Policy Considerations

THE CONCERN FOR RETIREMENT INCOME SECURITY

As a group, retired people and their families enjoy a reasonable level of economic security in the United States today, particularly in comparison with earlier generations. While in 1959 the measured poverty rate for people aged 65 and older was 35 percent—well above the rate of 22.4 percent for the total population—in 1992 the poverty rate for the elderly was just 13 percent—below the rate of 14.5 percent for the total population (U.S. House of Representatives, 1994:859).

The expansion of the U.S. Social Security system, initially established some 60 years ago, played a major role in improving the economic circumstances of retired workers and their families. The system currently covers an estimated 96 percent of all jobs in the United States. From 1940 (when benefits were first paid out) to 1972, congressional action increased benefit levels on 10 occasions (although recent legislative changes have curtailed benefits in several ways). Since 1975, benefits have been indexed annually for inflation.

Over the post-World War II period, U.S. workers also benefited from provisions of the federal income tax code that encouraged the expansion of private pension coverage. (In 1993, 50% of full-time private employees were covered by an employer-financed pension plan—see Pension and Welfare Benefits Administration, 1994.) Most older people also have income from their own savings (although the amounts are usually small) or from other sources, including earnings from continued participation in the labor force.

However, not all of today's retirees are in comfortable economic circumstances: 13 percent are poor and another 15 percent are near poor (with incomes between 100% and 150% of the poverty line). Moreover, there is growing concern that the typical retiree in future years may face much bleaker economic circumstances than the typical retiree today. The reasons are many.

First, the current level of Social Security benefits cannot be sustained indefinitely at the current tax rates. One reason is that there will eventually be too few workers relative to the number of retirees to provide the needed level of contributions. The 1995 annual report of the Old-Age, Survivors, and Disability Insurance (OASDI) trustees projects that the old-age and survivors insurance trust fund will start running a deficit by the year 2015 and will be increasingly unbalanced through the rest of the 75-year projection period, which ends in 2070. (The



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Toward Improved Modeling of Retirement Income Policies: Interim Report Policy Considerations THE CONCERN FOR RETIREMENT INCOME SECURITY As a group, retired people and their families enjoy a reasonable level of economic security in the United States today, particularly in comparison with earlier generations. While in 1959 the measured poverty rate for people aged 65 and older was 35 percent—well above the rate of 22.4 percent for the total population—in 1992 the poverty rate for the elderly was just 13 percent—below the rate of 14.5 percent for the total population (U.S. House of Representatives, 1994:859). The expansion of the U.S. Social Security system, initially established some 60 years ago, played a major role in improving the economic circumstances of retired workers and their families. The system currently covers an estimated 96 percent of all jobs in the United States. From 1940 (when benefits were first paid out) to 1972, congressional action increased benefit levels on 10 occasions (although recent legislative changes have curtailed benefits in several ways). Since 1975, benefits have been indexed annually for inflation. Over the post-World War II period, U.S. workers also benefited from provisions of the federal income tax code that encouraged the expansion of private pension coverage. (In 1993, 50% of full-time private employees were covered by an employer-financed pension plan—see Pension and Welfare Benefits Administration, 1994.) Most older people also have income from their own savings (although the amounts are usually small) or from other sources, including earnings from continued participation in the labor force. However, not all of today's retirees are in comfortable economic circumstances: 13 percent are poor and another 15 percent are near poor (with incomes between 100% and 150% of the poverty line). Moreover, there is growing concern that the typical retiree in future years may face much bleaker economic circumstances than the typical retiree today. The reasons are many. First, the current level of Social Security benefits cannot be sustained indefinitely at the current tax rates. One reason is that there will eventually be too few workers relative to the number of retirees to provide the needed level of contributions. The 1995 annual report of the Old-Age, Survivors, and Disability Insurance (OASDI) trustees projects that the old-age and survivors insurance trust fund will start running a deficit by the year 2015 and will be increasingly unbalanced through the rest of the 75-year projection period, which ends in 2070. (The

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Toward Improved Modeling of Retirement Income Policies: Interim Report disability insurance trust fund is projected to run a deficit as early as 2004, while the Medicare hospital insurance trust fund has already begun to run a deficit and is expected to be exhausted by 2002.)1 The Social Security trust fund imbalance must be corrected by some means, which could include reductions in benefits or increases in payroll tax rates (or both). The problems with the Social Security system are particularly important because of pressures on other sources of retirement income and because a significant fraction of the elderly rely almost entirely on Social Security benefits for retirement income support. (In 1992, 14% of Social Security beneficiaries aged 65 and older had no income from other sources, and another 21% had other income of less than $2,000; U.S. House of Representatives, 1994:Table A-9.) Second, the trend toward expansion of employer-financed pension coverage, including all types of plans, peaked in 1979 at 50 percent of full-time private workers (much higher percentages of government employees and much lower percentages of part-time employees are covered). Since then, coverage has fluctuated, declining to 46 percent in 1988 and increasing again to 50 percent in 1993 (Pension and Welfare Benefits Administration, 1994). For some groups, such as men under age 30 and men aged 50 to 59, pension coverage continued to decline through 1993 (in each year, coverage rates are higher for older than for younger workers). Reasons for the leveling off of the extent of pension coverage include the shift of employment from manufacturing to service companies, which are less likely to offer pension plans, and the declining influence of labor unions. For younger workers, another reason is the increasing propensity of employers to offer 401(k) plans, which require employee contributions—younger workers are less likely than older workers to elect to participate in such plans. Finally, the standards for pensions to qualify for favorable tax treatment may have led some companies to discontinue or scale back their plans. Third, trends in the types of private pensions offered to employees have raised questions about the likely contributions of private pensions to retirement income security. More and more employers are offering defined contribution plans (which include 401(k) plans, profit-sharing plans, and others) as the sole pension plan or as a supplement to a defined benefit plan. Defined contribution plans, in contrast to defined benefit plans, guarantee a contribution (by the employer and/or the employee) but not a specific retirement benefit. Hence, such plans transfer the risk of providing retirement income security from the employer (and from the Pension Benefit Guaranty Corporation, which ensures defined benefit plans) to the worker. It is not clear which type of plan ultimately provides more security (see, e.g., Samwick and Skinner, 1993). On the one hand, the benefits from defined contribution plans may be less predictable because of the greater flexibility that many such plans offer workers (e.g., to determine the level of contributions, to allocate contributions among investment vehicles, to make withdrawals for pre-retirement consumption) and because workers who change jobs may spend their lump-sum distributions. On the other hand, workers covered by defined benefit plans face risks as well. For example, workers who are laid off in mid-career may receive significantly lower benefits, given that such plans typically link benefits to years of service and highest years of earnings. Fourth, it appears unlikely that private savings will make up shortfalls in public and private pension benefits. Survey data indicate that many people approach retirement with 1   The figures in the text are based on the “intermediate” projections for the old-age and survivors and disability trust funds (Board of Trustees [OASDI], 1995:Table II.F13; see Board of Trustees [HI], 1995:Table I.D2 for Medicare). The high-cost (pessimistic) projection shows the old-age and survivors trust fund running a deficit as early as the year 2000 and markedly out of balance thereafter. The low-cost (optimistic) scenario shows the trust fund only modestly out of balance for the period 2020-2070.

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Toward Improved Modeling of Retirement Income Policies: Interim Report virtually no private savings of any kind beyond perhaps a home. For example, 25 percent of couples, single men, and single women ages 51-61 in 1992 had, respectively, less than $13,000 in financial assets (e.g., stocks, bonds, savings accounts), less than $1,000 in financial assets, and no financial assets. If financial assets are counted together with home equity, 25 percent of couples, single men, and single women ages 51-61 in 1992 had, respectively, less than $56,000, less than $4,000, and less than $1,200 in such assets (Gustman and Juster, 1994:Table A-1). Aggravating the situation is that people with lower income and asset levels are less likely to have employer pension coverage than are people with higher income and asset levels. Fifth, health care costs have risen markedly in recent decades, and few effective measures have been taken as yet to contain costs. Although virtually all of the elderly have Medicare coverage and many have supplementary private insurance coverage or Medicaid coverage, they incur significantly higher out-of-pocket costs for medical care on average than younger people. (In 1987, 89% of people aged 65 or older incurred out-of-pocket medical care costs, not counting insurance premiums or long-term care costs, and their mean expense was $1,005; the corresponding figures for younger people were 74% and $391; Taylor and Banthin, 1994:Table 2). Also, the elderly on average spend a higher proportion of their income on medical care than do younger people (e.g., in 1987, 23% of elderly households compared with only 7% of nonelderly households had out-of-pocket medical expenses that exceeded 10% of their income; Taylor and Banthin, 1994:Table 8). The reasons that the elderly incur higher costs are their higher rates of medical care utilization together with gaps in coverage (e.g., prescription drugs are not paid for by Medicare) and the requirement to pay insurance premiums, deductibles, and copayments. If medical care costs continue to increase, a retirement income stream that would have been adequate in the past to cover needed consumption, including health care, may no longer be adequate. Moreover, cutbacks in Medicare, Medicaid, and medical insurance provided to retirees by their former employers would exacerbate the situation, if there is no corresponding ability to reduce utilization or costs.2 Finally, contributing to the concern about future retirement income security are such demographic and socioeconomic trends as the following: Rising life expectancies, which means that retirement income must be stretched out over a longer period—a particular concern when retirement income flows are not indexed for inflation (e.g., in the case of private pension plan payments for which there is no regular cost-of-living adjustment). Lower ages at retirement, which means that workers have fewer years in which to save for retirement (also fewer years to contribute to the financing of Social Security benefits for current retirees) and, again, more years of retirement consumption to support. The post-World War II period saw a marked drop in labor force participation rates for older men (the rates for men aged 60 to 64 declined from 83 percent in 1955 to 54 percent in 1993; the rates for men aged 65 and over declined from 40 percent to 16 percent in the same period; U.S. House of Representatives, 1994:856). Recently, the trend toward earlier ages at retirement for men has 2   The proportion of current workers who are covered by employer-provided health insurance declined from 65 percent to 61 percent of all wage and salary workers over the period 1988 to 1993. The decline was concentrated among private sector workers and appeared to stem largely from lower rates of provision of health care plans by employers rather than from higher rates of nonparticipation by workers at employers offering plans (Pension and Welfare Benefits Administration, 1994:4). Data on trends in retiree health insurance coverage are harder to come by, but there are indications that a significant proportion of employers are dropping health insurance coverage for future retirees and requiring current retirees to pay more for continued coverage (see, e.g., Lohse, 1993).

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Toward Improved Modeling of Retirement Income Policies: Interim Report leveled off; also, labor force participation rates for women aged 60 and over, which are significantly below those of men in the same age group, have increased somewhat.3 Whether the provisions in the 1983 Social Security amendments to gradually reduce initial benefits (sometimes referred to inaccurately as an increase in the “normal” retirement age), offset for workers older than ages 65 to 67 by an increase in the delayed retirement credit, will lead to later ages at retirement will not be known for some years.4 Trends toward increasing disabilities among workers, which lowers labor supply and the opportunities to save and increases the need for income support over a longer period. While survey measures do not appear to show higher rates of disability in the elderly population (see, e.g., Freedman and Soldo, 1994; Waidmann, Bound, and Schoenbaum, 1995), it is the case that higher proportions of workers have been applying for and receiving Social Security and other disability benefits. 5 Also, there appears to be a trend toward younger ages for first receipt of disability benefits by workers (Rust, 1993). Under one set of assumptions, it is possible to forecast a dire scenario for the time when the baby boom generation begins to retire: Retirees receive significantly less from Social Security, perhaps because of a combination of such steps as raising the retirement age, reducing the cost-of-living adjustment, taxing benefits more fully, and reducing benefit amounts in relation to covered earnings. Fewer retirees have employer-financed pension income or health insurance coverage because more of them lacked long-term, full-time employment in industries that traditionally offer defined benefit pensions or because they took and spent pre-retirement lump sum distributions or because employers cut back on benefits. Fewer retirees have personal savings other than a home (perhaps because more of them had to pay higher payroll taxes to finance even a reduced level of Social Security benefits). Retirees face increased costs for health care, including long-term care, because of higher disability rates and reduced health insurance coverage. Under such a worst-case scenario, future retirees as a group will likely pay more in Social Security taxes and private pension contributions prior to retirement, yet receive less in post-retirement benefits. Moreover, under such a scenario, retirement income levels are likely to vary widely: some people will be relatively well off (e.g., people who retained jobs in industries with good benefits), while many others will be badly off. It is also possible, with somewhat different assumptions, to forecast a much more benign scenario, in which most baby boomers and subsequent generations of retirees enjoy a reasonably adequate level of income without the need for substantial tax increases on currently 3   For historical data on labor force participation rates for men aged 60 and over, see Ransom et al. (1988, covers the period 1870-1937) and Lumsdaine and Wise (1994, continues the time series through 1980). Burkhauser and Quinn (1994) argue that the decline in labor force participation rates has bottomed out, while Perrachi and Welch (1994) argue the opposite, particularly for low-wage earners. 4   For differing views on the likely effects of these provisions, see Reimers and Honig (1993); Rust and Phelan (1993); and Gustman and Steinmeier (1991). 5   Workers receiving disability benefits under Social Security increased as a percentage of covered civilian workers from 0.8 percent in 1960 to 3.2 percent in 1975. The number of disability beneficiaries declined to 2.7 percent of covered workers in 1985, largely due to a decline in the percentage of applications that were approved, but increased again to 3.1 percent of covered workers in 1991 (calculated from U.S. House of Representatives, 1994:Tables 2-8, 3-5; see also Lewin-VHI, 1994).

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Toward Improved Modeling of Retirement Income Policies: Interim Report employed workers or other wrenching policy changes. For example, higher immigration levels or an increase in fertility rates could mean higher revenues to the Social Security system. Whether a worst-case or best-case situation will eventuate cannot be known, but policy adjustments (e.g., some changes in Social Security financing) will very likely be needed even in the best case. Moreover, to the extent that needed changes are delayed, they may have to be larger in magnitude. POLICY LEVERS Many public policies affect retirement and post-retirement income security, both directly and indirectly through their effects on employer and employee behavior and on the general level of economic activity. Among these policies are the Social Security system (both provisions of the payroll tax and the benefit structure); the federal personal and corporate income tax code (provisions that affect employer-provided pensions and health care benefits, such other forms of saving as IRAs and housing, and bequests); the Medicare and Medicaid systems; public assistance programs (e.g., Supplemental Security Income [SSI] for the poor elderly and disabled and the disability component of Social Security); and government regulations that affect employer work force practices (e.g., laws prohibiting age discrimination in hiring or mandatory retirement) and that affect pension benefits (e.g., the 1974 Employee Retirement Income Security Act [ERISA] and subsequent amendments). Overall macroeconomic policies that affect inflation, employment, and real wage growth also have major implications for retirement income security. Finally, employer and government agency efforts to educate workers about their pension benefits and investment options could potentially affect workers' retirement income security, although very little is known about the extent or efficacy of such education efforts. Each of these policy areas represents a lever that policy makers can maintain or alter, with consequent effects for retirement income security and the costs to workers to attain such security. Generally, separate agencies handle each of these areas (e.g., the Social Security Administration [SSA], Department of the Treasury, Pension and Welfare Benefits Administration [PWBA], Pension Benefit Guaranty Corporation [PBGC], Health Care Financing Administration [HCFA]). The large number of retirement-income-related policy areas and characteristics of the policy process surrounding them have implications for retirement income modeling. One characteristic of the process is that policy making and policy analysis for each area tend to occur in isolation, without systematic coordination among the relevant agencies. For example, recent changes in tax laws on pension funding were analyzed with regard to their potential to increase revenues in the short term without considering their possibly adverse effects, such as leading to employers' decisions to drop or scale back their pension plans (see, e.g., Lindeman and Utgoff, 1992).6 Similarly, analysis of provisions in the 1983 Social Security amendments that were designed to put the Social Security trust fund on a sounder footing may not have been sufficiently broad. Thus, the provisions to gradually reduce initial benefits and gradually increase the delayed retirement credit may not have the intended effects. One reason is that employers are increasingly seeking to find ways to induce older workers to retire early (e.g., by offering some categories of workers “window” plans with incentives to encourage leaving the organization). Moreover, making it less attractive to retire 6   The U.S. Treasury Department has sometimes conducted studies of the broader implications of tax law changes after these have been enacted —see, for example, the 1991 study of the pension security effects of the 1987 Omnibus Budget Reconciliation Act legislation that limited prefunding of defined benefit pension plans.

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Toward Improved Modeling of Retirement Income Policies: Interim Report early on Social Security may simply induce more workers to apply for SSI or OASDI disability benefits. Models ideally should take account of these kinds of interactions, but the decentralization of the analysis function, as well as inadequate data and incomplete or conflicting research findings, presents barriers. Another characteristic of the policy process is the tendency toward micromanagement. The U.S. tax and transfer systems are very detailed —for example, the tax code embodies very precise and complex regulations about the pension treatment of employees at different earnings levels. Employers must meet federal requirements if their pension plans are to qualify for favorable tax treatment. These kinds of detailed provisions complicate the task of modeling the likely effects of continuing current policies unchanged into the future and of making one or another kind of policy change. The fact that retirement income security is a policy concern of many other nations with aging populations offers both opportunities and challenges to the United States (see World Bank, 1994). Some countries have adopted retirement systems that are radically different from the traditional Social Security type of system. For example, Chile mandates that salaried workers invest a percentage of their wages in their own individual retirement accounts (participation by self-employed workers is voluntary). Workers can choose among a number of investment funds, which are closely regulated by the government. The government supplements retirement incomes for people who receive low returns from their accounts. Other countries have modified the traditional type of system to minimize the long-term risk of insolvency. For example, Sweden recently indexed the benefit paid to new retirees to measured life expectancy when reaching retirement age. The intent is to pay the same total lifetime benefit, on average, to members of each cohort of retirees, which is achieved by reducing the yearly benefit for members of cohorts that are expected to live longer. Still other countries (most recently, Australia) have mandated that all employers provide pension coverage to their workers. These ideas and others may warrant consideration in the United States; however, again, the analytic challenge is to take a broad rather than a narrow approach to analyzing such policy options. NEAR-TERM POLICY ISSUES The questions our study is charged to answer are what can be done with existing retirement income models and what improvements are needed in data, models, and research knowledge to improve the capability for cost-effective policy modeling in the future. To arrive at answers, we need to know the kinds of policy scenarios for which policy makers are likely to want estimates in the near term (discussed in this section) and the kinds of information that policy makers will need to evaluate the costs and benefits of alternative policy proposals (discussed in the next section). We have identified a list of four areas and possible policy changes within each area that we believe may be considered in upcoming debates about retirement income security in the United States. The four areas are Social Security, employer-provided pensions, other private savings and wealth more broadly, and health care needs and costs. Social Security Social Security clearly needs and will receive attention to consider ways to restore a balance between costs and benefits. It seems likely to us that the policy debate will look for solutions to the system 's problems that spread the costs broadly. Such a goal will likely lead to consideration of a combination of smaller changes in the system instead of larger changes that

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Toward Improved Modeling of Retirement Income Policies: Interim Report are concentrated on one or two features. Hence, models will likely need to estimate the effects, not only in isolation but in combination, of such changes to the system as are outlined below. Note that each change is framed in terms of the direction that is needed to restore balance to the Social Security trust fund (e.g., increasing rather than decreasing payroll tax rates): increase payroll tax rates for employers, employees, or both; increase the payroll tax base (e.g., by removing the current cap on the amount of earnings that is subject to the old-age and survivors insurance portion of the payroll tax and making all earnings subject to tax as has already been done for the Medicare portion); decrease benefits by changing the benefit formula (e.g., the bend points for calculating the primary insurance benefit amount);7 means-test benefits, so that retirees with other sources of income or assets receive smaller Social Security payments; increase the amount of benefits that is subject to income tax; lower the amount of earnings that beneficiaries can receive without a reduction in benefits; reduce the yearly cost-of-living adjustment; and increase the early retirement age. Because changes in the retirement benefit component of the system may have effects on the disability and health insurance components of the system, we believe that models will likely need to address policy changes that more closely integrate Social Security with the other components. For example, without closer integration, an increase in the Social Security early retirement age will be less effective in restoring balance to the system if more people apply for and receive disability payments. A proposal for closer integration that might be modeled is to raise the Social Security early retirement age (say, to age 65) and at the same time to reduce disability payments. We also believe that models will be asked to estimate the effects of yet more radical alternatives, such as partially privatizing the Social Security system, perhaps with the intent of restoring confidence in the system. At present, public opinion data indicate that younger workers doubt that they will receive Social Security benefits commensurate with the taxes they are paying into the system (see Burtless, 1995:2). Privatizing some (or all) contributions could restore the confidence of younger workers that their taxes will in due course be returned to them as benefit streams from their “own” retirement accounts.8 Employer Pensions Social Security is not and was never intended to be the only source of retirement income security: historically, employer-provided pensions have also been expected to make an impor- 7   At present, there are two bend points: for a worker reaching age 62 in 1994, the primary insurance amount is calculated as 90 percent of the first $422 of the worker's average indexed monthly earnings, plus 32 percent of the next $2,123, plus 15 percent of the remaining amount above $2,545, if any (U.S. House of Representatives, 1994:12). 8   Indeed, a problem with policy changes that tinker with the existing system is that they may increase the perception that the system is at risk and that workers cannot count on the rules of the game staying the same for any length of time.

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Toward Improved Modeling of Retirement Income Policies: Interim Report tant contribution. There is extensive legislation and government regulation of employer plans, and, hence, there is a need for models that can estimate the effects of changes to these laws and regulations. Examples of policy changes that could increase retirement income security by requiring workers to maintain their pension contributions for retirement purposes (i.e., to require insurance against longevity risk) or by encouraging them to increase their contributions include the following: increasing the penalties for early withdrawals from 401(k) plans and other defined contribution pension plans; mandating that workers, when they change jobs, roll over their pension plan contributions to some other plan (i.e., disallowing acceptance of lump sums that are not earmarked for retirement purposes); mandating that retirement income from employer pensions be drawn in the form of an annuity (i.e., disallowing any lump-sum benefits); regulating pension investment options; and increasing tax incentives to contribute to defined contribution plans. Perhaps even more important to model are policy changes that alter employer behavior. Examples of policy changes that could increase retirement income security by altering the behavior of employers include the following: equalizing the tax treatment of employee contributions in defined benefit versus defined contribution pension plans (currently, contributions to defined benefit plans are in before-tax dollars, whereas contributions to defined contribution plans can be made in after-tax dollars); increasing protections for spousal benefits in pension plans; raising the limits on the extent to which employers can prefund defined benefit pension plans; changing the insurance rules for defined benefit pension plans; changing nondiscrimination rules so as to encourage employers to establish and expand pension plans; changing age-discrimination laws to encourage employers to retain older workers and provide them benefits (e.g., giving employers flexibility to alter compensation for older workers); mandating additional pension plan design constraints for employers, such as indexation of pensions and altering the ability to offset employer pensions by Social Security benefits; allowing employers to opt out of Social Security (as is possible in the United Kingdom) and provide comparable or better benefits through pension plans; and mandating employer pensions. Many of these policy proposals (e.g., a policy to require all employers to provide pensions) would be radical steps that would require careful consideration of a wide range of effects, not only on retirement income security but on the economy more broadly (see below). Generally, it would be important to assess whether changes that are proposed to increase retirement security would actually have the desired effect or its opposite (e.g., by inducing employers to opt out of pension plans). Finally, it is important to model interactions of employer pensions with other tax policy provisions (e.g., the corporate profits tax) and with the Social Security system. Many employer plans are designed to be integrated with Social Security (e.g., paying different amounts of benefits for earnings below the Social Security

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Toward Improved Modeling of Retirement Income Policies: Interim Report payroll tax threshold), so it would be important to assess the effects of Social Security policy changes on employer plans. Other Private Savings and Wealth Also important to address are policy changes that affect people's private savings other than their pension plan contributions. IRAs are one type of private savings that government policy has encouraged in order to increase retirement income security. Policy changes that models may be asked to address with regard to IRAs and other forms of tax-deferred savings include increasing incentives to contribute to IRAs (e.g., by raising the annual limit on the amount of tax-deferred contributions), increasing (or decreasing) penalties for early withdrawals, and mandating that income be taken in the form of an annuity. Generally, it is important to address policy changes that affect people's ability to acquire wealth, broadly defined (including tax-deferred and non-tax-deferred financial investments, property, insurance, etc.), and save it for retirement, as well as to pass it on to the next generation. The reason is that the baby boom generation may need to rely significantly on their own savings and also on bequests from their parents for retirement income. The direction that policy should take in this area is not clear. For instance, there may be reason to encourage older cohorts to hold assets for bequest purposes so as to enhance the retirement income security of their children. In this case, models could be asked, for example, to address policy changes that protect assets against the risks of long-term health care costs—for example, subsidizing long-term-care insurance or providing tax-advantaged medical savings accounts. Alternatively, there could be reason to encourage current retirees to use their assets to reduce the taxpayer costs of providing health care and other benefits to them. Policy changes that models could be asked to address in this vein include raising estate tax rates; taxing capital gains on inherited assets; lowering asset limits for program eligibility (e.g., for SSI) or imposing asset tests (e.g., for Medicare or Social Security); and encouraging reverse-mortgage-type programs to allow the elderly to unlock housing equity. Finally, it could be important to have models look at the effects of changes in the federal government deficit on savings and wealth accumulation generally. Health Care Needs and Costs Health care needs and costs are an important, as well as a highly uncertain, aspect of retirement income security or well-being. To the extent that medical care costs continue to escalate, particularly for the elderly, then no assessment of retirement income security is complete without consideration of health care needs and costs. In this report, we do not specifically consider government policy models of health care needs, costs, or benefits. However, for completeness, we identify some of the kinds of policy changes that we believe health care models are likely to be asked to address. We also believe it is important to have links between models of retirement income security and models of health care costs and benefits. There are a number of possible health care policy changes that relate specifically to retirees. Some of these changes are directed to making adequate health insurance coverage more widely available; others are directed to curtailing utilization of services and reducing costs: mandating the provision of retiree health insurance coverage by former employers (e.g., extending the Consolidated Omnibus Budget Reconciliation Act legislation); providing spousal protection in employer-sponsored health insurance plans;

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Toward Improved Modeling of Retirement Income Policies: Interim Report equalizing the tax treatment of employer-provided versus individually purchased health insurance; providing government insurance for long-term care (or providing tax incentives to purchase such insurance); and making one or a combination of changes to Medicare, such as changing coinsurance rates and deductibles, changing the mix of benefits (e.g., providing prescription drug coverage but curtailing some other kinds of benefits), increasing Medicare payroll taxes, moving enrollees into managed care systems, means-testing the receipt of Medicare benefits, improving the monitoring of Medicare claims to reduce unneeded services and fraudulent claims, or turning Medicare into a catastrophic insurance program with the expectation that private insurance will cover expenses up to the ceiling at which Medicare begins to provide benefits. OUTCOMES ON WHICH TO EVALUATE POLICY CHANGES In order to evaluate the costs and benefits of alternative policy proposals, decision makers require information on a range of outcomes. In consultation with members of the Social Security Advisory Council Technical Panel on Retirement and Income, co-chaired by panel member Olivia Mitchell, we developed a list of outcome criteria for which policy models are likely to be asked to provide information. Models will need to provide estimates of outcomes for one or more demographic and economic scenarios in which current retirement-income-related policies are maintained and for scenarios in which one or more policy provisions are changed. Not all kinds of policy changes require information on each of the listed outcome criteria; however, we believe that decision makers will most often want to evaluate policy alternatives by using more than a single criterion. Examining a range of criteria is quite important because there are often tradeoffs that must be considered: for example, selecting the desired balance between benefit reductions and tax increases to restore actuarial balance to the Social Security system. Examining a range of outcome criteria is also important because policy changes can change behavior in ways that alter the original estimates of costs and benefits. To take an example, a policy change that is adopted to maintain the adequacy of income for future retirees by, say, requiring increased contributions to employer pension plans or in Social Security payroll taxes might induce workers to reduce work hours and thereby decrease their pension plan or payroll tax contributions. Retirement Income Adequacy An important evaluation criterion is how a policy change affects the adequacy of retirement income. Measures of income adequacy include the poverty rate for the elderly, which focuses on the most vulnerable tail of the distribution, and the rate at which public or private pension income replaces earnings for people across the entire distribution. 9 To provide adequate information to apply this criterion requires a capability for disaggregation of model inputs and outputs (e.g., disaggregated data on earnings histories to estimate replacement rates for people with lower, average, and higher earnings). Insurance Against Income Fluctuations Another criterion by which to evaluate the 9   While the poverty rate is a useful measure of income adequacy, the arbitrariness of the poverty line should be acknowledged. Also, the current official poverty measure is flawed in many respects: for example, it has lower thresholds for elderly single people and couples compared with other one- and two-person families, and it has an inconsistent definition of family resources that counts taxes and other nondiscretionary expenses as available for needed consumption but excludes the value of such in-kind benefits as food stamps (see Citro and Michael, 1995).

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Toward Improved Modeling of Retirement Income Policies: Interim Report entire retirement income system, including Social Security and employer plans, is how well the system provides insurance against unforeseen events that cut off a worker's flow of income. Thus, Social Security and many employer pensions offer survivor and disability benefits and also permit early retirement for those without appealing job opportunities due to industry downsizing or obsolescence of skills, as well as for those with a taste for leisure.10 A cost of providing such insurance is that its availability undoubtedly introduces labor market inefficiencies (e.g., encouraging early retirement or application for disability benefits). The question then is whether a proposed retirement income policy change achieves an appropriate balance between increasing insurance against unforeseen income shocks and increasing the distortions in labor markets. Equity of Taxes and Benefits Within and Across Generations Current retirement income policies often involve transfers within and across generations. For example, in some employer pension plans, healthier people may, on average, receive more lifetime pension benefits than less healthy people with the same contributions because of their longer life expectancy (the same is true of Social Security). A comparison across generations shows that current retirees are the beneficiaries of large net transfers of Social Security benefits from current workers who are paying more in payroll taxes and will receive less in benefits relative to their contributions compared with current (and past) retirees. Assessments of proposed policy changes will often need to consider issues of within- and across-generational equity. Financial Soundness of the Retirement Income System Clearly, an important outcome criterion for any proposal to change the Social Security system concerns the implications for long-term actuarial balance of taxes and benefits. Reforms that do not provide for balance in the system over the standard 75-year projection period, or even longer, are not likely to be acceptable. Similarly, changes in the rules under which employers maintain their pension plans, and under which individuals save for their retirement, should be considered from the perspective of their likely effects on the financial soundness of these plans. Another issue in this area is the extent to which government guarantees of pension benefits, such as are currently provided by PBGC, should be provided as a backstop to private sector guarantees and the appropriate price to charge for these guarantees. Avoidance of Market Inefficiencies Another important evaluation criterion is the extent to which a policy change avoids introducing or exacerbating market distortions with respect to individuals' choices of labor versus leisure or savings versus consumption. Labor-Leisure Choices Although research knowledge is not definitive about the magnitude of the effects, it is clear that Social Security, employer pensions, the tax code, and other policy levers (e.g., disability benefits) influence people's choices of labor versus leisure, including their decisions on hours of work early and later in their careers and their decisions about when to retire and whether to retire completely or only partially. It is important to know the extent to which a proposed policy change increases or reduces market distortions in terms of labor-leisure decisions and the implications of feedback effects on workers' labor supply for estimates of retirement income adequacy and other outcomes. 10   Employers provide insurance principally through defined benefit pension plans (also through such benefits as disability insurance). Another pension issue that has an insurance aspect is whether to restrict lump-sum payments of benefits (from defined benefit or defined contribution plans) and thereby require individuals to insure against the risk of above-average longevity.

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Toward Improved Modeling of Retirement Income Policies: Interim Report Savings-Consumption Choices Social Security, private pensions, the tax code, and other policy levers (e.g., publicly provided health care benefits) also affect people's choices about how they allocate income between savings and consumption during their work years versus their retirement years. It is important to know the extent to which a proposed policy change increases or reduces market distortions with regard to pre-retirement savings in order to support post-retirement consumption. For example, Social Security could move toward ensuring adequate retirement accumulations by making retirement benefit payments depend more on the size of private pension accumulations. But such a policy would lower the value of any personal savings, thus encouraging individuals to save less on their own during their working lives. Such distortions in savings-consumption choices of individuals throughout their lives can have direct ramifications for the economy. Encouragement of National Savings It is widely believed that U.S. savings rates (including individual, corporate, and government savings) are too low, either to provide adequate income support to future retirees or to provide adequate investment levels with which to increase future economic output and the overall standard of living. Hence, one criterion for evaluating a proposed policy change is the extent to which it would increase national savings. For example, current restrictions on the extent to which employers can prefund defined benefit pension plans are designed to increase federal tax revenues in the short run. However, these restrictions also most likely decrease corporate savings, certainly in the short run and perhaps in the long run as well, with the result that the net effect on national savings may be negative (see Schieber and Shoven, 1993; England, 1994). In this case, it is important to have estimates of the effects, not just on tax revenues, but on aggregate national savings. Encouragement of Overall Economic Efficiency, Competitiveness, and Growth For some kinds of policy changes, it is important to consider the effects on the behavior of employers that, in turn, affects the overall efficiency of the national economy, the rate of economic growth, and the ability of the United States to remain competitive in world markets. For example, such information would be critical in evaluating a policy change that required all or a large proportion of employers to take certain actions (e.g., provide health care benefits for their retirees or pensions for their workers). What would be the effects of such mandates on employer behavior that might affect, say, the industrial structure of the economy or the rate of real economic growth, which is critical to increasing gross domestic product and the nation's standard of living? Cost-Effectiveness of Benefit Program Administration In evaluating the effects of retirement-income-related policy changes, policy makers should recognize the existence of important issues involving the efficiency and effectiveness of program administration. For example, “leakage” occurs in the Social Security system to the extent that benefits are paid to deceased people or to disabled people who could return to work. However, minimizing leakage of benefits could entail increased costs for program administration. In the private sector, there is concern about the effects of government regulation of pension and health care benefit plans on costs incurred by employers for plan administration and, in turn, the effects on employer decisions about whether and what kinds of plans to offer. Were some or all of the Social Security system to be privatized, it would clearly be very important to evaluate the likely efficiency and effectiveness of schemes for administering workers' IRAs. Similarly, administrative costs are an important evaluation criterion for any major change in the health care benefit system, including changes to Medicare.