February 25, 2000 | Backgrounder on Retirement Security
Congress soon will have the opportunity to take a small step toward genuine Social Security reform. Members of Congress will consider H.R. 5, the Senior Citizens' Freedom to Work Act introduced by Representative Sam Johnson (R-TX). The Act would repeal an outdated law that reduces Social Security benefits for working retirees--the so-called earnings test. The earnings test affected by Representative Johnson's bill applies to retirees who are 65 to 70 years of age. The proposal in this bill would not affect a similar earnings test for retirees between the ages of 62 and 65.
Designed during the Great Depression as a way to encourage working seniors to retire and open their jobs to younger people, this earnings test has worked only too well. Combined with the growing tendency of Americans to retire sooner, the number of employed males over the age of 65 has fallen from 47 percent 50 years ago to less than 17 percent today. In an era of low unemployment, it no longer makes sense to penalize retirees who want to continue working. Instead, these citizens should be encouraged to continue working to share their valuable experience with a younger labor force.
Although eliminating this outdated statute would do nothing to relieve the financial crisis that awaits Social Security, it would assist lower- and middle-income retirees who must continue working to make ends meet.1 The earnings test especially hurts senior citizens who face heavy medical bills or other expenses in caring for a spouse or other family members. In addition, the earnings test is cumbersome and expensive to administer. By finding a way to end one of the inequities in the current program, Congress could begin the task of restructuring the Social Security system to face the realities of the workforce in the 21st century.
|A Note on Our Analysis
This study estimates the number of affected retirees aged 65 through 69 who receive lower Social Security Old-Age and Survivors Insurance benefits because their wage and salary income exceeds the Social Security earnings limit. Data from the March 1999 Current Population Survey, which contains 1998 income and demographic data, were used to determine the number of seniors affected as well as their level of income and the state in which they reside.
A senior was considered to receive fewer Social Security benefits if wage and salary income exceeded $14,500 in 1998. Seniors who did not receive Social Security benefits and whose wage and salary income exceeded the earnings limit were considered to have lost all Social Security benefits as a result of the earnings limit. The estimate from this analysis is higher than the Social Security Administration's current estimate of 800,000 plus 150,000 auxiliary beneficiaries* due to the fact that the threshold level of the earnings test has increased from $14,500 to $17,000 in two years. The size of this increase allows some seniors who were subject to the earnings limit in 1998 to regain all their Social Security benefits in 2000.
* See Kenneth S. Apfel, Commissioner of the Social Security Administration, testimony before the Subcommittee on Social Security of the Committee on Ways and Means, U.S. House of Representatives, 106th Cong., 2nd Sess., February 15, 2000.
Under the existing law, retirees who are between the ages of 65 and 70 see their Social Security benefits reduced by $1 for every $3 they earn in wages or salaries over $17,000. A retiree who earned $18,500 in 2000, for example, would have his or her Social Security benefits reduced by $500--one-third of the $1,500 earned over the exemption level. Current law would raise this exemption level to $25,000 in 2001 and $30,000 in 2002. Only wages are counted for purposes of this test; funds from a private pension, interest and dividend income, and similar "unearned" income are excluded. Once a retiree reaches the age of 70, there are no restrictions on the amount of additional income he or she could earn without affecting Social Security retirement benefits.
In addition to reducing the Social Security benefits of selected retirees, the earnings test also reduces the benefits of "auxiliary" beneficiaries--spouses or other dependents whose benefits are based on another income source. For instance, a spouse who is entitled to a benefit equal to 50 percent of the employed retiree's benefits would also receive a reduced benefit.
Although the retirement benefits of the affected senior citizens are reduced until they reach the age of 70, some retirees may be eligible for increased benefits after age 70. A senior citizen whose entire monthly benefit has been taken by the earnings test, or who has delayed retirement until the age of 70, is eligible for "delayed retirement credits." These credits increase those retirees' monthly benefits by 6 percent for each year of lost or delayed benefits. Under current law, the delayed retirement credit will increase to 8 percent a year for workers who reach the age of 65 in 2008 or later.
The earnings test, which Congress created to encourage older workers to leave the labor force, has existed since the Social Security Act was passed in 1935. Although initially designed to eliminate the monthly Social Security benefits of any retiree who earned wages, by 1940 Congress had modified it to allow them to earn up to $14.99 a month before their benefits would be affected. Retirees above the age of 75 became exempt from the earnings test in 1950. This exemption was lowered to age 72 in 1954 and age 70 in 1983.
A retiree who had additional earnings lost all benefits until the policy was changed in 1960 so that $1 in benefits would be lost for every $2 of earnings above the income exemption level. In 1990, the loss was reduced to $1 for every $3 of earnings. A 1996 law gradually raised the level of annual earned income that is exempt from the earnings test.
Retirees Affected by the Earnings
According to the 1999 Current Population Survey of the U.S. Bureau of the Census, about 1,153,000 retirees and auxiliary retirees are affected by the earnings test directly.2 Social Security statistics suggest that there are slightly more than five retirees affected by the earnings test for every one auxiliary retiree who has his or her benefits reduced.3
The 1.15 million retirees subject to the earnings test in 1998 are almost evenly divided between those whose benefits were reduced and those whose benefits were eliminated altogether. This number does not include an unknown number of workers who either have delayed retirement until after age 70 or have failed to file for Social Security benefits because of the earnings test.
Geographic Distribution of Seniors
California has more retirees affected by the earnings test (about 161,000) than any other state. As Table 1 shows, other states with high numbers of seniors affected by the earnings test include New York (116,000), Florida (81,000), Texas (64,000), Illinois (58,000), Pennsylvania (48,500), Ohio (48,000), Georgia (48,000), Michigan (44,000), and New Jersey (37,000). Due to insufficient information, the numbers of retirees affected by the earnings test could not be estimated for the states of Maine, Oregon, South Carolina, Utah, and Vermont.4
Income Levels of Retirees Affected.
Over half of senior citizens affected by the earnings test have earned incomes that include their Social Security benefits of $45,000 or less. A fourth of them earn $30,000 or less (see Table 2).5
The Earnings Test for Retirees Under
There is also an earnings test that is applied to retirees between the ages of 62 and 65. In this case, benefits are reduced by $1 for every $2 they earn over $10,080 in 2000. Thus, under current law, a retiree in this age group who earned $15,000 in 2000 would have his or her benefits reduced by $2,460. The earnings test in this case also is based only on earned income and not on private pensions or dividends from investments. As mentioned above, the earnings test for retirees under the age of 65 would not be affected by the proposed legislation.
Repealing the earnings test for seniors aged 65 to 70 would be the first step toward genuine reform of the Social Security system, which faces serious funding problems in the next 15 years. Eliminating the age-discriminatory earnings test would increase benefit outlays to retirees who are 65 to 70 years of age by about $22.7 billion over the next 10 years. However, the Social Security Administration estimates that doing so will not result in higher costs for the program.6 Eliminating the need to recalculate these affected workers' benefits to reflect the delayed retirement credits would save money that would offset much of this cost. In addition, administering the earnings test is estimated to cost as much as $100 million to $150 million annually. Repealing the test could eliminate much of this cost.
Although repealing the obsolete and costly earnings test is a worthy objective, Members of Congress should not assume that doing so would amount to genuine reform of Social Security. That program still faces a major financial crisis in the coming decades as the baby boom generation approaches retirement, and it continues to provide workers with an extremely poor rate of return on their withholding taxes.7
Congress must begin to provide Americans with correct information about the actual state of the current Social Security system and its so-called trust fund. In addition, it needs to continue taking steps to allow workers to invest a portion of their existing withholding taxes in a personal retirement account that they can own and leave to their heirs.8 Only then will Social Security begin to meet the financial challenges it will face in the future.
1. The authors recognize that retirees who continue to earn taxable wages or salaries will add revenue to the Social Security system. However, Social Security Administration Commissioner Kenneth Apfel recently stated in testimony before Congress that these increased revenues would be largely offset by increased benefit outlays. See Kenneth S. Apfel, Commissioner of the Social Security Administration, testimony before the Subcommittee on Social Security of the Committee on Ways and Means, U.S. House of Representatives, 106th Cong., 2nd Sess., February 15, 2000.
4. Data in Table 1 are based on a senior's household residence. Some states do not have sufficient data samples with which to make an accurate estimate. Estimates based on 1998 data and earnings test amounts.
7. See, for example, Gareth G. Davis and Philippe J. Lacoude, What Social Security Will Pay: Rates of Return by Congressional District (Washington, D.C., The Heritage Foundation, 2000). For a general discussion of Social Security, see David C. John, "Social Security: Improving Retirement Income," in Stuart M. Butler and Kim R. Holmes, eds., Issues 2000: The Candidate's Briefing Book (Washington, D.C., The Heritage Foundation, 2000).
8. For a general discussion of Social Security, see John, "Social Security: Improving Retirement Income." See also, David C. John, Improving Retirement Security: A Handbook for Reformers (Washington, D.C., The Heritage Foundation, 2000).