System (RRS), unlike any other pension plan covering private-sector employees, has provisions set by federal statute and is administered by the U.S. government. Thus, changes in RRS benefits or finances affect the federal budget. The RRS, which currently provides mandatory pension coverage for employees of approximately 1,000 railroad companies, requires annual outlays of some $5.7 billion. At present, about 500,000 railroad workers and their employers support nearly one million beneficiaries, of whom something over half are spouses and survivors.

Since the inception of the system in 1935 (that is, before the establishment of Social Security), the Congress has repeatedly revised RRS benefits and financial provisions. The most recent statutory amendments, enacted in the summer of 1981, raised the total RRS taxes that partially finance the system from about 19 percent to some 22 percent of total payroll; they also modified benefits and authorized the RRS to borrow from the general fund of the U.S. Treasury. Without the 1981 legislation, the RRS program would have become insolvent by 1985. But as amended, the system should maintain a positive financial condition through 1990 provided employment in the industry does not decline precipitously.
 

HOW THE SYSTEM WORKS

Today, RRS remains independent of the Social Security program, although the two systems now have many common features and do coordinate coverage. In 1975, the RRS was restructured to resemble the two-part retirement available to most private-sector employees: a Tier I component that not only substitutes for Social Security but also provides extra benefits; and a corporate-type component, Tier II, which in some instances may be augmented by a longevity supplement and a "windfall," or dual, payment earned by nonrailroad employment prior to 1975.

About 62 percent of RRS revenues come from the payroll taxes that railroad employees and employers pay, and about 28 percent come from a transfer payment from Social Security. (The intent of the transfer payment was to assure that neither the RRS nor the Social Security program is better or worse off financially because of their independence. The transfer currently works to the advantage of RRS, because past declines in railroad employment have resulted in smaller payroll tax revenues to suppport Social Security-type benefits now being paid by RRS.) The remaining RRS revenue comes mainly from interest and federal appropriations, which finance windfall payments.
 

FINANCIAL CONDITION AND CONTINGENCY MEASURES

The solvency of the RRS remains the subject of some concern because, even with the 1981 amendments, RRS reserves will drop from $1.94 billion to $1.88 billion during 1982. Uncertainties limit the accuracy of any projections, but the future condition of the RRS will depend generally on the revenues collected from payroll taxes and in turn, on the level of railroad employment. Statistical analysis indicates that, during the past 20 years, railroad employment has been directly correlated with changes in real Gross National Product (GNP), Most current economic projections predict some annual growth in the real GNP.

The Congressional Budget Office currently assumes (somewhat optimistically) that the economy will grow at an average annual rate of 3.5 percent through 1987. If this growth materializes, RRS reserves will accumulate in 1983 and subsequent years, reaching an estimated $2.4 billion in 1987, or 33 percent of the year's RRS outlays. Under less optimistic economic assumptions, projected levels of railroad employment would be lower and would thus generate less tax receipts. According to actuarial projections prepared by the Railroad Retirement Board, the RRS could face funding problems if, in 1984, employment fell below 450,000. But a drop of this magnitude is not likely, assuming future growth in the nation's economy and a continuation of historical relationships between real GNP and railroad employment. The RRS, however, remains subject to other forces that could reduce program revenues, including technological changes in the transportation industry, amendments to Social Security, labor disruptions, and future declines in the demand for transporting coal.
 

COMPARISON WITH OTHER PRIVATE-SECTOR RETIREMENT

Railroad retirement includes several benefit provisions that are superior to those commonly available in the rest of the private sector--including:

• No benefit reduction for career employees retiring as early as age 60;
  
  
• Spouse payments that include a corporate-type benefit component;
  
  
• Tax-exempt status for virtually all RRS benefits; and
  
  
• Guaranteed cost-of-living adjustments.

Considerations of RRS benefit advantages should not overlook the quite high and recently raised payroll withholdings railroad companies and employees pay toward the corporate benefit component. Tier II payroll withholdings have just been raised from 9.5 to 13.75 percent (the employee pays 2 percentage points) of the first $24,300 of earnings in calendar year 1982.

Taken together, the comparative advantages of RRS help provide married career employees highly attractive income security at relatively early ages of retirement. The initial RRS income for such new annuitants, who represent more than half of those now retiring directly from the railroads, could easily exceed the net annual salary received just before retirement. Largely because of early-retirement provisions and Tier II spouse payments, railroad retirement offers benefits to married annuitants that appear among the highest in private industry. This point becomes particularly clear when expressed in terms of after-tax wage replacement. For a married worker retiring with an annual salary of $22,000, RRS provides a net wage replacement of 129 percent; the RRS wage replacement of a $30,000 salary is 105 percent. These rates exceed those available under retirement plans, reviewed by CBO, in the utilities and other transportation industries.
 

ALTERNATIVE BENEFIT PROVISIONS

The Congress may want to consider modifying RRS as a means to fortify further the program's financial condition, to reduce federal budgetary costs, or to align the RRS better with typical private-sector practices. Because of the increased RRS tax burden already imposed and the link to future scheduled increases in Social Security taxes, any modifications to the current system would most likely entail benefit reductions rather than additional tax increases.

The arguments for and against maintaining the current system and three possible modifications are outlined below. (The alternatives are based on the assumption that the federal role in RRS will not change radically, although some proposals to withdraw most or some of the government's involvement in RRS have been advanced.) Options II and IV go beyond the adoption of private-sector practices in order to demonstrate the maximum budgetary effect possible. For estimating purposes, all of the options are assumed to have an October 1982 effective date. As a practical matter, the timing and duration could differ, and the Congress could mix or adapt the measures to fulfill specific reduction objectives. The three alternatives could generate five-year savings ranging from $0.1 billion to $1.9 billion (see Summary Table).

Option I: Continue the Current System

Advocates of the current system point out that the Congress recently enacted changes to assure adequate finances for the RRS. Opponents argue that the system's payroll taxes, already representing 22 percent of payroll, support a program that provides excessive benefits to many new annuitants.

Option II: Reduce Benefits for Early Retirement

Under this option, career employees who spent 30 or more years with the railroads could still retire as early as age 60, but primary and spouse benefits would be reduced by the same age factors that apply to Social Security. As a result, some 10,000 employees per year would either receive lower benefits or delay retirement. Cumulative savings during the first five years would total $0.7 billion. (Such an early-retirement reduction proposal would probably carry certain retroactive provisions; otherwise, RRS costs would rise sharply as employees accelerated retirement plans to avoid scheduled benefit cuts.)

In light of proposals to increase Social Security's early-retirement reductions, some observers might view Option II as not going far enough. Others would criticize it because many railroad workers have already made plans for early retirement. In some cases, however, early-retirement annuities available under Option II would continue to exceed after-tax income from active railroad employment.

Option III: Reduce Tier II Spouse Benefits

Option III would automatically achieve savings by suspending the annual cost-of-living increases in Tier II spouse payments, excluding survivor benefits. This would recognize the unique benefit advantage available to married RRS retirees and avoid reductions both in the initial annuities awarded new retirees and in present payments to current annuitants. Option III would also bring Tier II survivor provisions into closer alignment with retirement practices in the rest of the private sector. Cumulative savings through 1987 could reach $120 million.

In order to provide spouse survivor protection, most private-sector retirees must accept an actuarial reduction in their initial annuities. Option III would apply the more modest offset currently in effect for federal civilian retirees (2 1/2 percent of the first $3,600 plus 10 percent of the remaining annual annuity).

Opponents of Option III would point out that spouse and survivor benefits were revised as part of the 1981 railroad amendments and that further revisions would breach standing agreements between labor and management. Single and widowed employee annuitants could argue, however, that an individual's marital status should not influence the size of a corporate pension. From their perspective, Option III should further limit spouse benefits as a means to increase the railroad employee's annuity.

Option IV: Tax Railroad Retirement Benefits

This alternative would reduce federal costs for RRS by increasing income tax receipts at the expense of railroad annuitants. First-year savings would equal some $360 million and would accumulate to about $1.9 billion over five years.

Railroad annuitants would object to Option IV because the typical private-sector retiree receives tax-exempt Social Security benefits. But this approach would allocate the financial loss according to total taxable income. Railroad annuitants most able to accommodate the reduction would likely bear the greatest burden, and low-income annuitants would be liable for little if any of the new tax.

The Congress could continue the tax exemption for half of the RRS benefits as an approximation of the Social Security tax exclusion available to other private-sector annuitants. This more limited action could be viewed as sound public policy, regardless of RRS financial considerations.

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