November 13, 2013

RevenuesOption 19

Expand Social Security Coverage to Include Newly Hired State and Local Government Employees

(Billions of dollars) 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2014-2018 2014-2023
Change in Revenues 0.7 2.2 3.9 5.5 7.0 8.7 10.4 12.3 14.2 16.3 19.3 81.1

Source: Staff of the Joint Committee on Taxation.

Note: This option would take effect in January 2014. The change in revenues would consist of an increase in receipts from Social Security payroll taxes (which would be off-budget), offset in part by a reduction in individual tax revenues (which would be on-budget). In addition, the option would increase outlays for Social Security by a small amount. The estimates do not include those effects on outlays.

Nearly all private-sector workers and federal employees are covered by Social Security, but a quarter of workers employed by state and local governments are not covered. Under federal law, state and local governments can opt to enroll their employees in the Social Security program, or they can opt out if they provide a separate retirement plan for those workers instead. State and local governments may also have their employees participate in Social Security and be part of a separate retirement plan. In contrast, all federal employees hired after December 31, 1983, are covered by Social Security and pay the associated payroll taxes. Furthermore, all state and local government employees hired after March 31, 1986, and all federal government employees are covered by Medicare and pay payroll taxes for Hospital Insurance (Medicare Part A).

Under this option, Social Security coverage would be expanded to include all state and local government employees hired after December 31, 2013. Consequently, all newly hired state and local government employees would pay the Social Security payroll tax. That 12.4 percent tax on earnings, half of which is deducted from employees’ paychecks and half of which is paid by employers, funds the Old-Age, Survivors, and Disability Insurance programs. If implemented, this option would increase revenues by a total of $81 billion over the 2014–2023 period, the staff of the Joint Committee on Taxation estimates. (The estimate includes the reduction in individual income tax revenues that would result from shifting some labor compensation from a taxable to a nontaxable form.)

Paying the Social Security payroll tax for 10 years generally qualifies workers (and their dependents) to receive Social Security retirement benefits; other work requirements must be met for employees to qualify for disability benefits or, in the event of their death, for their dependents to qualify for survivors’ benefits. Although extending such coverage to all newly hired state and local employees would eventually increase the number of Social Security beneficiaries, that increase would have little impact on the federal government’s spending for Social Security in the short term. Over the 2014–2023 period, outlays would increase only by a small amount because most people who would be hired by state and local governments during that period would not begin receiving Social Security benefits for many years. (The estimate does not include any effects on outlays.)

In the long term, the additional benefit payments for the expanded pool of beneficiaries would be only about half the size of the additional revenues. That is largely because most of the newly hired workers would receive Social Security benefits anyway under current law for one of two possible reasons: They might have held other covered jobs in the past, or they were covered by a spouse’s employment. As a result, this option would slightly enhance the long-term viability of the Social Security program, which faces the prospect that income from Social Security payroll taxes will not be sufficient to finance the benefits that are due to beneficiaries under current law.

Another rationale for implementing the option concerns fairness. Social Security benefits are intended to replace only a percentage of a worker’s preretirement earnings. That percentage (referred to as the replacement rate) is higher for workers with low career earnings than for workers with higher earnings. But the standard formula for calculating Social Security benefits does not distinguish between people whose career earnings are low and those who just appear to have low career earnings because they spent a portion of their career working in jobs that were not covered by Social Security. To make the replacement rate more comparable for workers with similar earnings histories, current law reduces the standard benefits for retired government employees who have worked a substantial portion of their career in employment that is not covered by Social Security. However, that adjustment is imperfect and can affect various public employees differently: Specifically, it can result in higher replacement rates for some public employees who were not covered by Social Security throughout their career and in lower replacement rates for other public employees. This option would eliminate those inequities.

Implementing this option would also provide better retirement and disability benefits for many workers who move between government jobs and other types of employment. By facilitating job mobility, the option would enable some workers—who would otherwise stay in state and local jobs solely to maintain their public-employee retirement benefits—to move to jobs in which they could be more productive. Many state and local employees are reluctant to leave their jobs because pensions are structured to reward people who spend their entire careers in the same pension system. If their government service was covered by Social Security, there would be fewer disincentives to moving because they would remain in the Social Security system. State and local governments, however, might respond to greater turnover by reducing their investment in workers—by cutting training programs, for example—causing the productivity of state and local employees to decline.

An argument against such a policy change is that it might place an added burden on some state and local governments, which already face significant budgetary challenges. State and local pension plans are generally designed to be prefunded so that participants’ contributions can be invested to pay future benefits. As long as the plans are fully funded, transferring new employees to the Social Security system would not cause any problems. However, many plans are underfunded and depend on contributions from new participants to make up the shortfall. Under this option, the affected state and local governments would probably restructure their plans in one of two ways. They might exclude newly hired state and local employees from participation—thereby forgoing a possible source of new funding—which would place an additional burden on those governments. Or, they might choose to supplement the Social Security coverage for new employees by formulating a benefit package that, with Social Security included, was equivalent in value to their current plan. But such a package would increase costs to state and local governments because the cost per dollar of Social Security benefits for state and local government employees would probably exceed the cost per dollar for pensions provided by state and local governments. Social Security costs would be greater because that program initially paid benefits to recipients who had not contributed much to the system and because Social Security redistributes benefits to workers with low career earnings. Delaying implementation of the option for a few years would provide state and local governments time to restructure their pension plans. Nevertheless, costs to the affected governments would probably rise.