Academic journal article Social Security Bulletin

The Distributional Effects of Changing the Averaging Period and Minimum Benefit Provisions

Academic journal article Social Security Bulletin

The Distributional Effects of Changing the Averaging Period and Minimum Benefit Provisions

Article excerpt

This study evaluates the effects of changing the averaging period used to calculate Social Security benefits from 35 years to 38 or 40 years and the introduction of a minimum benefit provision for future retirees born during the early part of the baby boom generation. Proposals to change the averaging period have been recommended by a majority of the 1994-96 Advisory Council on Social Security. Based on the Survey of Income and Program Participation (SIPP) matched to Social Security Administration earnings records, the study projects retirement benefits for different subgroups of the population under existing and proposed benefit rules. The magnitudes of the retirees' benefit changes vary by demographic group. The minimum benefit provision substantially mitigates the effects of the change to a 40-year averaging period for some groups of women.

Introduction

Concern about the long-term solvency of the Old-Age and Survivors Insurance (OASI) Trust Fund has spawned numerous proposals to reform the existing structure of the Social Security program. Recent projections of the Social Security Trustees estimate that the assets of the combined OASI and Disability Insurance (DI) Trust Funds will be depleted by the year 2034 under present law and the intermediate assumptions. I The retirement of the baby boom generation will strain the system as benefit payments to retirees increase relative to contributions made by workers. Many proposed policy changes reduce retirement benefits to promote long-term solvency. Obviously if aggregate benefit payments are reduced, more retirees could be paid over a longer period of time. This article examines the distributional effects of increasing the number of years of earnings counted in the formula used to determine retirement benefits and establishing a povertylevel benefit for persons who worked 40 years.

Currently, retirement benefits are calculated using the highest 35 years of earnings during one's lifetime work history. The formula used to determine the monthly primary insurance amount (PIA), or full benefit for a retired worker, is based on the individual's lifetime average indexed monthly earnings (AIME), which is derived from their highest 35 years of earnings. A majority of the 1994-96 Social Security Advisory Council (1997) proposed increasing the number of years of earnings in the AIME formula from 35 to 38 years.2 Some recommended that this number be increased to 40 years.' As indicated by these two proposals, changing the averaging period of the benefit formula has attracted the attention of policymakers.

Some also recommended a minimum benefit provision designed to increase the progressivity of the existing benefit structure. Such a benefit is designed to shield lowincome contributors from adverse effects of other provisions recommended to restore the Social Security program to solvency. Retirees who have contributed to the program for 40 years could be guaranteed a benefit equal to the aged poverty level. Workers with 20 years of covered earnings could be guaranteed a benefit that is equal to 60 percent of the poverty level. For workers with more than 20 years of covered earnings, the minimum benefit level increases 2 percent of the poverty level with every additional year of contributing into the system, so that those who contribute for 40 years could be guaranteed the poverty level benefit. Since a proposal could call for the minimum benefit component to be phased-in from 2001 through 2020, workers born during the baby boom generation could be affected.

The Social Security benefit formula uses a multi-year averaging period to relate a worker's retirement benefit to their career earnings (Ball 1998). Proponents of changing the period argue that since most people work more than 35 years, counting more years would cause benefits to reflect average career earnings more accurately than they do now. However, if a number of years of zero earnings were added, due to the progressivity of the benefit formula, an increase in the averaging period would have a greater effect on the benefits of people with low earnings. …

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