April 5, 2016

Will Change Come to the Social Security Windfall Elimination Provision?

Jason J. Fichtner

Former Senior Research Fellow
Summary

While the WEP is intended to ensure that Social Security beneficiaries are treated fairly and that benefits are provided only for years in which people paid into the Social Security system, the result is that the replacement rate for some people with high lifetime combined earnings is higher than those with low lifetime earnings.

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On March 22, I presented testimony before Congress on a proposal to reform the Windfall Elimination Provision, or "WEP." The WEP reduces a person's Social Security benefit if they also receive a government pension from non-covered employment on which Social Security payroll taxes were not paid. While the WEP is intended to ensure that Social Security beneficiaries are treated fairly and that benefits are provided only for years in which people paid into the Social Security system, the result is that the replacement rate for some people with high lifetime combined earnings is higher than those with low lifetime earnings. Thus, the WEP mistakenly treats some high-income earners as if they were low-income earners.

The good news is there is real opportunity for reform — the administration and members of Congress on both sides of the aisle agree that the WEP formula should be addressed. The challenge will be ensuring any changes are an improvement for both the Social Security program and its beneficiaries.

Lower income vs. higher 

By way of background, and as readers of MarketWatch know, Social Security retirement and disability benefits are funded via a payroll tax on covered wages. The system is designed with a progressive-benefit formula that provides a higher replacement rate for lower-income earners than for higher-income earners. The result is that monthly Social Security benefits represent a larger share of lifetime earnings for lower-income workers than higher-income workers. This does not mean that a lower-income worker's monthly benefit amount is higher in nominal dollars thana higher-income worker, but rather that the replacement rate is higher.

For workers with entire careers in covered employment (employment subject to the Social Security payroll tax), lower lifetime wage earners receive a higher replacement rate than higher lifetime wage earners. But problems arise when workers have earnings from non-covered employment, such as earnings received through state and local governments in careers such as public school teachers, police officers, or firefighters.

If these workers have an entire career in state and local government that is not covered by Social Security, there is no problem with the WEP. However, many of these state and local government employees still qualify for some Social Security benefits, either because they have employment history in both covered and non-covered employment, or because they work simultaneously in two or more jobs that include covered and non-covered employment.

The challenges

The WEP formula is challenging to reform, as it is complicated and hard to explain to beneficiaries. The current Social Security Statement provides estimated monthly benefit amounts that are not adjusted for the WEP. For people relying on the Social Security Statement as a retirement-planning tool, the current non-WEP-adjusted information in the Statement could cause people to overestimate their financial readiness for retirement. The current WEP reduction also tends to be regressive, harming lower-income beneficiaries.

Completely eliminating the WEP will only return Social Security to its pre-WEP state and reinstate a windfall for those with both covered and non-covered employment. Hence, repeal is not advised. However, a "proportional" or pro-rated formula would improve fairness of the WEP while maintaining fairness and equal treatment.

The tools necessary for change

As of January 2017, SSA will have 35 years of employment history including both covered and non-covered employment — data that was not available in 1983 when the current arbitrary and imprecise formula for WEP was devised. Thus, we now have both the information and the tools necessary to reform the WEP and move to a prorated formula.

President Obama's full-year 2017 Budget contains such a proposal, and a similarbill has been introduced by Representatives Kevin Brady (R-TX) and RichardNeal (D-MA). As these proposals are similar, it appears there's a chance that Congress and President Obama may act to reform WEP this year.

For workers whose entire careers are in covered earnings, the resulting Social Security benefit amount is the same. However, for those with non-covered earnings, but with similar combined average annual lifetime earnings, now their covered earnings receive the same replacement rate as those whose entire careers were spent in covered employment.

In other words, the replacement rate on covered earnings is now the same and treats both workers with identical lifetime earnings history equally,thus restoring some fairness to the system while still maintaining the original intent of the WEP to avoid a "windfall" to those with non-covered earnings.

As with any reform to Social Security, there are always winners and losers, pros and cons, and trade-offs, as Kathleen Romig of the Center on Budget and Policy Priorities (CBPP) points out in this blog post. Nevertheless, the simplicity and fairness of a prorated formula is that it would apply to all workers — those with both covered earnings only and those with both covered and non-covered earnings. This would make the WEP easier for SSA to administer, and help beneficiaries better plan for retirement. Additionally, the Social Security Statement could provide accurate monthly benefit amounts to better enable people to plan for their financial security in retirement.