Next week, the House of Representatives is expected to vote on a bill to increase Social Security benefits for the small percentage of workers who receive pensions from jobs not covered by Social Security. This legislation, which is projected to cost $196 billion over the next ten years, would repeal two provisions of current law, the Government Pension Offset (GPO) and the Windfall Elimination Provision (WEP).
Those who support repeal claim they are trying to treat everyone fairly, but repealing these provisions would have the opposite effect. Without the GPO and WEP, workers with pensions from non-covered employment would get more and pay less than everyone else covered by Social Security. To see why this is true, it’s necessary to understand how Social Security treats married couples and lower-wage workers.
When married couples are covered by Social Security, each spouse is potentially eligible for two different types of benefits: (1) “worker” benefits (retirement and disability) based on their own wages, and (2) “auxiliary” benefits (spouses and survivors) based on the wages of their spouse. When only one spouse works, the working spouse receives a worker benefit, and the non-working spouse receives an auxiliary benefit. When both spouses work, each spouse receives a worker benefit, plus any portion of the auxiliary benefit that exceeds their own worker benefit. Thus, each spouse effectively receives the higher of the two benefits. The $1-for-$1 offset between worker benefits and auxiliary benefits is known as the dual-entitlement rule.
Auxiliary benefits are intended to subsidize “traditional families” where one spouse spends time out of the workforce caring for children or elderly parents. The cost of providing these benefits is offset by the payroll tax imposed on covered workers and the benefit reduction imposed by the dual-entitlement rule.
Before the GPO was enacted in 1977, the dual-entitlement rule did not apply to non-covered pensions. Workers who were exempt from Social Security could receive a pension based on their own non-covered employment, plus 100 percent of the auxiliary benefit based on their spouse’s covered employment. The GPO reduces auxiliary benefits by two-thirds of the non-covered pension. This offset serves as a proxy for the dual-entitlement rule.
The necessity of offsetting the cost of auxiliary benefits, either through payroll taxes or the dual-entitlement rule, is evidenced by the fact that non-covered pensions require workers to take a reduced annuity to offset the cost of providing survivor benefits to their spouses. But auxiliary benefits for Social Security are more expensive because they include both spousal and survivor benefits.
Advocates of repealing the GPO seem to believe that because they are not covered by Social Security, they should be exempt from the dual-entitlement rule. However, non-covered workers are already exempt from the Social Security payroll tax. Without the GPO, or similar provision, they would contribute nothing toward the cost of the auxiliary benefits they receive from Social Security.
In addition to auxiliary benefits, workers who receive a non-covered pension may also become eligible to receive a worker benefit from Social Security. This eligibility occurs when workers divide their career between covered and non-covered employment. Before the WEP was enacted in 1983, workers with a divided career would disproportionately benefit from Social Security. There are two reasons for this unintended benefit.
First, Social Security benefits are based on average lifetime earnings, which are defined as the 35 highest years of covered wages. Workers with a non-covered pension are more likely to have less than 35 years of covered wages due to their years of non-covered employment. Because years of non-covered employment are counted as zeros ($0) in the 35-year average, workers with a non-covered pension typically have a lower average wage when calculating their Social Security benefit.
Second, the Social Security benefit formula is progressive, which means workers with lower average wages receive proportionally higher benefits, whereas workers with higher average wages receive proportionally lower benefits. The ratio of benefits to wages is known as the replacement rate – or how much of a worker’s average lifetime earnings are replaced by Social Security in retirement. Figure 1 below shows how replacement rates vary by average monthly wages.
Figure 1: Social Security Replacement Rates
To see how the use of average lifetime earnings and the progressive benefit formula can produce an unintended benefit, consider the following scenarios. Workers who earn $1,000 per month for 35 years have a 90 percent replacement rate; whereas workers who earn $3,500 per month for 35 years have a 51 percent replacement rate. However, due to the use of 35-year averages, workers who earn $3,500 per month for 10 years have a 90 percent replacement rate, instead of 51 percent, because their 35-year average wage is $1,000 [i.e., ($3,500 x 12 x 10) / (12 x 35) = $1,000].
For workers employed less than 35 years, the higher replacement rates that result from the additional zeros included in the 35-year average are intended to provide a subsidy to “traditional families” similar to the subsidy provided by auxiliary benefits described above. However, for workers with non-covered employment, the additional zeros result from the years they spent earning a non-covered pension and avoiding the payroll tax. Without the WEP, or similar provision, non-covered workers would receive the higher replacement rates intended for lower-wage workers.
The GPO and WEP were enacted to maintain parity between covered and non-covered workers with respect to the dual-entitlement rule and the progressive benefit formula. Even though these provisions are admittedly flawed, they still serve a legitimate purpose. Unfortunately, rather than seeking to improve these provisions, opponents are seeking their repeal. That would be a costly and inequitable mistake.
