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This file contains material relating to proposals for reform of social security financing.

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Social Security (2)
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Social Security (2)
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This file contains material relating to proposals for reform of social security financing.
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James Cannon's Issues Files
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The original documents are located in Box 33, folder "Social Security (2)" of the James M. Cannon Files at the Gerald R. Ford Presidential Library. Copyright Notice The copyright law of the United States (Title 17, United States Code) governs the making of photocopies or other reproductions of copyrighted material. Gerald Ford donated to the United States of America his copyrights in all of his unpublished writings in National Archives collections. Works prepared by U.S. Government employees as part of their official duties are in the public domain. The copyrights to materials written by other individuals or organizations are presumed to remain with them. If you think any of the information displayed in the PDF is subject to a valid copyright claim, please contact the Gerald R. Ford Presidential Library. ACTION THE WHITE HOUSE WASHINGTON May 16, 1975 FC23 MEMORANDUM FOR: THE PRESIDENT FROM: JIM CANNON FORD is LIBRARY GERALD SUBJECT: Social Security The purpose of this memorandum is to present for your decision key issues regarding the financing of Social Security. Behind all of these issues lie two questions: 1. Whether you should propose before 1977 some kind of increase in the payroll tax. 2. If you should, when should you propose the increase. CURRENT SYSTEM Under present law benefits are financed out of current income from Social Security taxes. These taxes are applied equally to employer and employee. The revenue flows through trust funds - one set of funds for Old Age, Survivors, and Disability (OASDI) benefits. -- and a Medicare fund to finance health care for the aged. Benefits are related to actual income (the wage base subject to Social Security taxes) but are also adjusted according to the cost of living. The wage base subject to taxes is also adjusted for inflation. Under present law: Calendar Year 1976 1977 1978 1979 1980 OASDI Tax 4.95% 4.95 4.95 4.95 4.95 Medicare Tax 0.90 0.90 1.10 1.10 1.10 Total Tax 5.85 5.85 6.05 6.05 6.05 Earnings Base 15,000 16,500 18,300 19,800 21,300 Digitized from Box 33 of the James M. Cannon Files at the Gerald R. Ford Presidential Library -2- ISSUE A. Financing 1. Short Term Since the Social Security system is exceedingly sen- sitive to changing economic conditions most recent trends indicate that Old Age, Survivors, and Disability outgo will exceed income by a widening margin so that trust fund reserves will be exhausted in the early 1980's. The Medicare Trust Fund is projected to be relatively stable. 2. Long Term Current demographic projections and recent provisions for automatic cost of living adjustments which provide a double benefit increase for current workers raise serious questions about the fiscal stability of the system over the next 50 years. B. Selected Advisory Council Recommendations The Advisory Council on Social Security recommended action to deal with a number of specific items such as: --- maintaining retirement test -- equal treatment of men and women -- minimum benefits -- older disabled workers STRATEGY FOR DEALING WITH ISSUES Secretary Weinberger must testify before Ways and Means on May 20th and recommends: 1. A specific decision be made now on a proposal to deal with the short term financing problem and announced in his May 20 testimony. 2. In that testimony we should indicate the Administra- tion intends to submit in January a proposal to deal with the long term issues. 3. Not dealing now with the selected Advisory Council recommendations with the one exception of equal treat- ment for men and women which has recently been sub- ject of a Supreme Court decision. REACTIONS TO THIS PROPOSED STRATEGY I recommend concurrence with strategy items two and three above. No objections have been raised on these points and the long term problem needs to be addressed and January would be an appropriate point in time. equal treatment of men and women has been the subject of a court decision and the options avail- able now are not likely to change with time. There is, however, a sharp difference of opinion on the key question, point one, of whether the short term problem should be: -- dealt with now and a specific option should be announced by the Secretary on May 20th, or -- should be included with the longer term problems and a single comprehensive plan to stabilize the Social Security system should be presented in Janu- ary 1976. ARGUMENTS IN FAVOR OF ACTING ON THE SHORT TERM PROBLEM NOW 1. The public is concerned about the stability of the system and a specific proposal now will help calm that concern. 2. Failure to present a specific recommendation could provide increased impetus to Congressional moves toward general, revenue funding. 3. Action now would put the Administration in the position of taking the initiative. ARGUMENTS AGAINST ACTION NOW 1. Since proposals, either now or in January, would not become effective until 1977 at the earliest there is no need to make a decision immediately. 2. OMB believes the data furnished by HEW is insufficient to make a decision as important as this. 3. Any adjustments now have a long term affect anyway so they will have to be integrated in the long term proposal. -4- 4. The long term proposal is needed not just for financial problems but also for basic structural changes. Action now could remove the leverage needed to gain support for these changes. STRATEGY DECISIONS Option I: Act now on the short term problems by having Secretary Weinberger announce a specific proposal on May 20th. Favored by: HEW Bill Seidman Option II: Defer action on the short term problem, proceed with work on both long and short term problems and submit in January 1976 a single comprehensive plan for stabilizing the system. Favored by: OMB Treasury Department Phil Buchen Alan Greenspan RECOMMENDATION That you approve Option II, deferring action on short term issues now and including short term issues in a single comprehensive plan in January 1976. Approve Disapprove SPECIFIC OPTIONS FOR ACTION NOW The Secretary suggests three basic options if you wish to deal now with the short term problem. He suggests that the aim be to maintain OASDI Trust Fund reserves of no less than 30 percent of outgo. The options available are: 1. TAX RATE ONLY OPTION: Simply raise the tax rate. -- In 1977 increase total tax from 5.85 to 6.20. The OASDI tax would go from 4.95 to 5.30. In 1978, take the scheduled .20 percent Medicare tax increase and apply it in part. A total tax of 6.20 would apply in 1977 and 6.40 in 1978. Pro 1. Would stabilize trust fund at about 36 percent of outgo. -5- 2. Utilizes relative stability of Medicare Trust Fund to assist troubled OASDI system. 3. Has promptest corrective affect on trust fund. 4. Would have the least detrimental affect on savings flow and capital investment. Con 1. Would impact most heavily on low income families reinforcing charge that Social Security tax is regressive. 2. Largest total tax increase of any option. 3. A higher tax yields no increase in benefits by itself. 2. BASE/RATE OPTION A: Modest increase in earnings base coupled with some tax increase. -- Rather than the scheduled 1977 increase to $16,500 in earnings base subject to tax, increase the base to $18,000. In addition, raise total tax rate in 1978 from scheduled 6.05 to 6.30. Part of scheduled Medicare increase would be shifted and coupled with an additional increase to protect OASDI Trust Fund. Pro 1. Would spread burden to higher income levels thus moving toward greater progressivity. 2. Change in earnings base is not severe and will have a lesser affect on savings. 3. Occurs in conjunction with previously scheduled increases. Con 1. Tax increase beyond present law. 2. New level of wages subject to tax. 3. Slowest affect on stabilizing trust fund. -6- 2. BASE/RATE OPTION B: Increase wage base substantially and shift part of Medicare increase. -- This proposal would increase wage base to $21,000 in 1977, shift part of the 1978 Medicare increase to OASDI but not increase total tax beyond what present law requires. Pro 1. Total tax is not increased beyond present law. 2. Moves substantially toward greater pro- gressivity. 3. Has more immediate corrective affect on trust fund outgo. 4. It gives something back in higher benefits to those who will be paying the higher rate. Con 1. It has long been agreed that Social Security protection should not extend to the total earnings of covered workers for this coverage would substitute for private insurance funded in the private sector. Under this option, 95 percent of the covered work force would have their entire salary protected under Social Security. 2. Concentrates total cost of correcting trust fund problems on the higher income group, thus having the most severe affect on savings flow. 3. This is a short-term proposal, but the effect of an increase in the wage base goes well into the long range future. A wage base increase results in a higher base for the computation of benefits. It increases the cost of the system in the future not all of the revenue is available for covering the deficit. Some is lost in higher future benefits). Thus, it is a more costly and permanent change than a tax rate increase for the same amount of revenue. -7- STAFF COMMENTS Robert Hartmann: Base/Rate Option A Jack Marsh: Tax Rate Only Option with Base/Rate Option A as a fall back position. Alan Greenspan: "If there is to be action now tax rate only more progressivity reduced savings flow and capital investment. " Phil Buchen: "Any proposal advanced at this time should combine increases in both the tax rate and earnings base. " Bill Seidman: Supports the three recommendations by Secretary Weinberger including Base/Rate Option B. RECOMMENDATION I recommend that if you choose to act now you select the Base/Rate Option A which provides for a modest increase in earnings base and a tax increase. Approve Disapprove ACTION THE WHITE HOUSE WASHINGTON May 16, 1975 MEMORANDUM FOR: THE PRESIDENT FROM: JIM CANNON QUEALO FORD LIBRARY SUBJECT: Social Security The purpose of this memorandum is to present for your decision key issues regarding the financing of Social Security. Behind all of these issues lie two questions: 1. Whether you should propose before 1977 some kind of increase in the payroll tax. 2. If you should, when should you propose the increase. CURRENT SYSTEM Under present law benefits are financed out of current income from Social Security taxes. These taxes are applied equally to employer and employee. The revenue flows through trust funds -- one set of funds for Old Age, Survivors, and Disability (OASDI) benefits. -- and a Medicare fund to finance health care for the aged. Benefits are related to actual income (the wage base subject to Social Security taxes) but are also adjusted according to the cost of living. The wage base subject to taxes is also adjusted for inflation. Under present law: Calendar Year 1976 1977 1978 1979 1980 OASDI Tax 4.95% 4.95 4.95 4.95 4.95 Medicare Tax 0.90 0.90 1.10 1.10 1.10 Total Tax 5.85 5.85 6.05 6.05 6.05 Earnings Base 15,000 16,500 18,300 19,800 21,300 -2- ISSUE A. Financing 1. Short Term Since the Social Security system is exceedingly sen- sitive to changing economic conditions most recent trends indicate that Old Age, Survivors, and Disability outgo will exceed income by a widening margin so that trust fund reserves will be exhausted in the early 1980's. The Medicare Trust Fund is projected to be relatively stable. 2. Long Term Current demographic projections and recent provisions for automatic cost of living adjustments which provide a double benefit increase for current workers raise serious questions about the fiscal stability of the system over the next 50 years. B. Selected Advisory Council Recommendations The Advisory Council on Social Security recommended action to deal with a number of specific items such as: -- maintaining retirement test -- equal treatment of men and women --- minimum benefits -- older disabled workers STRATEGY FOR DEALING WITH ISSUES Secretary Weinberger must testify before Ways and Means on May 20th and recommends: 1. A specific decision be made now on a proposal to deal with the short term financing problem and announced in his May 20 testimony. 2. In that testimony we should indicate the Administra- tion intends to submit in January a proposal to deal with the long term issues. 3. Not dealing now with the selected Advisory Council recommendations with the one exception of equal treat- ment for men and women which has recently been sub- ject of a Supreme Court decision. -3- REACTIONS TO THIS PROPOSED STRATEGY I recommend concurrence with strategy items two and three above. No objections have been raised on these points and -- the long term problem needs to be addressed and January would be an appropriate point in time. -- equal treatment of men and women has been the subject of a court decision and the options avail- able now are not likely to change with time. There is, however, a sharp difference of opinion on the key be: question, point one, of whether the short term problem should -- dealt with now and a specific option should be announced by the Secretary on May 20th, or --- should be included with the longer term problems and a single comprehensive plan to stabilize the Social Security system should be presented in Janu- ary 1976. ARGUMENTS IN FAVOR OF ACTING ON THE SHORT TERM PROBLEM NOW 1. The public is concerned about the stability of the system and a specific proposal now will help calm that concern. 2. Failure to present a specific recommendation could provide increased impetus to Congressional moves toward general revenue funding. 3. Action now would put the Administration in the position of taking the initiative. GRAND FORD CLARARY ARGUMENTS AGAINST ACTION NOW 1. Since proposals, either now or in January, would not become effective until 1977 at the earliest there is no need to make a decision immediately. 2. OMB believes the data furnished by HEW is insufficient to make a decision as important as this. 3. Any adjustments now have a long term affect anyway so they will have to be integrated in the long term proposal. -4- 4. The long term proposal is needed not just for financial problems but also for basic structural changes. Action now could remove the leverage needed to gain support for these changes. STRATEGY DECISIONS Option I: Act now on the short term problems by having Secretary Weinberger announce a specific proposal on May 20th. Favored by: HEW Bill Seidman Option II: Defer action on the short term problem, proceed with work on both long and short term problems and submit in January 1976 a single comprehensive plan for stabilizing the system. Favored by: OMB Treasury Department Phil Buchen Alan Greenspan RECOMMENDATION That you approve Option II, deferring action on short term issues now and including short term issues in a single comprehensive plan in January 1976. Approve Disapprove SPECIFIC OPTIONS FOR ACTION NOW The Secretary suggests three basic options if you wish to deal now with the short term problem. He suggests that the aim be to maintain OASDI Trust Fund reserves of no less than 30 percent of outgo. The options available are: 1. TAX RATE ONLY OPTION: Simply raise the tax rate. -- In 1977 increase total tax from 5.85 to 6.20. The OASDI tax would go from 4.95 to 5.30. In FORD 1978, take the scheduled .20 percent Medicare tax increase and apply it in part. A total tax of 6.20 would apply in 1977 and 6.40 in 1978. LIBRAR Pro 1. Would stabilize trust fund at about 36 percent of outgo. -5- 2. Utilizes relative stability of Medicare Trust Fund to assist troubled OASDI system. 3. Has promptest corrective affect on trust fund. 4. Would have the least detrimental affect on savings flow and capital investment. Con 1. Would impact most heavily on low income families reinforcing charge that Social Security tax is regressive. 2. Largest total tax increase of any option. 3. A higher tax yields no increase in benefits by itself. 2. BASE/RATE OPTION A: Modest increase in earnings base coupled with some tax increase. -- Rather than the scheduled 1977 increase to $16,500 in earnings base subject to tax, increase the base to $18,000. In addition, raise total tax rate in 1978 from scheduled 6.05 to 6.30. Part of scheduled Medicare increase would be shifted and coupled with an additional increase to protect OASDI Trust Fund. Pro 1. Would spread burden to higher income levels thus moving toward greater progressivity. 2. Change in earnings base is not severe and will have a lesser affect on savings. 3. Occurs in conjunction with previously scheduled increases. Con 1. Tax increase beyond present law. 2. New level of wages subject to tax. 3. Slowest affect on stabilizing trust fund. -6- 2. BASE/RATE OPTION B: Increase wage base substantially and shift part of Medicare increase. -- This proposal would increase wage base to $21,000 in 1977, shift part of the 1978 Medicare increase to OASDI but not increase total tax beyond what present law requires. Pro 1. Total tax is not increased beyond present law. 2. Moves substantially toward greater pro- gressivity. 3. Has more immediate corrective affect on trust fund outgo. 4. It gives something back in higher benefits to those who will be paying the higher rate. Con 1. It has long been agreed that Social Security protection should not extend to the total earnings of covered workers for this coverage would substitute for private insurance funded in the private sector. Under this option, 95 percent of the covered work force would have their entire salary protected under Social Security. 2. Concentrates total cost of correcting trust fund problems on the higher income group, flow. thus having the most severe affect on savings 3. This is a short-term proposal, but the effect of an increase in the wage base goes well into the long range future. A wage base increase results in a higher base for the computation of benefits. It increases the cost of the system in the future (i.e., not all of the revenue is available for covering the deficit. Some is lost in higher future benefits). Thus, it is a more costly and permanent change than a tax rate increase for the same amount of revenue. STAFF COMMENTS Robert Hartmann: Base/Rate Option A Jack Marsh: Tax Rate Only Option with Base/Rate Option A as a fall back position. Alan Greenspan: "If there is to be action now tax rate only more progressivity reduced savings flow and capital investment. " Phil Buchen: "Any proposal advanced at this time should combine increases in both the tax rate and earnings base. " Bill Seidman: Supports the three recommendations by Secretary Weinberger including Base/Rate Option B. RECOMMENDATION I recommend that if you choose to act now you select the Base/Rate Option A which provides for a modest increase in earnings base and a tax increase. Approve Disapprove Secretary Weinberger's Memorandum WASHINGTON, D. C. 20201 MASSACHUSETTS May 2, 1975 MEMORANDUM FOR THE PRESIDENT FROM : Caspar W. Weinberger SUBJECT: Social Security I have been called before the Congress later this month to testify on the Administration's position on the short-term financing problem in the social security system and the longer term financial and structural problems and prospects for social security. In addition, the Administration has not yet, but should react more comprehensively to the Social Security Advisory Council report delivered to you and the Congress (and made public) in March. You and I commented un- favorably on its recommendation to finance Medicare from general revenues, and have indicated general endorsement of some revision in the future benefit structure. We have not, however, reacted to its other recommendations on benefits and coverage, or to its specific proposals for solving short- and long-term financial deficits. This memorandum highlights a somewhat longer decision memorandum that is attached. Background There is a serious short-term financing problem in social security cash benefit programs. This problem was understated in the Advisory Council report, but later cost estimates are now available, and are known publicly. The forthcoming Trustees Report will underscore it. Given current projects and current law, outgo exceeds income by a widening margin so that reserves, now 66 percent of annual outgo, dwindle to nothing in the early 1980's. These problems arise because the social security system is exceedingly sensitive to changing economic conditions. The recent high inflation rates followed by recession have caused large unanticipated reductions in income and increases in outgo. Also Congress has increased benefits by about 70% in the last 5 1/2 years. Beyond the near-term problems, there are a series of interrelated financing issues. These issues are caused by the demographic shift Page 2 -- Memorandum for the President toward a proportionately larger aged population as a result of falling birth rates, and by the current computational structure for social security benefits which automatically adjusts the benefits of future retirees in such a way as to overcompensate for inflation. The Congress is aware of these issues, and plans to debate the near- term issue soon. The relevant committees have initiated a review on a more deliberate schedule of the long-term issue. The Advisory Council has offered its solution. Many ideas, including general fund financing, exist in the Congress. A debate of immense importance is under way. Discussion The first problem at hand is near-term financing. In brief, we need more revenue, even though current law provides for some increases in the future. (The earnings base on which payroll taxes are collected goes up for both social security cash benefits and Medicare under the indexing features of current law. Medicare also has a small payroll tax rate increase scheduled in law for 1978.) In my opinion, the realistic alternatives for increasing revenues are a small increase in payroll tax rates, an increase in the payroll tax earnings base, or a combination thereof. While the Advisory Council recommended general revenue financing, I strongly believe that we should con- tinue to maintain our stance against it. I regard the Advisory Council recommendation as a first step toward destroying the discipline of connecting benefits and taxes. The timing of the increase in revenues is partly judgmental, but is strongly determined by the perception of how large or how small the reserve should be. Not long ago, we thought it should be 75-100 percent of annual outgo. There is no "right" number, but I think less than about 30 percent would not suffice in recessionary periods and would begin to erode public confidence in the system. If this is correct, then increased revenues should start to flow in 1977. In addition, the longer we wait to increase revenues, the higher and sharper the increases in any one year must be. We also need to grapple with the long-term issues, correctly identi- fied by the Advisory Council. There is a substantial consensus that we need to stabilize the future benefit structure, but the Advisory Council solution is only one of many. Like the Congress seems prepared to do, I believe we should work our way carefully through this problem, looking toward a proposal to Congress next January. With respect to other Advisory Council recommendations on benefits and coverage, I think we should openly set those aside for now as too costly to con- sider. I would make an exception for those low-cost items related to unequal treatment of men and women, particularly in light of the recent Supreme Court decision in this area. Page 3 -- Memorandum for the President The final area of concern relates to the timing of Administration proposals to solve the short-term financing problem. I believe we must take a position on this subject. We do, however, have the choice of announcing now our specific proposals for increasing short-term revenues and waiting until next year to put forward long-range solutions, or alternatively acknowledging the issues now and announcing all our proposals in January. The advantages of proceeding now with a specific proposal include: attempting to lead the debate, preempting or competing early with other solutions we would oppose, and avoiding a new tax increase proposal in 1976. Waiting would allow us to tie the short- and long-range proposals together in one comprehensive Administration plan. Recommendations In the attached memo which contains the specific decision options, I am recommending that you choose the following: Adopt a specific proposal now to deal with the short-term financing problem (through 1980). The proposal would adjust upward the earnings base beginning in 1977 but would not alter the combined social security/Medicare payroll tax rate currently scheduled in law. Reconfirm endorsement of need for legislation to stabilize future benefit structure and proceed with studies of alter- native ways of accomplishing this. Ignore other Advisory Council financing recommendations that are based on cost estimates that are now out of date. With the exception of selected measures on equal treatment, set aside for now Advisory Council recommendations on benefits and coverage in light of economic conditions and the overriding importance of the short- and long-term financing problems. Attachment May 2, 1975 MEMORANDUM FOR THE PRESIDENT Through: Honorable James M. Cannon Domestic Council Purpose The purpose of this memorandum is to obtain Presidential decisions concerning: RL 1. The Administration's response to the recommendations of the 1975 Advisory Council on Social Security. 2. The financing of deficits (both short- and long-term) facing the social security system. Each of these topics is discussed separately below. At the end of each topic you will find a set of options for Presidential decision. I. ADVISORY COUNCIL RECOMMENDATIONS On December 11, there was a briefing for the President on social security financing problems and on the major social security issues that have been addressed by the Advisory Council. An outline of each of the Council's major recom- mendations was also contained in the enclosed memorandum of January 24 (Tab A). The Council's report, which has been transmitted to the Congress, recommended a series of cash benefit proposals to (1) modify coverage and benefits; (2) stabilize the future benefit structure; and (3) finance both the short- and long-term deficit. Coverage and Benefit Modifications The first group of proposals affecting coverage and benefit provisions (by eliminating differences in the treatment of men and women, liberalizing the retirement test, changing the definition of disability for older workers, etc.) are described in Tab A. Some of them have merit. The Council's recommendations for promoting equal rights for men and women under social security are of particular interest at this time in light of the recent Supreme Court decision in the Wiesenfeld case which held unconstitutional the provision of present law under which social security benefits are payable to a widow with a child beneficiary in her care but not to a similarly situated widower. In the near future the Department of Health, Education, and Welfare will forward recommendations for changing those provisions of the social security law which differentiate between men and women. (The short-term cost of these legislative recommendations is not large enough to have an effect on the short-term financing options discussed in part II of this paper.) Almost all of the Council's other benefit recommendations involve additional program costs. All things considered, it is recommended that this group of recommendations be opposed at this time on the grounds that the current economic outlook and the tenuous financial status of the social security system militate against these changes in benefits and coverage. Such a position would be consistent with the President's "no-new-starts" policy. Stabilizing the Benefit Structure The subject of stabilizing the benefit structure replacement rates was discussed in some detail in a meeting with the President on December 11 and in the enclosed memorandum of December 23 (Tab B). It is recommended that the President strongly endorse the principle of stabilization and the need to develop and adopt a stabilization proposal as quickly as possible but that we consider the Council's model as one among a number of possible alternatives. The Administration should take the position that it is examining alternative ways of accomplishing the objective and will present a specific recommendation to the Congress at a later date. FORD Financing the Deficits As a practical matter, the Council's financing plan is not GERALD very helpful: -- First, it will not completely solve the long-term financing problem. While their plan would finance a long-term deficit of over 3 percent of taxable payroll, the latest actuarial estimates suggest a deficit of over 5 percent. 3 -- Moreover, the Council would finance Medicare from general revenues and transfer Medicare payroll taxes to bail out the old-age, survivors and disability insurance (OASDI) trust funds. The Administration should oppose this and all other general fund financing schemes. Another consideration is that it would probably be a mistake to decide on a long-term financing plan before a decision is made concerning a specific benefit stabilization plan, since stabilization will substantially reduce the long-term deficit. Suggested Presidential Decisions Concerning Advisory Council Report 1. Proceed with development of proposals on equal treatment of men and women and reject the Council's other proposed modifications in coverage and benefits not on their merits, but on grounds that the system cannot afford the cost. Approved Disapproved 2. Endorse legislation to revise and stabilize benefit structure and indicate that Administration will present specific plan to Congress. Approved Disapproved 3. Concur in Council's conclusion that steps must be taken to solve system's financing problems; reject Council's specific plan; and develop an Administration financing plan. Approved Disapproved 4 II. FINANCING A. Long Term Long-range actuarial cost estimates indicate that the old-age, survivors, and disability insurance system has a substantial long-range deficit. It is estimated that the program is under- financed over the customary long-range valuation period of 75 years by an average annual amount equivalent to 5.32 percent of taxable payroll, with the larger part of this deficit occurring after the turn of the century. A significant part of the high long-range cost of the program in the next century is due to the projected increases in benefit levels relative to earnings levels under the automatic benefit adjustment provisions of present law. The previously mentioned recommendation to stabilize the future benefit structure would have a significant favorable impact on this long-range deficit. The Department is studying alternative proposals that would result in such stabilization. However, until a specific plan to accomplish this is developed, a specific method of dealing with this long-range deficit should be postponed. There is adequate time to deal with this long-range problem. B. Short Term The immediate financing problem--probably the most critical of the several issues facing the social security system--is what to do about the short-term deficit facing the cash benefit part of the system. At the time the President was briefed in December, the yearly deficits in the cash benefit trust funds beginning in 1976 were expected to be small; it appeared that these deficits could be covered over the next 5 or more years without reducing the reserve to an unacceptable level. Projections of the status of the trust funds were revised later in December, when the Council of Economic Advisers' economic assumptions for the 1976 budget became available. Current projections of program costs are based on more recent assumptions developed for use in the 1975 Trustees' reports which will be submitted to the Congress next week. (These latest assumptions are used throughout this memorandum.) Cost estimates based on the latest economic assumptions show (as did those based on the 1976 budget assumptions) that the reserve in the cash benefit funds will be impaired almost immediately and will be completely exhausted by the early 1980's. Social security is of course a dynamic system sensitive to changes in the economy, and shifts in the short-term economic outlook can have a significant effect on trust fund income and outgo. Income from the payroll tax is strongly influenced by the amount and duration of unemployment and the rate of increase in wages. With anticipated benefit increases tied to the cost-of-living projections, outgo estimates can vary sharply if. CPI assumptions are changed in any significant way. Basically, as compared to the 1976 budget assumptions, the Trustees' report assumptions show a slower rise in the CPI over the next several years, project unemployment rates to be somewhat higher in 1975 and lower in 1978-1980, and are less optimistic about productivity improvements in the latter part of this decade. (See Tab C.) The tables below show the status under present law of the cash benefit (OASDI) trust funds through 1980 under the assumptions developed by HEW for the Trustees' reports. Status of Old-Age, Survivors and Disability Insurance Trust Funds 1975-1980 Existing Legislation (Amounts in Billions) Calendar Year 1975 1976 1977 1978 1979 1980 1981 Income $66.5 $72.3 $81.8 $91.1 $100.3 $109.1 Outgo 69.5 78.1 87.5 97.1 107.1 116.8 Net (surplus/ deficit) -3.0 ,-5.8 -5.8 -6.0 -6.8 -7.7 Reserve at start of year: Amount $45.9 $42.9 $37.1 $31.3 $25.4 $18.6 $10.9 As percent of year's outgo 66% 55% 42% 32% 24% 16% 9% 6 Decisions on how to deal with the central issue of short-range financing of the cash benefits part of social security will necessarily involve resolution of three important sub-issues: the treatment of proposed social security legislation set forth in the 1976 budget; the timing of any financing initiative; and the specific nature of such an initiative. 1. Effect of Social Security Cost-Control Legislation on Financing The Administration has proposed a number of administrative and legislative initiatives which would have the effect of holding down social security costs. (A complete list of these proposals is included at Tab D.) The key measures which would have a significant effect on the funds are legislative proposals to (a) place a one-time, 5-percent limit on the social security cash benefit increase payable in July 1975, and (b) institute greater Medicare cost-sharing. It now appears extremely unlikely that the Congress will enact either the 5-percent cap on social security benefits or the Medicare cost-sharing legislation. (The Senate Finance Committee, in their budget considerations, did not accept the 5-percent cap, and more than 50 Senators have co-sponsored a Senate resolution opposing the cap. The House Ways and Means Committee has expressed strong sentiment against it.) Nor, to the best of our knowledge, is there any Congressional support for Medicare còst-sharing legislation. The Congress refused to consider this type of legislation 2 years ago. As a practical matter, therefore, it would seem unwise to predicate a financing plan on the assumption that the Administration's proposed social security cost-reduction legislation will be enacted. On the other hand, it is important to understand the effect that enactment of these proposals would have on the trust funds and their financing arrangements. We have therefore shown at Tab E an analysis of the effect of the proposed cost-control legislation and of a related financing plan that could be proposed assuming enactment of that legislation. The remainder of this paper assumes that the legislation will not be enacted. 7 2. Timing There are two questions with respect to the timing of Administration short-term financing proposals: When must additional revenue-producing measures take effect? When should the Administration submit a financing proposal to the Congress? The timing of a legislative effective date raises broad economic and political considerations, as well as the obvious concerns about the fiscal integrity of the social security system and public confidence in the system. Viewing the issue solely from the position of stewardship of the trust funds, the Administration would have to advocate legislation to provide additional financing at the earliest possible moment--that is, beginning in calendar 1976, when, under present law, expenditures from the cash benefit funds will significantly exceed income. It is recognized, however, that in the current economic situation such a proposal is strongly contraindicated. The basic premise therefore should be that, due to the state of the economy, no tax increases or other social security revenue-producing measures should be proposed which affect calendar years 1975 or 1976. Then the timing and design of financing alternatives should employ the following criteria: a. Further revenue development can be held in abeyance until, but not beyond, a point where the reserve level falls so low as to seriously erode public.confidence. (This is a judgmental matter.) b. The trust funds should not be allowed to operate with an annual deficit for any longer than necessary. In other words, income to the funds should exceed outgo as soon as it can be FORD LIBRARY safely assumed that additional revenue-producing measures will not adversely affect economic 19 recovery. C. Whatever the revenue-producing measure (s) adopted, it should not produce a sharp rise in the tax rates in any single year. 8 Considering the first criterion--public confidence level of the reserves--trust fund balances must be at least stabilized at (and not fall below) a level equal to roughly one-third of annual outgo. (Ideally, the financing plan should produce or trend toward a higher level--say 50 percent--but there is also a need to restrain tax increases in the near future.) The one-third level is to a certain extent arbitrary; it is probably as low as can be safely countenanced, given previous public expressions that the reserve should be set at 100 percent of annual outgo. Under present law, the reserve level of the cash benefits trust funds will have declined to the one-third level (32 percent) by the beginning of 1978. Thus, any financing plan based on present law must either (1) generate additional OASDI revenues beginning in 1977 or (2) involve a substantial increase in revenues effective January 1, 1978. Although implementation of additional financing measures can be delayed until 1977 or beyond, depending on circumstances, there remains the question of when to propose financing legislation. On balance, the Administration should introduce legislation this year, the earlier, the better. Controversy and public concern about the financing of the system is building rapidly, and release of the Social Security Trustees' reports this spring, as required by law, will add fuel to the fire. (The reports will increase public awareness of the deficit.) The Congress is almost certain to take the initiative if the Administration does not. Absent an Administration initiative, the forces favoring major general revenue financing of the trust funds would likely play a stronger hand, particularly in light of the Advisory Council recommendations. We believe that in light of these considerations it is desirable for the Administration to take the initiative promptly, rather than delaying until a comprehensive proposal dealing with both the short-range and the long-range situation could be presented. The Subcommittee on Social Security of the House Ways and Means Committee has scheduled hearings for later this month on the status of the trust funds and possible financing initiatives. These hearings would provide an ideal forum for presenting the Administration's plans. 9 3. Method of Financing a. General Approach There are four possible sources of trust fund revenue which can be used either singly or in combination. All require legislation. There are: -- Increased payroll tax rate (employer and employee, alike). - Increased earnings base (the maximum annual amount of earnings to which the tax rate is applied). -- Transfer of tax income from Medicare funds. (Existing law calls for an increase in the Medicare tax rate in 1978; some of the income from this increase is more than necessary to meet short-term needs.) ------------------------- General revenue financing. Consistent with previously stated Administration views, the Administration should continue to oppose any financing proposal involving substantial general revenues. Further, unless it is assumed that the proposed cost-control legislation is enacted, any proposal to rely solely on tax rate increases would involve significant tax rate increases. The Department's 'preferred approach combines increases in the earnings base with an adjustment in the tax rate schedule to transfer some income from Medicare to OASDI. The earnings base will increase annually due to the "automatic" provisions of present law; the Department's preferred approach would speed up the rate of the increases in the earnings base that will be produced by the "automatic" provisions of present law. Under one of the two earnings base/tax increase options that we are proposing, the total tax rate (OASDI-Medicare combined) would increase; under the other, the total tax rate would be unchanged from present law. IV A tax-rate-increase-only approach and an earnings base increase combined with a tax increase would be significantly different in their impacts on the taxpaying population at different wage levels. While any plan that depends entirely on an increased tax rate will impact on all workers, the greatest relative impact would fall on the low-paid worker as compared with the higher-paid worker (i.e., the tax is regressive). A plan which relies in part on an increase in the earnings base would be more progressive, spreading more of the burden toward the upper-income worker. The degree to which this occurs depends, of course, on how rapidly and to what level the earnings base is increased. An increase in the earnings base reduces the cost of the social security program expressed as a percentage of payroll and therefore makes it possible to meet long-term program costs with lower tax rates than would otherwise be necessary. An earnings base increase also increases the protection provided for higher-paid workers by increasing the proportion of their earnings that is counted for benefit purposes. As a practical matter, any plan incorporating an increase in the earnings base would automatically increase income to the Medicare program but would not affect outgo. This, in turn, would permit a transfer of a greater amount of Medicare income to the cash benefit programs, thereby helping to hold down the combined OASDI/Medicare payroll tax rate needed to finance the entire system. It is recommended that any plan to improve the short-range financing of the OASDI system include provision for transferring any unneeded Medicare income created during the period to the cash benefit (OASDI) trust funds. The transfer of taxes now scheduled for Medicare to OASDI is a critical element in all the financing plans discussed below. The proposed reallocation of Medicare taxes could have implications for the Administration's Comprehensive Health Insurance Plan (CHIP) when the Administration resubmits it. Comprehensive Health Insurance Plan contemplates the use of the Medicare taxes to finance the principal costs of coverage for the aged. The plans presented provide sufficient financing for Medicare and for that part of CHIP that is to be financed from payroll taxes. TT It should be recognized that a proposal to transfer income from Medicare may lead to a need to increase future scheduled Medicare taxes. While there will be a Medicare surplus in the near term, under present law, the outlook is for a small deficit over the full 25-year Medicare valuation period. To the extent that funds are "borrowed" from this fund today, additional revenue-producing measures may be required in later years. b. Specific Financing Approaches The following points will help to put the alternatives presented below into perspective. This review of the status of the funds and their financing requirements is limited to the period ending in 1980. The objective is to provide the minimum financing necessary to sustain the cash benefit trust funds through 1980 (i.e., keeping the ratio of assets to outgo of the funds at no lower than one-third in the latter part of the decade). This has been done on the assumption that new long-term financing provisions will be enacted and in effect by the start of the next decade. (i) Tax Only Approach The table below compares the tax rates scheduled in present law with the tax rates that would be necessary to prevent the OASDI trust funds from falling below a level of one-third of a year's outgo and to maintain the funds at about 36 percent of outgo if there were no increases in the earnings base over those that would go into effect automatically under present law. Calendar Year 1976 1977 1978 1979 1980 Present law OASDI tax GERALD R. LIBRATY FORD 4.95% 4.95% 4.95% 4.95% 4.95% Medicare tax 0.90 0.90 1.10 1.10 1.10 Total tax 5.85 5.85 6.05 6.05 6.05 Earnings base $15,000 $16,500 $18,300 $19,800 $21,300 Tax only approach OASDI tax 4.95 5.30 5.40 5.40 5.40 Medicare tax 0.90 0.90 1.00 1.00 1.00 Total tax 5.85 6.20 6.40 6.40 6.40 Earnings base (same as present law) 12 Under this approach a large, immediate (1977) increase in tax rates would be necessary and the total tax rate through 1980 would be significantly higher than under present law. Also, as mentioned earlier, this approach would impact most heavily on low-income earners. These considerations raise serious doubts about such a tax only approach. (Detailed information on this option appears at Tab F.) (ii) Base/Tax Approach On balance an approach involving a combination of earnings base and tax rate increases seems prefer- able. The following table sets forth two options. One shows modest base increases combined with a 1978 tax increase that goes significantly beyond the increase scheduled in present law; the other shows fairly substantial base increases--increases that would make it possible, with a reallocation of the Medicare tax, to avoid a total tax increase in excess of that scheduled for 1978 in present law. 13 Calendar Year 1976 1977 1978 1979 1980 Present law OASDI tax 4.95% 4.95% 4.95% 4.95% 4.95% Medicare tax 0.90 0.90 1.10 1.10 1.10 Total tax 5.85 5.85 6.05 6.05 6.05 Earnings base $15,000 $16,500 $18,300 $19,800 $21,300 Option A OASDI tax 4.95 4.95 5.30 5.30 5.30 Medicare tax 0.90 0.90 1.00 1.00 1.00 Total tax 5.85 5.85 6.30* 6.30* 6.30* Earnings base $15,000 $18,000* $20,700* $22,500 $24,300 Option B OASDI tax 4.95 4.95 5.10 5.10 5.10 Medicare tax 0.90 0.90 0.95 0.95 0.95 Total tax 5.85 5.85 6.05 6.05 6.05 Earnings base $15,000 $21,000* $24,000* $26,100 $28,200 * Changes from present law in the total tax rates and earnings bases required for each option are identified by an asterisk in the year they occur. An asterisk on an earnings base amount denotes that automatic increase provisions in present law would be overridden by a legislative change affecting the amount of the base in that year, but not affecting the functioning of the automatic provisions in subsequent years. The following table indicates the effects of these two options on the OASDI annual deficit and on the trust fund reserves. (Detailed information on these options appears at Tab F.) OASDI Reserves at Start of Income Minus Year as a Percentage of Outgo Outgo During Year (in Billions) OASDI Medicare 1977 1978 1978 1981 1978 1981 Present law $-5.8 $-6.0 32% 9% 69% 90% Option A -4.2 3.0 34 36 71 74 Option B -2.0 2.5 36 36 73 71 In order to provide some idea of the impact of the alternative short-range financial approaches on individual workers, the annual social security taxes for median workers and high-paid workers under present law, under a tax only approach, and under the two base/tax options are shown below. The table clearly shows that increasing the earnings base (base/tax options) would reduce the relative share of the additional taxes that would be borne by low-paid workers and raise the share borne by the higher-paid workers. SOCIAL SECURITY TAX LIABILITY Employee with wages equal to Estimated Median Wage for Employee with wages of Male Wage Earners* $24,000 or More . 1975 1976 1977 1978 1975 1976 1977 1978 Present law $479 $508 $554 $636 $825 $878 $ 965 $1107 Tax only option 479 508 592 673 825 878 1031 1171 Base/Tax Option A 479 508 554 662 825 878 1053 1304 Base/Tax Option B 479 508 554 636 825 878 1229 1452 *Estimated median wages for male wage earners: $8180 in 1975; $8687 in 1976; $9469 in 1977; and $10511 in 1978. 15 Another way of evaluating the effect of the tax increases contemplated under present law and under the alternative approaches is illustrated below. Percent Increase in Combined OASDHI Tax Rates, 1975-78 OASDHI Tax Rates 1975 1978 Increase Percent Increase Present Law 5.85 6.05 .20 3.4% Tax Only Option 5.85 6.40 .55 9.4% Base/Tax Option A 5.85 6.30 .45 7.7% Base/Tax Option B 5.85 6.05 .20 3.4% Suggested Presidential Decisions on Financing and Timing of Public Announcements Concerning Social Security 1. Endorse a two-part financing plan as follows: Part I. A proposal now to provide short-term financing-- through 1980--to handle the immediate problem and allow sufficient time to reform benefit structure and develop a long-term financing plan based on such reform. Part II. An integrated long-term financing and revised benefit structure plan to be submitted early next year. 2. Adopt financing plan represented by Tax Only Option Base/Tax Option A Base/Tax Option B Other HEW recommends Base/Tax Option B. Administration's posture as reflected by the decisions indicated in this paper. Approved Disapproved HEW recommends that the Secretary be authorized to present the Administration's posture on or before his appearance before the House Ways and Means Committee, scheduled by the Committee for mid-May. 4. Authorize the Secretary to proceed with the preparation of legislative proposals consistent with the decisions above. Approved Disapproved HEW recommends approval. Secretary Enclosures Tab A - Memorandum for the President of 1/24/75 Tab B - Memorandum for the President of 12/23/74 Tab C - - Discussion of Economic Assumptions Tab D - - Administration Cost-Control Proposals Tab E - Effect of Cost-Control Proposal Tab F - Effect of Financing Options PARATORS nage for aration. propriate further ation if and cover scotch 1 discard rcept the dby tape. 0 SURVEYS SEPARATOR SHEET A-69D (II-69) MEMORANDUM FOR THE PRESIDENT As you have no doubt learned from press reports, the Advisory Council on Social Security met over the weekend of January 18 and 19. (Since the Council's meetings were open to the public, the press has been reporting major Council actions as they have occurred.) This was the last meeting of the Council, which has been studying Social Security since last spring. The Council reached final decisions concerning proposals that will be made in its final report--now scheduled to be submitted formally by mid-February. Under the law the report must be sent to the Congress as well as to you. The purpose of this memorandum is to alert you to the decisions and conclusions of the Council. We have already given you our general endorsement of one Council recommendation, that is for restructuring social security benefits to stabilize replacement rates. However, their major recommendation has attracted so much attention that I wanted you to have my personal opinion now. We will be giving you our appraisal of the other recommendations soon. Unfortunately, the Council's recommendation on social security financing reached at the last minute in their deliberations, is most regrettable, in my opinion. They FORD is recommend that we no longer finance Medicare from pay- roll taxes, as at present, but that we use the Medicare portion of the existing payroll tax for Social Security GERALD benefits. Medicare (some $14 billion) would be paid for out of general fund revenues. As proposed by the Council, this shift would occur gradually over several years as the need for additional revenues for the cash benefits program increases. This would be the first step in using the general fund to finance social security - Medicare benefits, and, in my opinion, would add to existing pressures to fund all social security from the general fund, thereby removing the discipline that now requires tax increases to match (reasonably closely) benefit increases. While under the Council's approach, no net increase in the payroll tax would be necessary for many years obviously we would have to add the Medicare costs to the already huge deficit, or increase general taxation. The Council's recommendations are described briefly in the enclosed summary (Tab A). I am also attaching (Tab B) a memorandum I submitted to you on this subject after the Council's meeting in December. Much of that memorandum has obviously been overtaken by events; however, we would appreciate your guidance on the question of stabilizing replacement rates, Issue #2 on page 4. /s/ Cap Weinberger Secretary on Social Security A. Cash Benefits 1. Purpose and principles. The earnings-related OASDI program should be preserved as the Nation's primary means of providing economic security in the event of retirement, death, or disability. Future changes in OASDI should conform to the fundamental principles of the program: universal compulsory coverage, earnings-related benefits paid without a test of need, and contributions toward the cost of the program from covered workers and employers. 2. Benefit structure--replacement rates. The provisions of present law for computing average monthly earnings, on which benefits are based, and for adjusting the benefit table in the law to changes in prices may result over the long range in unintended, unpredictable variations in the level of benefits. The benefit structure should be revised to maintain the levels of benefits in relation to pre-retirement earnings levels that now prevail. Benefits for workers coming on the rolls in the future should be computed on the basis of a revised benefit formula using past earnings indexed to take account of changes during their working lives in the average earnings of all covered workers. As under present law, benefits for people on the rolls would continue to be increased as price levels increase. 3. Retirement test. The provisions of the present retirement test should be modified so that beneficiaries who work can retain more of their benefits. Instead of reducing benefits by one dollar for every two dollars of earnings above the exempt amount of earnings, as under present law, one dollar of benefits should be withheld for every three dollars of earnings between the exempt amount and twice the exempt amount, and one dollar for two dollars above that level. Also, the provision under which 2. full benefit may be paid for any month in which a beneficiary earns less than one-twelfth of the annual exempt amount should be eliminated, except for the first year of entitlement to benefits. The test should be based on annual earnings. ÷ * Latter proposal was included in the November 26, 1974, Presidential message on recommendations for reducing Federal outlays and is being resubuitted to the Congress with the 1976 Budget. 1/20/75 4. Treatment of men and women. The requirements for entitlement to dependents' and survivors' benefits that are now applied to women should be applied to men, and benefits should be provided for fathers and divorced men as they are for mothers and divorced women. At the same time, the law should be changed, effective prospectively, so that pensions based on one's work in employment not covered by social security will be subtracted from his social security dependents' 1 benefits. Other provisions of the social security program which are the same for men and women but which are criticized because they appear to have different effects on men and women (or different effects based on merital status) should not be changed. 5. Other recommendations. 2. Universal compulsory coverage. Although social security coverage is nearly universal, the gaps in coverage that remain may result in unwarranted duplication of benefits. Social security coverage should be applicable to virtually all gainful employment. Ways should be developed to extend coverage to those areas of employment, especially public employment, for which coordinated coverage under social security and existing staff-retirerent systems would assure that total benefits are reasonably related to a worker's lifetime earnings and contributions. b. Minimum benefit. Partly because of the gaps in social security coverage, the minimum benefit is frequently a "windfall" benefit to those, such as Federal retirees, who are already receiving 2 pension based on earnings in employment not covered by social security. Almost all workers who have worked in social security employment with some regularity become entitled to higher than minimum social security benefits. The minimum benefit in present law should be frozen at its level at the time the new benefit structure recommended under number 2 above goes into effect and the new system should not pay benefits exceeding 100 percent of the indexed earnings on which the benefit is based. C. Definition of disability. The definition of disability should be revised to provide reduced disability benefits for workers aged 55 or over who cannot qualify for benefits under present law but who are so disabled that they can no longer perform jobs for which they have considerable regular experience. d. Miscellaneous. Further study is needed on three matters: the effects of the social security program on different racial and ethnic groups, ways of simplifying the social security program and its administration, and the frequency of cost-of- living adjustments in benefits. In addition, a general study of social security by a full-time non-Covernment body is suggested. B. Financing 1. Actuarial status. While the cash benefits program will have adequate funds to meet its obligations for the short range, additional short- range financing would be needed to maintain trust fund levels and to meet the cost of the Council's benefit recommendations. Over the 75-year valuation period, the program faces a serious deficit. Steps should be taken soon to assure the financial integrity and long-range financial soundness of the program. 2. Contribution rate. a. Employee-emplover: No increase should be made in the total contribution rates for employees and employers for cash benefits and hospital insurance. However, the OASDI contribu- tion rate should be gradually increased, as OASDI costs increase, and the increases should be met by reallocating contributions now scheduled in the law for Part A (Hospital Insurance) of the Medicare program. Income lost to the Hospital Insurance program by this reallocation should be made up from the general funds of the Treasury. b. Self-employed: The present 7-percent limitation on the contribution rate for the self-employed should be removed. The self-employment. OASDI contribution rate should be the same multiple of the employee contribution rate as was fixed at the time the self-employed were first covered-150 percent. 3. Retirement age. The Council recognizes that under current demographic projections there will be a sharp rise in the number of people who have reached retirement age relative to the working age population in the first several decades of the next century. Although the Council is not now recommending an increase in the age of eligibility for social security retirement benefits in the next century, the Council does believe that such a change might merit consideration by the Congress in later years, when the burden on people still working may become excessive. E PARATORS page for eration. propriate further cation if and cover scotch in discard xcent the ed by tape. SURVEYS SEPARATOR SHEET A-63D (11-69) MEMORANDUM FOR THE PRESIDENT On December 11, we discussed social security problems and issues. At the close of our meeting, I indicated that we would suggest appropriate language concerning social security for inclusion in the State of the Union Message. We have already transmitted such language under separate cover as a part of this Department's general proposals for the State of the Union Message. The language that we recommend (Tab A) concerning social security would indicate your awareness of the problems and issues facing social security and your intention to make specific proposals sufficient to maintain the future financial integrity of the system--as soon as you have had an opportunity to consider the conclusions and recommendations of the 1975 Advisory Council on Social Security, which is expected to finish its work in late January or early February. The language deliberately avoids any commitment to a specific course of action at this time on the assumption that specific recommendations should await receipt of the Advisory Council report. At the close of our December 11 meeting, I also indicated that I would submit action proposals on each of the social security issues that we discussed. Since that meeting, the Advisory Council has had another session and is now considering several new proposals affecting financing that were not anticipated when we met with you. They have also moved a step closer to recommendations that would liberalize several features of the existing program. These liberalizations, if adopted, would increase the cost of the program for both the short and long term. Perhaps the most significant proposal now being considered is one that would increase the retirement age beginning in the 21st century. This is being reviewed by the Council as one means of reducing the long-term costs of the program and thereby limiting future tax requirements. The Council is also debating some rather rapid and early increases in the so-called wage base (the maximum amount of earnings taxable for a worker). An early increase in the wage base would produce new revenues and might facilitate postponement of tax rate changes in the near term. Adoption by the Council of any or all of these new considerations could have a significant effect on the design and timing of tax and other financing proposals--including any that the Adminis- tration might want to consider. Given these developments, I believe ve need to know more about the Council's final conclusions before the Administration makes its own decisions and choices. We should know precisely what the Council will finally recommend by around mid-January. This would still give us adequate time to make decisions and to draft legislative proposals, to the extent needed, for early submission to Congress. Therefore, it is my recommendation that two matters be decided at this time and that decisions on all other items be deferred until we know more about the Council's final recommendations. The two decisions that I believe to be necessary at this time are: 1. A decision as to whether to include language in the State of the Union Message-which we would urge you to do. I gather that this has all but been decided and that all that remains is selection of the language itself. 2. A decision as to whether you want to adopt, in principle at least, the idea of stabilizing replacement rates. In this case, we already know that the Advisory Council will recommend stabilization of replacement rates. Although a great deal of work has already been done on a rate stabilization proposal, consideration of alternative approaches and the design of a final legislative package will take some time. For this reason, we believe it would be wise to make a basic decision now. It is our belief that the replacement rate criteria that have been adopted by the Advisory Council would provide a sound basis for any Administration replacement rate proposal. The criteria being followed by the Advisory Council are: 1. The new formula should be constructed so as to neither increase nor decrease, on the average, current benefit levels. 2. The new formula should be constructed so as to continue weighted benefits for low-income workers. 3. Criteria 1 and 2 would result in stabilized replacement rates of about 60 percent for low-income workers, about 40 percent for median-income workers, and about 30 percent for higher-income workers. which no worker would be disadvantaged at the time of his retirement by reason of the new formula. In deciding the question of whether or not to proceed with development of an Administration proposal to stabilize replacement rates based on the above criteria, you should consider the following pros and cons: Pro 1. Stabilized replacement rates would result in a more rational social security system. In other words, future benefits would be based on public policy decisions as to how much of a person's earnings should be replaced rather than on the happenstance of future shifts in wages, prices, and productivity. 2. Stabilization should improve public understanding of what a worker earns for his tax contribution. 3. Under currently predicted economic circumstances (or under any economic circumstance in which inflation occurs or in which productivity falls), a decision to stabilize has the advantage of significantly reducing long-term costs. In turn, future tax rates would not have to be as high as otherwise predicted. Rate stabilization should reduce the ultimate tax rate as applied to the individual by 1 to 2 percent. 4. All actuaries and economists who have been consulted on this matter, whether by the Advisory Council, the Social Security Administration, or the Congress, have supported stabilization of replacement rates. Any proposal to do so should receive strong support from professionals in these fields. Con 1. Because future benefits would not rise as much as under current law, some are apt to oppose it. Organized labor might oppose such a proposal for this reason. (At this writing, labor representatives on the Advisory Council have tentatively voted for it.) about the adequacy of existing replacement rates. (Times being what they are, we doubt that this argument would prevail.) 3. Some might accuse us of making this proposal for purely fiscal reasons and at the expense of lower future benefits. A further discussion of the replacement rate issue is enclosed under Tab B. Recommendations We recommend that: 1. Language concerning social security be included in the State of the Union Message. 2. That a Presidential decision be made now to proceed with development of a specific plan for replacement rate stabilization that would become an early Administration initiative. 3. That, with the exception of the replacement rate stabilization issue, Presidential decisions concerning what to do about other social security issues, including the question of tax changes, be held in abeyance until about mid-January or as soon as we know with greater certainty what the Advisory Council will recommend on these issues. (At that time, we would provide you with a set of action choices on each of the items.) Decisions 1. Include social security as topic in State of the Union Message. Approved Disapproved Other LIBRARY 2. Proceed with immediate preparation of replacement rate stabilization legislative proposal for my later review and approval. Approved Disapproved Other 3. Defer other social security issues until Advisory Council recommendations become final (mid-January) and present specific decision proposals at that time. Approved Disapproved Other /s/ Caspar W. Weinberger Secretary Enclosures 3958938 This year marks the 40th anniversary of social security. Today, almost every American family is protected by the program, and one out of every seven Americans is currently receiving social security benefits. In recent years, great strides have been made in upgrading benefit levels and assuring adequate benefits for the future. Our concern now must be to insure that social security is adequately financed for the future. The system's financing and a number of other social security issues have been under study by this Administration and the current Advisory Council on Social Security. The Advisory Council is now preparing its final report. After I have an opportunity to consider the Council's conclusions, I will present to the Congress my own recommendations for insuring the future adequacy of the social security system. The most meaningful way to measure the effect of social security is to look at replacement rates--the share of a worker's most recent earnings that is replaced by his retirement or disability benefit. Current law results in replacement rates with two characteristics: 1. They are weighted in favor of lower-income workers. This is the result of a deliberate public policy choice, adopted because low wage earners have less margin for reduction in their income due to retirement or disability. 2. They are not stable or fixed for the future. They can change dramatically, depending on what happens to the economy. This clouds public understanding and does not reflect any deliberate public policy choice. Current Replacement Rates Today, social security retirement benefits replace about 62 percent of the most recent earnings of a person with an income of $3,200. For a person earning about $7,700 per year (the median earnings), the current replacement rate is about 44 percent. In the case of a person earning $13,200 per year (the maximum earnings base against which the tax is assessed), the replacement rate is about 30 percent. The latest long-range forecasts show, beginning in about 1995, that replacement rates will start to rise sharply. They will reach about 75 percent for the low-income worker at the turn of the next century and will exceed 85 percent by the year 2040. In some cases, it will even be possible for benefits to replace significantly more than 100 percent of an individual's most recent earnings. (This would be true only for low wage earners.) Although replacement rates will not rise as sharply for median earners and maximum earners, unplanned increases are also predicted for these groups. Effect of "Double Indexing" Under Present Law Because the cost-of-living indexing system now in the law is driven by changes in both wages and prices, replacement rates will always rise whenever both wages and prices rise over a to changes in wage levels rather than to both wages and prices, as under present law, replacement rates would be stabilized and long-term program costs would not increase to the extent now estimated. Under this concept, cost-of-living increases based on price rises would affect benefits only after a person came onto the benefit rolls. In other words, under a stabilized system, the benefit a current worker would receive when he retired would increase based on increases in his wages, and after retirement it would be kept up to date with the cost of living. If the benefit formula were changed so as to stabilize replacement rates at current levels, long-term costs to the system could be reduced. The Advisory Council has developed a rate stabilization formula that would (1) stabilize replacement rates at about current levels, (2) continue the existing weighting in the benefit formula, (3) assure that the average worker would suffer no loss in benefits during the period of transition from the old formula to the new formula, and (4) result in about a one-third reduction in the long-term actuarial deficit. E C PARATORS page for aration. propriate further ation if and cover scotch d discard xcept the adby tape. 6 SURVEYS SEPARATOR SHEET HOAD (11-69) NOTE: This memorandum was prepared on the assumption that the automatic benefit increase for 1975 would be 8.1 percent rather then 8.0 percent as determined by recent CPI changes. All other assumptions are still valid, The actual dollar figures relating to the progress of the trust funds will change very slightly as 2 result of the lower benefit increase. 4/23/75 GERALD 8. LIBRARY TORD March 31, 1975 FROM: Lawrence Alpern IAC-1 SUBJECT: Operations of the OASI and DI Trust Funds Under Present Law, on the Basis of Two Sets of Economic Assumptions, Calendar Years 1974-80 Estimates of the operations of the old-age and survivors insurance (OASI) and disability insurance (DI) trust funds under present law in calerdar years 1975-80 have been completed. The presentation of such estimates necessarily calls for full recognition of the difficulties of estimating the income and expenditures of 2 system that is highly sensitive to economic change. This is particularly true today because of the un- certainty of future economic developments. One set of estimates WES prepared on the basis of the economic assumptions set forth on page 41 of the President's 1976 Budget. Since significant changes in economic trends have taken place after those assumptions were prepared (e.g., 2 lower level of economic activity, 2 somewhat slower rate of increase in the CPI, higher rates of unemployment), 2 second set of economic assumptions was just completed in SSA for use in preparing an updated set of estimates. The results of the two sets of estimates are summarized in the table shown at Tab A. The economic assumptions underlying the two sets of estimates, together with 2 brief narrative statement relating to the SSA assumptions, are shown at Tab B. The future path of the CPI and future increases in average annual wages in covered employment are different for the two sets of assumptions, as shown in the following table. Increase over prior year in annual average- Calendar Wages under- CPI under- 1976 Budget SSA year 1976 Budget SSA assumptions assumptions assumptions assumptions 1975 7.0% 6.2% 11.3% 9.0% 1976 9.8 9.0 7.8 6.6 1977 10.5 11.0 6.6 6.5 1978 9.2 8.8 5.2 5.7 1979 8.0 7.7 4.1 4.6 1980 7.9 7.0 4.0 4.0 The automatic increase provisions enacted in 1972 affect both future income and future expenditures of the OASDI system. The estimates presented herein reflect the following changes assumed to occur, under the automatic increase provisions, in each year 1975-80 (actual amounts for 1974, together with the already-established contribution and benefit base for 1975, are also shown, as a basis for comparison): General benefit increase Contribution and benefit base Calendar for June, under- on January 1, under- 1976 Budget SSA 1976 Budget SSA year assumptions assumptions assumptions assumptions 1974 11.0% 11.0% $13,200 $13,200 1975 8.7 8.1 14,100 14,100 1976 9.2 6.6 15,300 15,000 1977 6.9 6.4 16,800 16,500 1978 5.7 6.3 18,600 18,300 1979 4.4 4.8 20,400 19,800 1980 4.0 4.0 21,900 21,300 Alpern Deputy Chief Actuary Enclosures FORD LIBRARY USE SEPARATORS ne page for separation, appropriate add further fication if d, and cover th scotch ?end discard os except the vered by tape. Ratconos Survays SED SEPARATOR SHEET SSA-69 4-70} GPO:1972 0-481-270 - $ Entimated operations of the old-nge and survivors insurance (OASI) and disability insurance (DI) trust fundo under present lav, on the basis of two octo of economic assumptions, calendar years 1974-80 (Amounts in billions) Assets at beginnir endar Net increase Asseto at end year as n percent Income car Outgo in funds of year of outgo during 1976 Budget SSA 1976 Dudget SSA 1976 Dulget SSA 1976 Budget SSA 1976 Budget assumptions accumptions assumptions assumptions assumptions assumptions assumptions assumptions assumptions assu OASI and DI trust fundo, combined 74 $62.1 $62.1 $60.6 $60.6 $1.5 $1.5 $45.9 $45.9 73% 75 67.4 66.5 69.8 69.6 -2.3 -3.0 43.6 42.9 66 76 73.6 72.3 79.7 78.2 -6.1 -5.9 37.5 37.0 55 77 82.2 81.8 90.5 87.6 -8.3 -5.9 29.2 31.1 41 78 91.3 91.1 100.4 97.2 -9.1 -6.1 20.1 25.1 29 79 100.6 100.3 110.2 107.2 -9.5 -6.9 10.6 18.2 18 80 110.2 109.1 119.9 116.9 -9.6 -7.8 0.9 10.4 9 OASI truot fund 74 $54.7 $54.7 $53.4 $53.4 $1.3 $1.3 $37.8 $37.8 68% 75 59.4 58.6 61.0 60.8 -1.6 -2.2 36.2 35.6 62 76 64.9 63.8 69.5 68.1 -4.6 mlt.4 31.6 31.2 52 77 72.5 72.2 78.8 76.3 -6.2 -4.1 25.4 27.1 40 78 80.3 80.1 87.2 84.5 -7.0 -11.4 18.4 22.7 29 79 88.5 88.2 95.7 93.1 -7.2 -4.9 11.2 17.8 19 80 97.0 96.0 104.0 101.4 -7.0 -5.5 4.1 12.3 11 DI truot fund 74 $7.4 $7.4 $7.2 $7.2 $0.2 $0.2 $8.1 $8.1 110% 1 75 8.0 7.9 8.8 8.8 -0.7 -0.8 7.4 7.3 92 76 8.7 8.6 10.2 10.1 -1.5 -1.5 5.8 5.8 72 77 9.7 9.6 11.7 11.4 -2.1 -1.8 3.8 4.0 50 78 11.1 11.0 13.1 12.7 -2.1 -1.7 1.7 2.3 29 79 12.2 12.1 14.5 14.1 -2.3 -2.0 -0.6 0.4 12 as 13.2 13.1 15.8 15.4 -2.6 -2.3 -3.2 -2.0 wlj trust fund oxhausted 1n 1979 under 1976 Dudget accumptions and in 1980 under 8SA assumptions; reflocts "borrowing" from OASI trust fund. Social Security Administration Selected Numerical Values Under Two Sets of Economic Assumptions, 1975-80 Calendar years; dollar amounts in billions 1975 1976 1977 1978 1979 1980 Gross national product Current dollars Amount Budget (1975) $1,498 $1,686 $1,896 $2,123 $2,353 $2,506 Social Security Administration (SSA) 1,477 1,671 1,912 2,147 2,380 2,615 Percent change Budget 7.2 12.6 12.4 12.0 10.8 10.8 SSA 5.7 13.1 14.4 12.3 10.9 9-9 Constant dollars Amount Budget $794 $832 $879 $936 $997 $1,061 SSA 787 837 898 958 1,020 1,078 Percent change Budget -3.3 4.8 5.6 6.5 6.5 6.5 SSA 4.1 6.4 7-3 6.7 6.5 5.7 Wages end salaries Budget $792 $884 $999 $1,117 $1,236 $1,367 SSA 780 873 998 1,115 1,232 1,342 Prices (percent change) GNP deflator Budget 10.8 7.5 6.5 5.1 4.1 4.C SSA 10.3 6.4 6.7 5.3 4.1 4.C Consumer Price Index Budget 11.3 7.8 6.6 5.2 4.1 4.C SSA 9.0 6.6 6.5 5.7 4.6 4.C Unemployment rate (percent) Budget 8.1 7.9 7.5 6.9 6.2 5-5 SSA 8.8 8.0 7.0 6.2 5.4 4.E Addendum: Automatic benefit increase for June (percent) Budget 8.7 9.2 6.9 5-7 4.4 4.1 SSA 8.1 6.6 6.4 6.3 4.8 L-C Social Security Administration March 31, 1975 The path of prices, wages, and employment between 1975 and 1980 assumed by SSA is intended to reflect the following factors: 1. 2. lower level of economic activity in 1975 than was assumed in the 1976 Budget. 2. delay in implementation and uncertainty over the final form of an energy program. 3. a somewhat slower rate of increase in the CPI in 1975-76 than the Budget assumptions contain. 4. a more stimulative economic environment, which results in more rapid economic growth in 1976-78 than was assumed in the Budget. 5. failure of output per manhour to recover fully recent short- falls from its trend rate of growth, thus lowering projected constant dollar GNP at full employment (potential GNP) below that assumed in the Budget projections in 1977-80. The SSA set of assumptions yields a lower current dollar GNP in both 1975 and 1976 than the Budget assumptions. This is due to the assumed lower rate of increase in prices, and to the assumed delay in fully implementing any energy program until the end of 1977. Current dollar GNP is higher than the Budget assumptions in 1977-80, despite a somewhat lower GNP deflator, reflecting the higher level of constant dollar GNP in the alternative assumptions throughout that period. Constant dollar GNP is lower in the alternative assumption only in 1975. The higher level of constant dollar GNP in 1976-80 is attributable to & more stimulative fiscal environment which is assumed in the alternative. The largest differences in constant dollar GNP growth rates between the Budget and the SSA assumptions occur in 1976 and 1977. As a result, constant dollar GNP is 2.4 percent higher in 1978 in the alternative assumptions then in the Budget assumptions. The unemployment rate averages 8.8 percent in 1975 in the alternative assumptions compared to 8.1 percent in the Budget assumptions. This reflects the more rapid decline in economic activity assumed in the alternative in the near term. The more stimulative policy embodied in the alternative causes the unemployment rate to fall below the unemploy- ment rate projected in the Budget, starting in 1977. The trend rate of unemployment is assumed to be 4 3/4 percent, which is reached in 1980. Percentage increases in the CPI between the first quarter of each year (the relevant measure for social security benefit increases) are lower in 1975-77 in the SSA assumptions. The indicated automatic social security benefit increase effective in 1975 is reduced from 8.7 percent (Budget) to 8.1 percent. It is assumed that the recent favorable price behavior will continue. The delay that has been assumed in the imple- mentation of an energy program contributes to the reduction in the 1976 benefit increase (compared with the Budget assumptions). It is assumed that the total impact of an energy program on the CPI will be to raise the CPI by 2 percent, with the full effect being felt by the end of 1977. The delay, along with the generally lower rates of price increase contained in the alternative, reduces the 1976 benefit increase by 2.6 percentage points, while the lower rates of price increase reduce the 1977 benefit increase by 0.5 percentage point. Because some of the until after the first quarter of 1977, the CPI increase in the alterna- tive for 1978 is 0.6 percentage point higher. Wages and salaries are lower than the Budget assumptions in 1975, because of the lower levels of economic activity and average wages assumed by SSA. The lower average wages in the alternative produce lower wages and salaries in 1976-80, despite higher levels of economic activity assumed for those years. The increase in wages and salaries after 1975 is not as large as might be expected from the fiscal stimulus assumed in the alternative. This occurs because the alternative projections assume that part of the less-than-trerd increases in produc- tivity of recent years will not be recouped, thus reducing real earnings gains, and that the historically observed faster rate of growth in nonwage compensation as compared with wages and salaries will retard growth in total wages. Hence, contribution income, which is closely linked with total wages and salaries, will be relatively unchanged between the two sets of assumptions over the entire period 1975-80 even though higher levels of economic activity are assumed by SSA starting in 1976. FORD is LIBRARY 07/835 (1) PARATORS page for eration. propriate further ation if and cover scotch d discard xcept the >dby tape. SUAVEYS SEPARATOR SHEET -69D (11-69) Social Security Legislative and Administrative Proposals in FY '76 Budget OASDI and SSI Legislative Proposals: 1. Limit to 5 percent the amount of the automatic social security and SSI benefit increases scheduled to be paid in July 1975. 2. Eliminate retroactivity of social security benefit applications where permanently reduced benefits would result. 3. Tighten and simplify the retirement test by eliminating the monthly test of retirement except for the first year for which benefits are paid. Administrative Proposals: None Medicare Legislative Proposals: 1. Impose a hospital insurance (part A) coinsurance amount equal to 10 percent of charges above the $92 deductible amount. 2. Increase the supplementary medical insurance (part B) deductible automatically in proportion to the increase in cash benefits. Current deductible is $60. 3. Impose an annual cost-sharing liability limit under parts A and B each of $750 increased in the future in proportion to increases in cash benefits. 4. Authorize the Secretary to establish percentage limits on the rate of increase in incurred costs recognized as reasonable in deter- mining provider reimbursements. 5. Unfreeze the SMI premium. Administrative Proposals: 1. Conduct utilization review concurrent with a patient's admission. 2. Set upper limits on the amounts which Medicare will recognize as reasonable and will reimburse to hospitals. The current limit, which is set at the 90th percentile, will be reduced so that no routine costs above what the majority of hospitals incurred in payment will be automatically recognized as reasonable. 3. Limit Medicare reimbursement for drugs to the cost of less expensive generic equivalents if they are available. 4. Reduce the balances held by banks that service Medicare intermediaries. 5. Eliminate the allowance for higher than average nursing cost for Medicare patients. At present Medicare reimburses hospitals 8.5 percent more for routine nursing care for aged beneficiaries than for other patients. E PARATORS page for aration. propriate further cation if and cover scotch in discard except the E pdby tape. 6 SURVEYS SEPARATOR SHEET A-83D (11-69) EFFECT OF COST-CONTROL PROPOSALS While it is virtually certain that the Administration's cost-control legislation will not be enacted, it is useful to understand the specific effect of these proposals. The effect on the trust funds, if the proposed social security cost-reduction legislation were enacted, is illustrated in the attached table using presently scheduled taxes. It should be noted that an effective date of January 1, 1976, has been assumed for that portion of the cost- reduction legislation carrying a budgeted effective date of March 1, 1975. The 5-percent limit on the July 1975 benefit increase cannot, of course, be delayed. (It would have to be enacted by late April or early May in order to be reflected in the July benefit payment.) Enactment of the cost-control proposals would so substantially improve the financial status of the program that, with some reallocation of income from Medicare to OASDI, the tax rate increase now scheduled for 1978 could be reduced. The attached table also compares the tax rates scheduled under present law with those that would be sufficient to adequately finance both OASDI and Medicare if the cost-control legislation were enacted. This specific alternative tax rate schedule permits a large reallocation of Medicare income beginning in 1976 only because of a major and almost immediate reduction in Medicare outlays resulting from the cost-sharing proposals. Since these proposals would not affect CHIP, however, the Medicare tax rates shown in the attached table, although adequate to finance the Medicare program, would not adequately finance CHIP. Attachment Calendar Year 1976 1977 1978 1979 1980 Tax rates for employer and employee, each Present law OASDI 4.95% 4.95% 4.95% 4.95% 4.95% Medicare 0.90 0.90 1.10 1.10 1.10 Total 5.85 5.85 6.05 6.05 6.05 Cost-Control Option OASDI 4.95 5.05 5.20 5.20 5.20 Medicare 0.80 0.80 0.85 0.85 0.85 Total 5.75 5.85 6.05 6.05 6.05 Earnings base Present law and Cost-control option $15,000 $16,500 $18,300 $19,800 $21,300 Income minus outgo (in billions) OASDI Present law -$5.8 -$5.8 -$6.0 -$6.8 -$7.7 Cost-control option - 1.5 - 0.6 2.6 3.4 3.9 Medicare Present law $0.4 $0.9 $3.7 $3.9 $3.4 Cost-control option 0.3 1.1 1.4 0.9 0.3 Reserve at beginning of year as a percentage of outgo during year OASDI Present law 55% 42% 32% 24% 16% Cost-control option 58 50 45 43 43 Medicare Present law 82 73 69 79 86 Cost-control option 90 83 79 77 73 ARATORS age for ration. ropriate further tion if nd cover scotch discard cert the by tape. 0) u SURVEYS DEPALD FORD LIBRARY SEPARATOR SHEET 69D (11-69) Calendar Year 1976 1977 1978 1979 1980 Tax rates for employer and employee, each Present law OASDI 4.95% 4.95% 4.95% 4.95% 4.95% Medicare 0.90 0.90 1.10 1.10 1.10 Total 5.85 5.85 6.05 6.05 6.05 Tax Only Option OASDI 4.95 5.30 5.40. 5.40 5.40 Medicare 0.90 0.90 1.00 1.00 1.00 Total 5.85 6.20 6.40 6.40 6.40 Earnings base Present law and $15,000 $16,500 $18,300 $19,300 $21,300 Tax Only Option Income minus outgo (in billions) OASDI Present law -$5.8 -$5.8 -$6.0 -$6.8 -$7.7 Tax Only Option - 5.8 - 0.5 2.4 3.2 3.8 Medicare Present law 0.4 0.9 3.7 3.9 3.4 Tax Only Option 0.4 1.0 2.0 1.7 0.9 CHIP (Tax Only Option) ÷ - 0.5 1.1 1.2 0.2 Reserve at beginning of year as a percentare of outgo during year OASDI Present law 55% 42% 32% 24% 16% Tax Only Option 55 42 38 36 36 Medicare Present law 82 73 69 79 86 Tax Only Option 82 73 69 71 70 CHIP (Tax Only Option) * 56 48 46 45 * Assumes effective date for CHIP of 1/1/77. Calendar Year 1976 1977 1978 1979 1980 Tax rates for employer and employee, each Present law OASDI 4.95% 4.95% 4.95% 4.95% Medicare 4.95% 0.90 0.90 1.10 1.10 1.10 Total 5.85 5.85 6.05 6.05 6.05 Option A OASDI 4.95% 4.95% 5.30% 5.30% 5.30% Medicare 0.90 0.90 1.00 1.00 1.00 Total 5.85 5.85 6.30 6.30 6.30 Earnings base Present law $15,000 $16,500 $18,300 $19,800 $21,300 Option A 15,000 18,000 20,700 22,500 24,300 Income minus outgo (in billions) OASDI Present law -$5.8 -$5.8 -$6.0 $6.8 -$7.7 Option A - 5.8 - 4.2 3.0 4.5 5.3 Medicare Present law $0.4 $0.9 $3.7 $3.9 $3.4 Option A 0.4 1.3 2.5 2.4 1.7 CHIP (Option A)* -$0.2 $1.7 $1.9 $1.1 Reserve at beginning of year as 2 percentage of outgo during year OASDI Present law 55% 42% 32% 24% 16% Option A 55 42 34 34 35 Medicare Present law 82% 73% 69% 79% 86% Option A 82 73 71 75 76 CHIP (Option A)* 56% 49% 49% 50% * Assumes effective date for CHIP of 1/1/77. Calendar Year 1976 1977 1978 1979 1930 Tax rates for employer and employee, each Present law OASDI 4.95% 4.95% 4.95% 4.95% Medicare 4.95% 0.90 0.90 1.10 1.10 1.10 Total 5.85 5.85 6.05 6.05 6.05 Option B OASDI 4.95% 4.95% 5.10% 5.10% Medicare 5.10% 0.90 0.90 0.95 0.95 Total 0.95 5.85 5.85 6.05 6.05 6.05 Earnings base Present law $15,000 $16,500 $18,300 $19,800 Option B $21,300 15,000 21,000 24,000 26,100 28,200 Income minus outgo (in billions) OASDI Present law -$5.8 -$5.8 $6.0 $6.8 -$7.7 Option B - 5.8 - 2.0 2.5 3.5 4.1 Medicare Present law $0.4 $0.9 $3.7 $3.9 $3.4 Option B 0.4 1.7 2.2 1.9 1.2 CHIP (Option B)* $0.2 $1.3 $1.3 $0.6 Reserve at beginning of year as a percentage of outgo during year OASDI Present law 55% 42% 32% 24% 16% Option B 55 42 36 35 35 Medicare Present law 82% 73% 69% 79% 86% Option B 82 73 73 75 75 CHIP (Option B)* 56% 50% 49% 48% # Assumes effective date for CHIP of 1/1/77. DRAFT THE WHITE HOUSE WASHINGTON IW November 28, 1975 MEMORANDUM FOR: FROM: SUBJECT: Social Security Financing The purpose of this memorandum is to present for your decision options for dealing with the serious short and long term financing problems facing the Social Security System. The timing of any legislative proposal is clearly a key element in your decision. Therefore, the discussion of options will include a projection of the effect on the stability of the trust fund and an assessment of political and budgetary consequences. CURRENT SYSTEM: In 1974, the Social Security System collected $58.90 billion for OASDI from 99 million workers in covered employment and paid $58.5 billion in OASDI benefits to 31 million beneficiaries. The current OASDI tax rate is 9.9% (4.95% each paid by employers and employees) on a minimum wage base of $14,100. The wage base will increase to $15,300 in calendar year 1976. The current tax rate for the HI (medicare) trust fund is 1.8% (.9% each paid by employers and employees). An increase is scheduled in 1978. Social Security Tax Rates: Present Law Calendar Year OASDÍ HI TOTAL 1977 4.95% 0.90% 5.85% 1978 4.95 1.10 6.05 1979 4.95 1.10 6.05 1980 4.95 1.10 6.05 1981 4.95 1.35 6.30 1982 4.95 1.35 6.30 1983 4.95 1.35 6.30 1984 4.95 1.35 6.30 1985 4.95 1.35 6.30 Page 2 - Social Security Financing PROBLEMS The OASDI trust fund is underfinanced in the short and long term. Benefit outlays are expected to exceed payroll tax receipts in 1975 and every year thereafter. Under current law, the projected deficit will average 1.3% of taxable earnings over the next 25 years (1975 - 1999) and will rise to 4.1% in the following 25-year period (2000 - 2024). Unless some action is taken, OASDI trust funds will fall from the current 66% of yearly outgo to 43% in 1977, 33% in 1978; 11%in 1981, 3% in 1982, and the trust funds will be exhausted in 1983. The projected rapid decline in trust funds assets over the next few years can be attributed to: - Increased benefits resulting from wage growth and inflation. - Absence of equivalent increases in payroll tax revenues. (In fact payroll tax receipts have diminished due to high rates of unemployment.) The projected long term (beyond 2000) deficits can be attributed to: Future population trends which include a substantially increasing ratio of retired persons to the working population after the beginning of the 21st Century. A flaw in the current system which over adjusts the benefits of future retirees to inflation. The current formula which determines future benefits for workers increases the weighting of earnings by the rate of. inflation. Since wages normally grow with inflation, the result is an overcompensation - commonly referred to as a "coupled" system. There is a general consensus in the Congress and among outside experts that the inflation adjustment in the formula shoudl be eliminated, thus "decoupling" the system. Such a change would not affect the automatic CPI increases in benefits after re- tirement. It should be emphasized here that "decoupling" will have virtually no effect on the short term deficit. POLITICAL CONTEXT: An awareness of the political environment surrounding the Social Security System is crucial as we sort out these very important issues. Decisions regarding social security have traditionally followed a unique pattern which has insulated the system from sudden and far reaching changes. Structural modifications take place usually after extensive public debate including exhaustive studies and visible commissions. Protection of the system is fostered by Page 3 - Social Security Financing one of the strongest and largest constituencies in the public policy arena, including the elderly, organized labor and all of the wage earners who are contributing to the system and expect to benefit from it in the future. Members of Congress and espacially of the Finance and Ways and Means Committees have institutionalized this process of incre- mental reform. The Committees have jointly established a high level advisory working group to examine the "decoupling" problem and to recommend policy changes to the Committees in the spring of 1976. Because of the serious financing problems the Social Security System now faces, the public has begun to question its stability. Although the subtleties and complexities are not widely understood, there exists some general pressure to move toward stabilizing the trust fund with a minimum of disruption and change for those in the system. DECISIONS: Alternatives for your decisions are presented in three categories: 1. Options to deal with the short term decline in trust fund assets. 2. "Decoupling" options which alleviate the long term deficit. 3. Mechanisms for analyzing some of the broader structural issues in the Social Security System. These sets of options including choices of the timing of any initia- tive you choose are described as follows. SHORT TERM FINANCING: The choices for preventing the rapid decline of the trust fund are difficult ones. Simply expressed, revenues must be increased or benefits must be reduced. Your decision and the timing of any action should take into account the effect on the trust fund, budgetary and political consequences. Estimated Trust Fund Assets under Current Law: Calendar Year Assets at Beginning of Year as Percent of Outgo during Year 1975 66% 1976 55% 1977 43% 1978 33% Page 4 - Social Security Financing Calendar Year Assets at Beginning of Year as Percent of Outgo during Year 1979 25% 1980 18% 1981 11% 1982 3% 1983 0% These projections by the Social Security Administration are based on economic assumptions which are regarded by many as optimistic. HEW has taken the position that it would be dangerous for the trust fund assets to fall below 33%. In order to prevent the trust fund from falling below 33% in 1978, legislation to in- crease revenues or to decrease benefits must be enacted before January 1, 1978. If you agree that SSA's economic assumptions are optimistic and/or that the trust fund should not fall so low, then more immediate action is required during FY 1977 or FY 1978. Short term financing options which prevent the trust fund assets from falling below one-third include: 1. Increase Revenues by Raising Payroll Taxes. It would be necessary to increase taxes tes by .6% of payroll beginning in 1977 or 1978 and to gradually increase that amount to 1.1% or 1.2% by 1983. Given your proposal for a permanent tax reduction, it would be very difficult to propose and justify an increase in pay- roll taxes in the next year or SO. An increase in the payroll tax has a particularly harsh effect on low income wage earners. ON the other hand, such an increase would eliminate the trust fund deficit until 2000. 2. Increase revenues by a combination of a more modest increase in taxes and raising the wage base to which they apply. If the wage base were raised from the currently projected $16,800 for 1977 to $19,500, the necessary tax increase would be .3% of payroll beginning in 1977 or 1978 and approximately .9% by 1983. Again, even a more modest increase in taxes would be difficult, given economic and political considerations. Even though a tax/wage base increase would eliminate the trust fund deficit until 2000, high wage earners would assume more of the tax burden and would be entitled to higher future benefits, thereby enlarging the trust fund deficit after 2000. Page 6 - Social Security Financing 3. Reduce outlays by placing a cap on the July, 1976 CPI increase and decreasing certain other benefits. OMB has proposed increasing benefits by only 60% of the 1976 CPI and several program changes including: a) Do not pay retroactive benefits for the months before an application is filed if such a lump-sum payment would require a permanent actuarial reduction in future monthly benefits. b) Eliminate the monthly retirement test, making the retirement rest on cumulative annual earnings. c) Eliminate over a 4-year period special benefits for those aged 18 to 22 in school full-time. The 60% cap on CPI would save $2.24 billion in 1978 and an increasing amount in subsequent years. The other program changes would save approximately $1 billion in 1977 and in subsequent years. Such reduced expenditures would keep the trust fund levels about one-third of outgo until 1980. It would again be necessary to reduce expenditures further or to provide some additional income. This proposal to reduce benefits would be more consistent with our economic policy than any tax increase, but it may be difficult politically to propose reducing benefits for the elderly and disabled. It eliminates only a portion of the deficit until 2000. At best it postpones another decision on short term financing for about 4 years. RECOMMENDATIONS: Page 7 - Social Security Financing DECISION Take action in FY 1977 Option 1: Option 2: Option 3: Defer action until: FY 1978 FY 1979 DECOUPLING: Decoupling is a long term financing issue, as the coupled system (which went into effect in 1975) will not impact on the deficit until after 2000. There exists a general consensus in Congress and among outside experts that the overadjustment for inflation should be changed, thus "decoupling" the system. There is, unfortunately, no clear consensus about how the formula should be changed. The major issue, on which there may be wide disagreement, is a philosophical question about what should be the future role of social security. What levels of tax rates and benefits would be appropriate in the context of overall taxes and retirement income. In considering alternative "decoupling" models, this philosophical question translates into a choice between continuing to provide benefits at the same percentage of wages as the current system vs. allowing replacement rates to decline over time. A word of explanation about the concept of "replacement rates" -- The current benefit formula provides various replacement rates (benefit amounts as a percentage of wages) for various wage groups. At the time of retirement, the wages of a Social Security bene- ficiary are replaced at a given percentage of his wages (replacement rate). After retirement this benefit level rises automatically with increases in the CPI. In the current coupled system, replacement rates for every category of wage earner are rising over time due to the double indexing of the benefit base. This is clearly un- desirable and should be corrected. The question is whether replacement rates should remain constant or decline over time. If replacement rates are to remain constant, at what level should they be fixed or if they are to decline, at what rate should they be allowed to decline. The benefit formula can be adjusted to produce the desired constant or declining replacement rates. Page 8 - Social Security Financing The following graphs illustrates the effect on benefit levels (replace- ment rates) and expenditures under three alternative decoupling models as compared to the current law "coupled" system. Projected Replacement Rates I'OI Regular workers WITH Average wages % \ Replacement (c Present Law (u 60 50 44 45 Altarnative 1 43 42 40 30 Alternative 3 30 20 Altarnative 10 if i 1970 1976 1980 1990 2000 2010 2020 2030 2040 2050 Z Expenditures under Present Law, ;- Constant Replacement Rates (Current Power) Levels), EN percurres and Contribution Rate and under Present Law (Percent of Taxable Payroll, 1975 Trustees' 1 Report Assumptions) Declining Replacement Rates (Maintenance of Purchasing. % of Payroll 24 Present Law 21 Expenditures Expenditures due to rising replacement rates 18 Constant 15 Replacement Rate acternative Expenditures 3 altericitive I 12 Contribution Rate Declining 21 Replacement Rate Expenditures 2020 Page 9 - Social Security Financing Rising replacement rates under the current system are clearly unacceptable. The alternative choices are described, as follows: 1. Alternative 1 - simply holds constant current replace- ment rates. It eliminates approximately 50% of the long term deficit. Therefore additional tax revenues would be required eventually. Because this proposal decoupleswith a minimum of change in future benefits, it would probably prove the least controversial among constitutent groups and in Congress. 2. Alternative 2 - allows benefit levels for future retirees to keep pace with inflation instead of real wage growth. This means that if such a proposal were enacted in 1976, the level of future benefits of workers would maintain a portion of their purchasing power in 1976 rather than keeping up with higher standards of living resulting from real wage growth. Replacement rates would decline substantially over time, as illustrated in graph #1, thus reducing the future role of social security. This proposal would eliminate the entire long term deficit and would allow future tax reductions. Such a far reaching change in the system would probably be very controversial. 3. Alternative 3 - represents a middle ground between alternatives 1 and 2. It allows future benefits to keep pace with approximately half of the growth in real wages. It would eliminate % of the long term deficit. This proposal could also be politically difficult. The existing consensus in opposition to the current coupled system provides a forum for discussion of decoupling proposals. There- fore one of these three models could be proposed in connection with a short term financing proposal. However, these alternatives, particularly the two which include declining replacement rates would prove very controversial and raise some fundamental questions about the role of social security which we may not be fully pre- pared to address at this point. STUDY OF SOCIAL SECURITY SYSTEM: To allow time for the necessary data collection, for analysis of the broader structural issues and for education of the public and consensus building, it is our judgement that a comprehensive study is needed. If you decide to defer legislative action on a short term financing proposal and/or decoupling, then the study group could address these issues over the next year. Page 10 - Social Security Financing Clarification of the role of social security in our society is neces- sary to insure its stability and continued public confidence. Some of the fundamental questions include the following: - What should be the role of social security in the context of the overall pension system? - What should be the role of social security in the overall tax system? - What should be the role of social security in the context of economic growth? What should be the role of social security in terms of wage replacement VS. income redistribution (welfare) ? It is our judgment that Domestic Council members should assist in developing a framework for the study which clearly identifies the appropriate issues, and should assist in the selection of a group of outside experts. The experts would provide needed analysis and facilitate increased public awareness of the issues. Responsibility for overseeing the study could be housed in either the Domestic Council or the Office of the Secretary, HEW. RECOMEMNDATION: DECISION: Propose decoupling: Alternative 1: Alternative 2: Alternative 3: Propose Study of Social Security: