The Social Security Fairness Act Bodes Ill for Social Security Reform

What Congress today calls "fairness" is treating identical people very, very differently

Imagine two public school teachers. Each earns a salary of $72,000 during the school year, which is about the average nationwide, and each takes on a part-time job during their summer vacation earning an additional $10,000. These two teachers are identical in every way, except for one: one of the teachers is covered by Social Security in her teaching job, while the other is one of a small number of public employees who, for historical reasons, pays into a government retirement plan instead of Social Security.

But, thanks to the so-called Social Security Fairness Act recently passed by Congress and signed by President Biden on January 5, that doesn’t mean this latter teacher won’t collect Social Security benefits. In fact, thanks to this recent legislation, public employees who don’t pay into Social Security in their government jobs will receive vastly superior treatment from the program than workers who pay taxes into Social Security throughout their careers.

If this is how Congress approaches Social Security reform as the trust fund’s insolvency approaches in 2033, we have much to fear from that process.

When Social Security was enacted in 1935, participation was mandatory for most employees. An exception, however, was Americans working for state or local governments. Public sector employees typically already had a government retirement plan. Moreover, at the time there was a view, rather than quaint in the current context, that the federal government lacked the constitutional power to force state and local governments to participate in a federal program. Now, many state and local governments chose to participate in Social Security. But today, about one-quarter of state and local government employees still are exempt from Social Security. Instead, they pay into a public pension plan that substitutes for Social Security.

In certain cases, this presents no issues. For instance, if an unmarried state/local government employee works their entire career for the government, without ever working in a job that’s covered by Social Security, the issue is cut-and-dried: they receive whatever pension benefit their government plan provides while receiving nothing from Social Security.

But in other cases, such as our two public school teachers, two otherwise identical employees can be treated dramatically different by Social Security – or at least they will be under the terms of the miscast Social Security Fairness Act.

Let’s start with Teacher 1, who pays into Social Security in her teaching job. Assuming she retired in 2025 at the full retirement age of 67, her $72,000 annual teaching salary would entitle her to an annual Social Security benefit of $25,064. The additional $10,000 in annual earnings she received from summer jobs would boost her annual Social Security benefits by an additional $1,500.

Now consider Teacher 2. She pays into a government pension for her teaching job. Usually these public sector plans are more generous than Social Security, but for these purposes let’s assume the benefits are the same. Her $10,000 in summer earnings each year, however, entitle her to an annual Social Security benefit of $7,305. That’s $5,805 more than the $1,500 annual benefit that Teacher 1 receives based on her summer earnings. How can that be right?

It’s not right, in any fairness sense. It’s also not right when we consider need, since we assumed the two teachers had the same annual earnings and received the same government pension or Social Security benefits based on their teaching job. Yet Teacher 2, who mostly paid into a government pension in her teaching job, receives a total retirement income that’s $5,805 higher than Teacher 1. And that difference arises solely from how the two teachers are treated by Social Security.

The difference derives from a fundamental precept of Social Security, one that is key to the program but which both public employees and, less forgivably, Members of Congress failed to understand: that Social Security calculates retirement benefits to replace career-average pre-retirement earnings on a progressive basis. In other words, the lower your career-average earnings, the greater the percentage of them that Social Security replaces. Or, to put it another way, Social Security replaces a smaller portion of the last dollar of your earnings than it does the first dollar. It’s like the federal income tax brackets in reverse.

This explains why Teacher 2 receives so much more back from Social Security for her $10,000 per year summer job than does Teacher 1. For Teacher 1, her $10,000 summer salary comes on top of her $72,000 teaching salary. Since Social Security replaces pre-retirement earnings progressively, Teacher 1 receives back an annual benefit equal to only about 15 percent of that $10,000 in annual earnings. But for Teacher 2, Social Security’s benefit formula doesn’t see her $72,000 salary because that job isn’t covered by Social Security. As far as Social Security’s benefit formula is concerned, that $10,000 in summer earnings is the only salary Teacher 2 receives each year. Teacher 2 looks poor, and so Social Security gives her a benefit that replaces about 73 percent of that $10,000 in summer earnings.

The difference of $5,805 is referred to as a windfall: it’s not an extra benefit that Teacher 2 earned, since she paid in the same $10,000 in summer earnings that Teacher 1 did. Nor does Teacher 2 need that benefit more than Teacher 1, since they have precisely the same annual earnings and precisely the same pension or Social Security benefit from their main job.

To address this, in 1983 Congress enacted the Windfall Elimination Provision. The rules can be complex, but in this case Teacher 2’s Social Security benefit would be reduced to about $3,766. Moreover, the WEP is reduced for individuals with 20 or more years of work under Social Security, and eliminated for those with 30 or more years of covered employment, so Teacher 2 might not be hit by the WEP at all. But even if she took the full WEP reduction, she would still receive twice as much in benefits for her $10,000 in annual summer earnings as did Teacher 1.

The Social Security Fairness Act repeals the Windfall Elimination Provision, restoring the windfalls received by public employees who don’t participate in Social Security.

But this isn’t the end of things. Imagine that Teacher 1 and Teacher 2 were both married. Their spouses worked in Social Security-covered jobs their entire careers and also earned $72,000 annually. How does a spouse play into things?

In addition to retirement benefits, Social Security offers a supplemental spousal benefit to the lower-earning spouse. If the lower-earning spouse has a benefit based on her own earnings (even today, it’s still usually a her) that is less than half the benefit received by the higher earning spouse, then Social Security provides a spousal supplement to increase the lower-earning spouse’s total benefit to half that of the higher-earning spouse. But spousal benefits only are paid if the lower-earning spouse’s benefit is less than half the higher-earning spouse’s. If her benefit is greater than half, she receives nothing extra.

Similarly, when one spouse dies, the surviving spouse received the greater of their two benefits. However, she cannot receive both her own benefit and the benefit paid to her deceased spouse. It’s one or the other.

Those are the rules that Teacher 1 must live by. She will not receive a spousal benefit, because her earned benefit is the same as her spouse’s. Similarly, when her spouse dies she’ll continue to receive her own benefit, but her spouse’s benefit will cease. Like it or not, that’s how Social Security works for nearly every American.

Except, thanks to the Social Security Fairness Act, for public employees like Teacher 2. At retirement, she will receive an annual benefit of $7,305, based upon her own earnings – which, again, is higher than what Teacher 1 receives. On top of this, however, Teacher 2 is eligible to receive a spousal benefit of $5,227. This takes her total Social Security benefit up to $12,532 per year. If Teacher 2’s spouse dies prior to her, she can then receive a survivor’s benefit equal to the $25,064 benefit that her spouse received based upon their own earnings.

These also constitute windfalls. And to address them, Congress in 1977 enacted the Government Pension Offset, which reduces Social Security spousal and survivor benefits for retirees who also receive a government pension from a job that wasn’t covered by Social Security. The GPO prevents the kind of double-dipping that’s not allowed under Social Security but which otherwise non-covered public employees could take advantage of.

The Social Security Fairness Act also repeals the Government Pension Offset, restoring windfalls of spousal and survivors benefits.

So let’s compare Teacher 1 and Teacher 2 again. Both earn the same amounts in their teaching jobs. Teacher 1 receives a Social Security benefit of $25,064 based on her teaching salary, and we assume (conservatively) that Teacher 2 receives the same amount from her government pension. Both also work summer jobs in Social Security-covered jobs. For that, Teacher 1 receives an additional $1,500 in Social Security benefits per year, generating a total benefit of $26,564. Teacher 2 receives $25,064 from her government pension plus another $7,305 from her $10,000 per year summer salary, plus an additional spousal benefit of $5,227, bringing her combined pension and Social Security check to $37,596, which is $11,032 more than what Teacher 1 receives. And when Teacher 2’s spouse dies, she will receive a full survivor’s benefit of $25,064 while Teacher 1 will receive no survivor’s benefit. In widowhood, Teacher 2 will receive a combined government pension and Social Security benefit of $50,128, which is twice the $25,064 that Teacher 1 will receive.

Let’s assume that both Teachers survive for 15 years as part of a couple and then an additional five years as a widow. Over that time, Teacher 2 would receive combined pension and Social Security benefits that are $283,300 higher than those received by Teacher 1. They both had the same salaries and, by assumption, Teacher 2’s government pension benefit was no higher than the Social Security benefit that Teacher 1 received based upon her teaching salary. The entire difference derives from Social Security windfalls, which in 1983 Congress had addressed but which our current Congress chose to restore.

This, my fellow Americans, is what bipartisan majorities of Congress and President Biden describe as “Social Security fairness”: two individuals, with the same earnings and the same marital situations, being treated dramatically differently by Social Security.

Unfortunately, there is little that can be done about the Social Security Fairness Act now. There are proposed reforms to Social Security that, for the purposes of encouraging longer work lives, would base benefits upon annual earnings in which the person worked, not career-average Social Security-covered earnings that look artificially low for public employees who don’t pay into Social Security. These reforms would address some but not all of the Social Security windfalls Congress has restored.

But the larger lessons to be drawn are on the quality of Congressional policymaking. Now, I will grant you that understanding the need for the Windfall Elimination Provision and the Government Pension Offset is not simple. Even using my simplified examples, one must take the time to understand how Social Security’s retirement, spousal and survivor’s benefit formulas work.

But, if you managed to read this far, you most likely now do understand them. Which means that you understand more than the average Member of Congress did.

And, not to put too fine a point on it, if you are a Member of Congress, it’s your job to understand these issues, particularly before you vote in favor of legislation that would drain nearly $200 billion from Social Security and cause its trust fund to be exhausted roughly six months earlier.

All of this makes me far less optimistic that broader Social Security reform, when it comes, will be a success. Social Security’s retirement trust fund is projected to run dry in 2033, at which time the program’s revenues will be 21 percent short of what it needs to pay full benefits. For years, analysts of various orientations and points of view have put forward a range of solutions. Some are extreme on the financing side, restoring social security’s solvency entirely through tax increases or entirely through benefit reductions. Some are in between. Likewise, some proposals attempt to retain as much as possible of Social Security’s historical benefit structure and financing while others, such as my own, take a blank-slate approach of asking what a program devised for the 21^st century would look like. Regardless, there is no shortage of reasonable ideas for Members of Congress from both parties to choose from.

But I’m not sure reasonable ideas are what we’re going to get. No one seems to want to raise taxes, but no one wants to cut benefits either. President Biden pledged not to increase taxes on anyone earning less than $400,000, a promise that makes it all-but-impossible to pay full scheduled benefits going forward. President Trump promises no benefit cuts for anyone, ever, but has not argued for any tax increases for Social Security. A number of Members of Congress have dabbled with an idea to borrow several trillion dollars, invest it for 75 years at (one hopes) higher returns while simultaneously borrowing against the (one hopes) higher returns, then paying it back 75 years from now. None of this strikes me as what a well-functioning policy process would generate.

Moreover, Social Security reform involves understanding a great deal about how the program works, how it affects incentives to work and to save, how its payroll tax structure fits within the income tax code, and so on. Compared to 20 years ago, when President George W Bush was floating a fairly complex Social Security reform proposal, the typical Member of Congress simply seems to know less about how Social Security works. But, as the Social Security Fairness Act debacle shows, understanding the details really matters.

The broader scope of Social Security reform also requires a decent understand of Americans’ other sources of income in retirement, of knowing who depends on Social Security and how much. Much of the public, including Congress, seems to buy into the view that Americans have dramatically undersaved for retirement – despite massive federal tax preferences for retirement savings. The reality is that Americans’ retirement savings and retirement incomes have never been higher while the risk of poverty in old age has dropped dramatically over time. Social Security policy should be built around an understanding of these issues. Will it be? I doubt it.

The reality is that the U.S. Congress just isn’t that good at public policy anymore. The typical Member of Congress doesn’t understand very well how Social Security works. If they did, the Social Security Fairness Act wouldn’t have come close to passing. And they’re increasingly unwilling to take anything approaching a courageous stand, of telling the richest retirees in the history of the planet that maybe their benefits don’t need to keep increasing. It didn’t use to be that way. In the late 1990s and early 2000s politicians of both parties were willing to tell some difficult truths.

All of this makes me increasingly concerned that, when the exhaustion of the Social Security trust fund finally forces Congress’s hand, the results really may not be pretty.