1994-95 ADVISORY COUNCIL ON SOCIAL SECURITY TECHNICAL PANEL ON TRENDS AND ISSUES IN RETIREMENT SAVING FINAL REPORT 1994-95 Advisory Council on Social Security Technical Panel on Trends and Issues in Retirement Saving Final Report September 29, 1995 TABLE OF CONTENTS Executive Summary . . . . . . . . . . . . . . . . .Page iv Preface .. . .. . .. . .. . .. . .. . .. . .. . .. . . . xx I. Introduction . .. . .. . .. . .. . .. . .. . .. . .. . . . 1 II. Labor Market, Pension, and Saving Trends, and Implications for Retiree Well-being. . .. . .. . .. . . . 3 A. The Labor Market for Older Workers.. . .. . .. . .. . . . 3 B. The Changing Nature of Employment .. . .. . .. . .. . . . 16 C. Trends in Employer-Sponsored Pensions and Retiree Health Benefits.. . .. . .. . .. . .. . . . 21 D. Trends in National Saving. . .. . .. . .. . .. . .. . . . 40 E. Implications for Future Retiree Well-Being .. . .. . . . 51 III. Policy Options for Dealing with Projected Social Security Imbalances. .. . .. . .. . .. . .. . . . 70 A. Criteria for Evaluating Social Security Benefit and Tax Changes.. . .. . .. . .. . .. . .. . . . 70 B. The Scope of Social Security and the Timing of Adjustments . .. . .. . .. . .. . .. . . . 73 C. Alternative Means of Lowering Benefits .. . .. . .. . . . 84 D. Alternative Means of Increasing Revenues. . .. . .. . . . 98 E. Extending Social Security Coverage to State and Local Workers .. . .. . .. . .. . .. . .. . .. . . . 104 F. Investing Trust Funds in Private Capital Markets. . . . . 105 G. Individual Social Security Retirement Accounts . .. . . . 109 H. Conclusions and Assessment . .. . .. . .. . .. . .. . . . 114 IV. Other Policy Options Regarding Future Retirees' Incomes .. . .. . .. . .. . .. . .. . .. . .. . .. . . . 119 A. Integrating Social Security Eligibility Ages.. . .. . . . 119 B. Reducing Older Widows' Risk of Poverty .. . .. . .. . . . 125 C. Expanding the SSI program. . .. . .. . .. . .. . .. . . . 126 D. Mandating Private Employer-Sponsored Pensions. . .. . . . 127 E. Encouraging Employer Pensions and Private Savings.. . . . 130 F. Issuing Indexed Bonds . .. . .. . .. . .. . .. . .. . . . 131 G. Encouraging Reverse Annuity Mortgages. .. . .. . .. . . . 133 H. Conclusions and Assessment . .. . .. . .. . .. . .. . . . 134 V. Overview and Conclusions. .. . .. . .. . .. . .. . .. . . . 137 References. . .. . .. . .. . .. . .. . .. . .. . .. . . . 142 Endnotes .. . .. . .. . .. . .. . .. . .. . .. . .. . . . 162 1994-95 Advisory Council on Social Security Technical Panel on Trends and Issues in Retirement Saving Final Report EXECUTIVE SUMMARY The charge of the Technical Panel on Trends and Issues in Retirement Savings (TIRS) was to "assist the 1994-95 [Social Security] Advisory Council with respect to its charge to analyze the relative roles of the public and private sectors in the provision of retirement income, particularly how underlying policies of public and private programs, including relevant tax laws, affect retirement decisions and the economic status of the elderly." The Panel members were Olivia Mitchell, International Foundation of Employee Benefit Plans, Professor of Insurance and Risk Management, The Wharton School,University of Pennsylvania (co-chair) Joseph Quinn, Professor of Economics, Boston College (co-chair) G. Lawrence Atkins, Director of Health Legislative Affairs,Winthrop, Stimson, Putnam & Roberts Richard Burkhauser, Professor of Economics, The Maxwell School, Syracuse University Gary Burtless, Senior Fellow, The Brookings Institution Robert Clark, Professor of Economics and Business, North Carolina State University Peter Diamond, Paul A. Samuelson Professor of Economics, Massachusetts Institute of Technology John Haley, Watson Wyatt Worldwide, Inc. Daniel Halperin, Professor of Law, Georgetown University Eric Hanushek, Professor of Economics and Director, Wallis Institute of Political Economy, University of Rochester Diane Macunovich, Associate Professor of Economics, Williams College Dallas Salisbury, President, Employee Benefit Research Institute John Shoven, Charles R. Schwab Professor of Economics and Dean, School of Humanities and Sciences, Stanford University, and Stephen Zeldes, Professor of Finance, The Wharton School, University of Pennsylvania. The Panel met in Washington, D.C. for nine sessions, including two presentations before the Advisory Council, and produced this Report. Introduction The social security system is not in long-term actuarial balance. The Social Security Trustees, using their intermediate assumptions, project that currently legislated Old Age, Survivors, and Disability Insurance (OASDI) tax revenues will be less than currently legislated benefits after the year 2013. Projected benefits begin to exceed the sum of OASDI taxes and interest earned in 2020, resulting in a decline in the OASDI Trust Funds, and projected depletion in 2030. Over the 75 year long-range planning horizon, the difference between the projected income and cost flows is a deficit equal to an annual 2.17 percent of taxable payrolls. Some combination of benefit decreases and/or revenue increases will be required to close this gap. In addition to these social security retirement and disability program concerns, much more immediate funding problems exist with the Hospital Insurance component of Medicare, whose Trust Fund is projected to run out in 2002. Moreover, Congressional Budget Office analysis of the President's proposed budget for fiscal year 1996 projects continued federal budget deficits through the year 2000. It is in this context that the Technical Panel on Trends and Issues in Retirement Savings discusses various social security options below. The Executive Summary begins with a section on current and projected trends in labor markets, employer pensions, savings and the well-being of the elderly. The Summary then discusses policy options designed to deal with projected social security fiscal imbalances, as well as selected other proposals to improve the economic well-being of future retirees. The Summary includes other conclusions and suggestions that the Panel thought were useful to convey to the Advisory Council on Social Security and to the public at large. The Panel did not seek consensus; rather, its charge was to develop evaluation criteria and to use them to discuss a range of policy options. The Panel discussed both incremental and wide- ranging changes in social security and related programs, changes designed to alleviate both social security's long run fiscal deficit and the broader problem of potentially inadequate retirement income for future generations of retirees. On many of the issues discussed, Panel members were not unanimous, although on some issues they did all agree. Available evidence and supporting arguments are contained in the body of the Final Report. Some topics were beyond the Panel's charge and therefore are not discussed in detail in this Report. One is the central role of the nation's overall economic health, which has a major impact on the social security system's fiscal health. To the degree that social security encourages, or at least does not discourage, work and savings, it enhances the prospects for economic growth. The Panel also did not examine how changes in the medical care and health insurance markets will interact with the Medicare and Disability Insurance programs. These two components of the social security system were the subjects of reports by previous Social Security Advisory Councils, and were beyond this Panel's purview. Trends in labor markets, pensions, savings and the well-being of the elderly In this section, the Panel discusses recent and probable future trends likely to affect the economic well-being of future retirees. Here the Panel assumes no major changes in the institutional environment, even though it realizes that changes in the largest program, social security, are absolutely necessary. Given its importance to older Americans, significant changes in social security may well affect the trends discussed here. Labor force participation rates of older Americans (especially men) declined dramatically between 1950 and the mid- 1980s. This decline coincided with expanded coverage, increased real benefits and earlier ages of eligibility for retirement benefits in both social security and many employer pension plans. Since the mid-1980s, however, this early retirement trend has abated or stopped. In the absence of major institutional change, but given the already legislated change in the Normal Retirement Age for social security from 65 to 66, and then to 67, the Panel anticipates a slow and modest reduction in early retirement, with Americans retiring slightly later over the next several decades. The American labor market is changing in significant ways. Traditional manufacturing employment is declining, and service jobs are on the rise. Some evidence suggests that the quality of jobs is becoming more bimodal, with job growth among low-skilled, low-paid service workers and high-skilled, high-paid technical and professional employees. This pattern of job growth is reflected in the changing American income distribution, which is becoming more unequal. Employer pensions are also in flux. After increasing rapidly during the 1950s and 1960s, the proportion of workers participating in an employer pension has leveled off, with slight increases appearing in 1993 and 1994 for the first time in years. About half of the full-time civilian labor force is participating at any given time. Participation rates increase significantly with age, job tenure and earnings level, suggesting that the proportion of workers covered at some time during their work lives will be higher than indicated in any cross-sectional snapshot. Vesting in plans has grown, meaning that entitlement to benefits has increased. There is a movement away from traditional employer-managed and directed plans (often with defined benefits) to more individualistic plans, with faster vesting, more elective contributions and participant-directed investments. Barring major institutional change, it is unlikely that pension coverage will increase significantly over the next several decades. Benefit entitlement will grow because of faster vesting, and the trend toward more participant-directed, defined- contribution plans will continue. Below, the Panel discusses policy options that might be adopted to encourage additional pension coverage. Private and aggregate national saving in the United States are low by international and by the nation's own historical standards. Many Americans reach retirement age with little personal savings beyond equity in a home. Little professional agreement exists on what public policies short of mandates would encourage a significant change in American savings habits. The Panel is not optimistic about any dramatic turnaround in U.S. saving rates, although there is some expectation of modest increases in private savings if future social security benefits were decreased. The economic status of elderly Americans has improved significantly over the past several decades. Median incomes of the elderly have risen relative to those of the rest of the population, and elderly poverty rates have fallen precipitously, even as fewer and fewer older Americans remained at work. Much of the credit for this improvement goes to federal programs -- especially social security -- and to the growth of employer based pensions. Around these encouraging averages, however, remain significant pockets of economic distress, with poverty much more prevalent among elderly who are very old, living alone, female, Black or Hispanic. The financial costs associated with long-term care remain a major economic risk, even for middle- and upper- middle income Americans. Evaluation of the retirement prospects of the current generation of middle-aged workers, the baby boomers, depends on the point of comparison. Their income and asset accumulation experiences thus far suggest that current workers, especially those at the upper end of the income distribution, will approach retirement with more resources than their parents did, but without enough to maintain the standards of living that they themselves enjoyed prior to retirement. The baby boomers are unlikely to enjoy the dramatic increases in the value of their real estate or the legislated real increases in social security benefits that their parents did; in fact, social security benefits have been cut (through legislated delays in the Normal Retirement Age and the taxation of some benefits), and additional decreases may be legislated in the future. The groups of elderly now disproportionately at risk of poverty are likely to remain so. An important unknown is the rate of growth of real wages over the next several decades. Some analysts extrapolate from the dismal record of the past two decades, and foresee only very modest growth in the future. Others point to demographic changes on the horizon (smaller entry level cohorts), and anticipate real wage growth more in line with long-term trends Life expectancy is expected to continue to increase. Although life expectancy and health status do not always move in lock step, recent evidence suggests that the health status of the elderly is improving on average and will continue to do so in the future. Because the social security system is not in long-term actuarial balance, significant adjustments in future contribution levels and/or benefit outlays will be necessary. Social security benefit cuts (either directly or through further delays in retirement ages) are one option. The Panel asked whether there are changes already under way that would offset the effects of potential benefit cuts on the future economic well-being of the elderly. The general answer is no -- the Panel sees no easy solution on the horizon. The Panel anticipates small increases in the average age of retirement, which will help, and some members foresee either higher real wage growth and/or some increase in personal savings. But the Panel believes that far more substantial adjustments than are currently under way will be necessary to compensate for any significant decreases in social security benefits. What adjustments are most likely? Employer pension coverage? Patterns of personal savings? Labor force participation late in life? The Panel considered policy initiatives to encourage each of these, and discusses them below. The Panel's consensus, especially given further expected increases in life expectancy, is that the last option - delayed retirement - would be the most likely and easiest response for the majority of older Americans who leave career jobs and the labor market voluntarily and in good health. For others, however, poor health or poor labor market prospects late in life would make this adjustment difficult or impossible. Policy Options for Dealing with Projected Social Security Imbalances The Panel stresses that some combination of benefit cuts and/or revenue increases is necessary to restore the social security system to actuarial balance, and urges that appropriate legislation be enacted promptly. Policy options were analyzed in a three step process. First, the Panel developed six criteria against which to judge any specific proposal. Then, a straightforward baseline benefit cut (an across-the-board decrease in the Primary Insurance Amount (PIA) formula for future retirees) was compared with a straightforward baseline revenue increase (an increase in the OASI payroll tax rate). Finally, the Panel compared other means of lowering benefits with the baseline PIA decrease, and other means of raising revenues with the baseline payroll tax increase. The Panel adopted the following six criteria: 1) Adequacy of retirement income, relative to poverty thresholds and to the household's pre-retirement income; 2) Insurance against unforeseen income fluctuations (such as those caused by disability, the death of an earner, unanticipated early retirement or unexpected longevity); 3) Avoidance of market inefficiencies; in particular, in the labor-leisure choice (the allocation of time during and at the end of the worklife) and in the consumption-savings choice (the allocation of lifetime income between consumption during the worklife, consumption during retirement and bequests); 4) Equity of lifetime social security taxes and benefits, both between and within generations; 5) Encouragement of private and aggregate national saving; and 6) Strengthening the financial integrity of the nation's retirement income systems. Timing and Implementation of Policy Options Panel members concur on several issues regarding the timing of legislation and the implementation of whatever social security adjustments are chosen. The Panel urges that any significant changes in social security benefits be announced with sufficient lead time for workers to adjust their savings, consumption and retirement plans. The Panel suggests that promptly legislated policy changes combined with some delay in implementation best helps people plan for the future. The desirability of delayed implementation only increases the urgency of prompt legislation. The Panel urges that any payroll tax increases and benefit reductions be phased-in over time, rather than implemented abruptly. Gradual implementation reduces the magnitudes of notches (different treatment of cohorts close in age) and the perception of unfairness that notches engender. Benefit Decreases versus Revenue Increases The Panel acknowledges that the fiscal imbalance facing OASDI is a very serious one, demanding immediate attention, but did not attempt to reach a consensus on the appropriate mix of benefit cuts and revenue increases to address the imbalance. The Panel's focus was to analyze the pros and cons of achieving balance with different mixes of reduced benefits and increased revenues and to compare alternative means of both benefit decrease and revenue increase. The Panel's criteria do not unequivocally favor either raising taxes or decreasing benefits. Rather, some criteria, such as adequate retirement income, favored tax increases, while others, like equity of lifetime social security taxes and benefits between generations, favored benefit cuts. Closing the fiscal imbalance with additional revenues rather than benefit decreases is suggested if one emphasizes the first two criteria, adequate retirement income and insurance against unforeseen income fluctuations. Social security benefit cuts would increase the number of Americans with inadequate retirement income, and lower the insurance protection offered to workers, survivors and dependents. Within a generation, the use of tax increases rather than general benefit cuts favors those with the longest life expectancies -- those most likely to receive benefits for a long time -- and those with lower incomes for any given life expectancy. Closing the fiscal imbalance with benefit decreases rather than tax increases is suggested if one emphasizes the fourth and fifth criteria, equity between generations and the encouragement of private savings. The expected return on social security contributions is already going to be lower for baby boomers than for past, current and near-future recipients (and this return will decline even further when either social security taxes are raised or future benefits are cut). Younger participants would pay the higher taxes for many more years than would older participants planning to retire soon. Lower benefits would also encourage some individuals to offset part of the loss through their own savings behavior. Social security retirement benefits induce some older workers to leave the labor force earlier than they otherwise would. Benefit cuts, especially if combined with an increase in the early age of entitlement (now age 62), are likely to reduce this effect. In addition, payroll taxes may discourage the labor supply of younger workers, a labor market distortion that is more likely to decline if benefits are cut than if payroll taxes are increased. The Panel found little professional consensus on the size of the impact of social security on private savings. To the extent that social security benefits substitute for private savings, benefit cuts rather than tax increases would encourage private savings. But many workers with little or no savings beyond their home equity are unlikely to make significant changes in their savings behavior in response to the changes in social security benefits being contemplated. The Panel concludes that reducing benefits might have a small positive effect on private savings. Alternative Types of Benefit Decreases The Panel compared the effects of the baseline benefit cut (an across-the-board decrease in the PIA formula) with those of several alternatives, including reducing disproportionately the benefits of high-wage workers, delaying retirement ages, reducing the cost-of-living adjustment and means-testing benefits. If benefits are to be reduced, strong arguments suggest increasing the ages of eligibility for early and normal social security benefits. Most Panel members believe that delaying these retirement ages is a sensible response to increases in life expectancy, and one that prevents lifetime benefits from automatically increasing as recipients live longer. If benefits are to be reduced, most Panel members believe that the Normal Retirement Age (NRA) for social security benefits, currently scheduled to increase to age 67, should be increased further, and that it should eventually be indexed to life expectancy. Most agree that the scheduled hiatus between the increases to age 66 (2000-2005) and 67 (2017-2022) should be eliminated. Most Panel members believe that the Early Entitlement Age (EEA) for social security benefits should also be raised, with most supporting a new EEA of 64 or 65. The Panel opposed means-testing social security benefits on the basis of other retirement income or accumulated wealth. To avoid loss of social security benefits, some workers might reduce their own retirement saving or persuade employers to shift compensation from pension contributions to earnings. Either response would lower savings and private retirement incomes. If benefits are to be reduced by means other than or in addition to increases in the NRA and EEA (for example, if the PIA formula becomes less generous), most Panel members prefer disproportionate cuts at the top to an across-the-board decrease. The Panel also discussed how to allocate the burden of benefit reductions across different cohorts -- those already retired, those about to retire (for example, within 5 years), and those further away from retirement. If benefits are to be cut, the Panel does not favor entirely exempting people already retired or about to retire. However, the Panel favors smaller benefit reductions for these groups than for future retirees. Social security benefits are the only fully indexed annuity available to (nearly) all workers. The threat of inflation would be a very serious concern to retirees, especially those with long lives after retirement, if full indexation were eliminated. For this reason, the Panel opposes permanently indexing social security benefits by less than the cost of living. At the same time, the Panel urges that the Bureau of Labor Statistics investigate whether the specific Consumer Price Index currently used to adjust benefits correctly measures the cost of living. If this measure is found to be biased, the Panel would support corrective changes in the method of calculation. The Panel was split on whether a temporary delay or reduction in the cost-of-living adjustment would be desirable, Some Panel members favored this if benefits were decreased for future retirees, as a way of spreading some of the burden to current and near-future retirees. The Panel is concerned about the well-being of workers in poor health if the Early Entitlement Age (EEA) were raised from age 62. Under current law, individuals can apply for Disability Insurance (DI) before age 65, and those deemed eligible receive benefits equal to 100 percent of their PIAs. If the EEA were raised, some people who would have opted for early social security benefits at or after age 62 would instead seek DI benefits. Some would be found ineligible, and others would not even apply. In the case of an increase in the EEA, the Panel discussed whether DI rules should be relaxed for people aged 62 and older and whether the age of entitlement for Supplemental Security Income (SSI) should be lowered from age 65 to age 62. Both DI and SSI might experience large increases in applications if the age-of- eligibility rules were changed, highlighting the fact that altering one piece of the social security benefit structure can have profound effects on other components of social security and on other programs. The discussion persuaded some Panel members that persons as young as 62 should be allowed to apply for SSI benefits or face relaxed DI rules if the EEA is raised, to provide a safety net for those unable to support themselves until eligible for retirement benefits under the new EEA rules. Some members think that DI benefits should continue to equal 100 percent of PIA, regardless of the age of the disabled recipient, while others feel that DI benefits should be set equal to the early retirement amount, to avoid increased incentives to seek DI benefits if early retirement benefits are reduced. Others are concerned about the effect of such a reduction on the well-being of young and old disabled beneficiaries. The Panel focused in detail on the status of surviving spouses, because family benefits can fall substantially with the death of a husband or wife. The significant disparity in the poverty rates of elderly couples and those living alone suggest that mechanisms be considered to raise the ratio of survivors to couples benefits. If the early age of entitlement for widows benefits is increased, then the calculation of benefit reductions for widows should be changed to preserve benefit levels or limit benefit cuts for this population. Alternative Types of Revenue Increases The Panel compared the effects of the baseline revenue increase (a simple increase in the payroll tax rate) with those of three alternatives: raising the earnings limit on which payroll taxes apply, expanding the definition of taxable income to include employee benefits, and infusing additional general revenues into the Social Security Trust Fund. If additional revenues are to be raised, most Panel members favor raising the payroll tax rate rather than increasing the taxable earnings threshold. The threshold increase, unless applied only to the employers' portion or combined with a change in the benefit formula, would increase future benefits for those at the upper end of the income distribution, which a payroll tax increase would not. Panel members expressed little enthusiasm for including employee benefits in the taxable wage base, citing significant measurement problems. Panel members expressed almost no enthusiasm for additional direct infusion of general revenues, preferring to maintain the link between social security contributions made and benefits received. The OASI Trust Fund The OASI program is partially funded. The OASI Trust Fund currently exceeds one year's outlays, and is projected to grow for about two decades, as revenues exceed benefit payments. The Panel discussed whether OASI should remain at least partly funded or revert to a pay-as-you-go system as was in effect before the 1983 amendments. The Panel believes that OASI should continue to be at least partly funded, meaning that the Trust Fund should maintain a significant and stable margin over annual expenditures over the foreseeable future. On the assumption that Trust Fund reserves will continue to exist, the Panel discussed how to invest it. The Fund is currently invested in special issue Treasury securities, whose interest and principal are virtually free of default risk. The Panel examined whether part of the Trust Fund should be invested in private capital markets, with the expectation that investments would earn a higher rate of return than if invested solely in Treasury securities. The Panel believes that a judgment on this proposal should depend on an assessment of its opportunities and its costs. If investing the Trust Fund in stocks carried no risk and provided a higher expected return, the stock portfolio would obviously be preferable. However, there is a risk-return tradeoff which must be examined and assessed in light of social security objectives. A related issue involves who bears the risk if equities perform poorly - future social security recipients, future social security contributors, or general taxpayers? Panel discussions raised other questions. To what extent would investing the Trust Fund in equities increase national saving? How might it change perceptions about the size of the government deficit and increase political pressure to reduce it? How much would the inclusion of equities in the Trust Fund alter private household saving decisions? To what extent would this proposal expose future beneficiaries to additional political risk, because government officials might encourage the selection of private equity investments using criteria other than pure risk and return? The Panel did not reach a consensus on the proposal to invest some of the Trust Fund reserves in equities, and concluded that the issue deserves additional study. Individual Accounts within Social Security The Panel discussed the pros and cons of converting all or part of the Social Security Trust Fund (or the annual surplus) to individual social security accounts, over which participants would exercise some investment discretion. In considering this proposal, the Panel noted that distributing the annual surpluses to individual accounts would require additional adjustments to benefits and/or taxes beyond what would be required to achieve system solvency without this distribution. The Panel identified several attractive features of this proposal. Participants could allocate their funds as they preferred. Personal control might reduce uncertainty about the future politics of social security and increase public confidence in the system. It would probably be easier to increase social security taxes if the increases were directed to individual accounts. Moving these funds off-budget might create pressure to reduce the deficit, and thereby increase national saving. Panel members also raised concerns about introducing individual accounts within social security. Would people manage these retirement assets prudently, and understand the risk and return tradeoffs inherent in private investment holdings? Would additional regulatory structures be necessary? Should the government offer a market index fund as a low-cost option? Would the administrative expenses of an individualized system substantially exceed those of the current Social Security Administration? Should participants be permitted to access the funds prior to retirement, or lump sum payouts at retirement? Would these accumulations be considered "assets" for means-tested assistance programs? Can they be bequeathed? Despite these questions and concerns, many Panel members find promising the proposal to convert part of the Social Security Trust Fund to individual accounts, if the remainder of the social security system can still be made solvent. The Panel recognizes the need to coordinate the pattern of any benefit cuts with the pattern of benefits that would be received from these individual accounts. Most Panel members would prohibit access to the funds for any reason other than retirement, and would mandate that the benefits be wholly or in part distributed in the form of an annuity, rather than permitting a 100 percent lump sum cashout. The Panel was divided on whether the annuity could be best managed by the government or the private sector. Other Retirement System Changes The Panel considered other issues related to the nation's retirement system, public and private. The Panel identified strong arguments for including all new state and local employees in the social security system. The Panel reviewed the range of ages currently used in retirement income policy, and concluded that much more coherent and integrated policy is needed. These ages include several discussed above (the NRA, the EEA and the ages at which people can apply for SSI and DI) as well as the age at which surviving spouses can apply for survivor benefits and the maximum age of the social security earnings test. In addition, the Panel noted that ages specified in IRS tax code for tax-qualified pension plans should be coordinated with any new ages recommended for social security purposes. For example, tax law specifies that employer- provided pension benefits under qualified plans may not exceed a certain dollar level when the worker attains the social security NRA, and an actuarially reduced amount at earlier ages. These linkages should be considered as the NRA increases. Similarly, tax law requires that workers receive minimum distributions from their private retirement accounts once they attain age 70.5. This age should probably be reevaluated in light of other proposed reforms and increasing life expectancies. The Panel favors a more coherent policy on the ages the IRS uses in the tax code and the SSA uses in social security regulations. Many Americans save very little and many workers reach retirement with little or no employer pension benefits. To remedy this situation, some have advocated mandatory private pensions outside the social security system, or proposed additional tax inducements to save or simplified pension regulations to reduce the regulatory burden. The Panel discussed these issues concerning retirement saving, both inside and outside employer pension plans. The Panel overwhelmingly opposes mandated employer- pensions at the present time. This contrasts with the Panel's openness to individual accounts within social security. The Panel favors simplification of the tax rules under which employer pension plans operate. Differences arose regarding the precise ways in which the tax code and nondiscrimination legislation should be reformed. Some members favor raising the contribution and benefit limits covering employer-provided pensions, and/or coordinating the very different benefit levels for different types of defined-contribution vehicles. Many members also support the idea of having streamlined regulations that companies can follow when establishing a tax-qualified defined-benefit or defined-contribution plan. Most Panel members favor increasing the incentives for private savings, such as raising the limits on Individual Retirement Accounts. A valuable attribute of social security benefits is that they are the only life annuities that are fully inflation- protected and available to (almost) all workers in the United States. The Panel urges the federal government to consider issuing inflation-indexed bonds which firms or individuals could buy to generate private sector retirement annuities protected from inflation. The Panel favors the government issue of Treasury bonds indexed to price inflation, recognizing that some phasing in of this new credit instrument would be necessary. SSA Policy Modeling and Research The Panel urges the Social Security Administration to take advantage of its new independent agency status to re-structure its policy analysis and forecasting functions, making more use of the expertise in the policy community. Some Panel members suggest that the Social Security Administration would benefit from more frequent interactions with academic and practicing experts outside the government to advise SSA on issues of assumptions and methods, and also on broader issues facing the nation's retirement income system. The Panel urges SSA to make available to the research and policy community the actuarial and economic models it uses for forecasting and analysis. Computer programs, documentation and research reports should be more widely available. The Panel also urges that the data used in modeling social security system outcomes be made available to the research and policy community, in ways that preserve confidentiality while permitting analysts outside SSA to evaluate forecasts and simulate alternative policy scenarios. We note that implementation of these recommendations would have resource implications for the SSA research offices. Many questions that the Panel struggled with require up- to-date, sophisticated modeling and data sets. The Social Security Administration's longitudinal Retirement History Survey (1969-79) played a major role in augmenting our understanding of retirement processes in the 1970s. The current longitudinal Health and Retirement Survey will do the same in the 1990s. The Panel urges that the Social Security Administration increase its support of data gathering and analysis efforts as a means of answering the policy questions raised in this report and others that will confront the system as it continues to evolve. Conclusion The social security program in the United States has been extremely successful and popular since its inception, and has been instrumental in improving the well-being of millions of American retirees and their dependents and survivors. When fiscal problems have been forecast in the past, adjustments have been made to address them. The same is needed now. The earlier the necessary adjustments are legislated, the better, because early notification of impending changes gives people time to adjust their savings and retirement plans accordingly. The fiscal problems currently anticipated with the graying of the baby boom generation are manageable, and the Panel strongly urges policymakers and politicians to decide promptly on the appropriate mix of benefit decreases and revenue increases to return social security's fiscal house to order. 1994-95 Advisory Council on Social Security Technical Panel on Trends and Issues in Retirement Saving Final Report Preface In October 1994, the 1994-95 Advisory Council on Social Security convened a panel of technical experts to assist it in its deliberations. The charge of this Technical Panel on Trends and Issues in Retirement Savings was to "assist the 1994-95 [Social Security] Advisory Council with respect to its charge to analyze the relative roles of the public and private sectors in the provision of retirement income, particularly how underlying policies of public and private programs, including relevant tax laws, affect retirement decisions and the economic status of the elderly." The Panel members were Olivia Mitchell, International Foundation of Employee Benefit Plans Professor of Insurance and Risk Management, The Wharton School, University of Pennsylvania (co-chair) Joseph Quinn, Professor of Economics, Boston College (co-chair) G. Lawrence Atkins, Director of Health Legislative Affairs, Winthrop, Stimson, Putnam & Roberts Richard Burkhauser, Professor of Economics, The Maxwell School, Syracuse University Gary Burtless, Senior Fellow, The Brookings Institution Robert Clark, Professor of Economics and Business, North Carolina State University Peter Diamond, Paul A. Samuelson Professor of Economics, Massachusetts Institute of Technology John Haley, Watson Wyatt Worldwide, Inc. Daniel Halperin, Professor of Law, Georgetown University Eric Hanushek, Professor of Economics and Director, Wallis Institute of Political Economy, University of Rochester Diane Macunovich, Associate Professor of Economics, Williams College Dallas Salisbury, President, Employee Benefit Research Institute John Shoven, Charles R. Schwab Professor of Economics and Dean, School of Humanities and Sciences, Stanford University, and Stephen Zeldes, Professor of Finance, The Wharton School, University of Pennsylvania. The Panel met in Washington, D.C. for nine working sessions between October 1994 and March 1995, including two presentations before the Advisory Council, on January 27 and March 11, 1995. The Panel divided its work into three substantive areas. The first was a review of several trends relevant to the current and future economic well-being of older Americans. These included labor market, employer-sponsored pension and private savings trends. The next was the development of specific criteria with which to judge policy options for reducing the Social Security fiscal gap, and detailed evaluations of several means of raising Old Age and Survivors Insurance (OASI) revenues or reducing OASI expenditures. Finally, the Panel discussed other policy options that might affect future retiree well-being. Members of the Panel, individually and in groups, researched these areas, and presented drafts of their findings and recommendations to the entire Panel. These were then the topics of lively discussions at our meetings, which led to subsequent revisions of the text. This Final Report and its Executive Summary were edited by the co-chairs, with considerable and frequent input from members of the Panel. Our intention was to make the report as non-technical as possible, given the constraints of the subject matter. Interested persons may consult the extensive list of references for further reading. The Panel thanks David Lindeman, the Executive Director of the 1994-95 Advisory Council on Social Security, and his staff of Dan Wartonick, Wayne Sulfridge, Arlene Berger, Nick Curabba and Jeanne Hawkins, who handled our many requests cheerfully, quickly and professionally. We also thank Stephen Goss and Steven Sandell of the Social Security Administration, who assisted us in our work, and Joseph Foote and Marilyn Thomas, who offered numerous editorial suggestions that substantially improved the manuscript. Olivia S. Mitchell Joseph F. Quinn (co-chairs) I. Introduction The social security system is not in long-term actuarial balance. The Social Security Trustees, using their intermediate assumptions, project that currently legislated Old Age, Survivors, and Disability Insurance (OASDI) tax revenues will be less than currently legislated benefits after the year 2013. Projected benefits begin to exceed the sum of OASDI taxes and interest earned in 2020, resulting in a decline in the OASDI Trust Funds, and projected depletion by 2030. Over the 75 year long-range planning horizon, the difference between the projected income and cost flows is a deficit equal to an annual 2.17 percent of taxable payrolls. Some combination of benefit decreases and/or revenue increases will be required to close this gap. In addition to these social security retirement and disability program concerns much more immediate funding problems exists with the Hospital Insurance component of Medicare, whose Trust Fund is projected to run out in 2002. Moreover, the Congressional Budget Office analysis of the President's proposed budget for fiscal year 1996 projects continued federal budget deficits through 2000. It is in this context that the Technical Panel on Trends and Issues in Retirement Savings (TIRS) discusses various social security options below. Many topics were beyond the Panel's charge and therefore are not discussed in detail in the Final Report. One is the central role of the nation's overall economic health, which has a major impact on the social security system's fiscal health. To the degree that social security encourages, or at least does not discourage, work and savings, it enhances the prospects for economic growth. The Panel also did not examine how changes in the medical care and health insurance markets will interact with the Medicare and Disability Insurance programs. These two components of the social security system were the subjects of reports by previous Social Security Advisory Councils, and were beyond this Panel's purview. This Report has three goals: -To assess how observed trends in labor markets, employer pensions and private savings are likely to affect the old-age security of current and future retirees in the absence of major institutional change; -To develop evaluation criteria and apply them to specific policy options for reducing the social security actuarial imbalance; and -To discuss other policy changes that might improve retiree well-being in the future. The Panel did not seek consensus about which policy options should be selected. Rather, it presents a range of options and a set of evaluation criteria that can be used to choose among them. The Panel discusses both incremental and wide-ranging changes in social security and related programs, changes designed to alleviate both social security's fiscal deficit and the broader problem of potentially inadequate retirement income for future generations of retirees. On many of the issues discussed, Panel members were not unanimous, although on some issues they did all agree. Part II describes trends in labor markets, employer-sponsored pensions and national savings, and discusses the implications of these for the economic well-being of future retirees. Part III turns to policy options for social security, first outlining a set of six evaluation criteria, and then applying these criteria to a range of general and specific policy options. Part IV discusses the integration of various social security eligibility ages, including the age for early retirement benefits, and then expands the analysis to other issues that will affect retiree well-being in the next century. The Report ends with an Overview and Conclusions. II. Labor Market, Pension, and Saving Trends, and Implications for Retiree Well-Being The purpose of this section is to offer informed opinion on the future of labor markets, pensions, and savings behavior, and on how these trends might affect the economic well-being of future retirees. Here the Panel assumes no major changes in the institutional environment, even though we realize that changes in the largest program, social security, are necessary. Given its importance to older Americans, significant changes in social security may well affect the trends discussed here. The Panel begins with a discussion of the labor market for older workers, emphasizing recent retirement trends, the influence of social security and employer pensions on labor force decisions, and some barriers to work that older Americans face. It then addresses trends in employer-sponsored retirement and health benefits, including changes in the types of coverage, and the characteristics of and risks associated with defined-benefit and defined-contribution pension plans. It then turns to saving trends, and asks whether Americans save too little and why it matters. Throughout this discussion, the Panel identifies policies that might encourage changes in these trends, for example, longer work lives, growth in pension coverage or additional saving. Section II ends with a discussion of the implications of these issues for the economic well-being of older Americans, including the past and current status of retirees and the prospects of those in the future, especially the members of the baby-boom generation who will begin to reach traditional retirement age early next century. A. The Labor Market for Older Workers The post-World War II period has seen dramatic changes in the labor force behavior of older workers. Americans are retiring much earlier than they used to and, given increases in longevity, are spending much longer periods in retirement. These changes have coincided with increases in the magnitude and generosity of public and private retirement income programs -- social security and employer pensions -- and there is reason to believe that these phenomena are related. This section briefly reviews recent retirement trends and discusses the evidence that the financial incentives in retirement income programs have played an influential role. An important implication is that retirement trends are not exogenous, but rather have been and can be influenced by public policy decisions. Retirement trends: A remarkable demographic development has occurred in the U.S. during the past 40 years. Older workers, especially men, have been leaving the labor force at younger and younger ages, at least until recently. In 1950, for example, nearly half of all American men aged 65 or over were in the labor force; by the mid-1980s and still today, fewer than 1 in 6 are. The early retirement trends can be seen in detail in figure II-1, which shows labor force participation rates for 5-year cohorts of older American men over the past three decades. The long-term patterns are clear. The percentage declines since 1964 are about 30, 40 and nearly 50 percent for men aged 60-64, 65-69 and 70 or over, respectively. For men aged 50-54 and 55-59, below the earliest age of eligibility for social security retirement benefits, the declines are much less dramatic. Figure II-1 also suggests that the long term early retirement trend may have abated or come to a halt. For all the male cohorts shown, participation rates have changed very little since the mid-1980s. For women, as can be seen in figure II-2, the pattern is very different, because two offsetting phenomena are at work. Although people are retiring earlier, women, especially married women, are more likely to work than before. For the oldest two cohorts, aged 65 and above, the resultant trends are flat. For the younger two groups, the latter trend dominates, and participation rates are on the rise. For the middle group, women age 60-64, the long term trend is flat, but there has been a noticeable increase during the past few years. More detailed data on older men illustrate an interesting point. Figure II-3 shows participation rates since 1968 for men aged 60 through 65, by individual age. Note the increasing importance of age 62, the earliest age of eligibility for social security retirement benefits. In 1968, the largest labor supply decline occurred at age 65. Now, the biggest decline occurs at age 62. A significant gap at 65 still remains, but much of the labor force withdrawal has already occurred by then. The story is similar for women -- the behavioral change at age 62 is larger than that at age 65. Part-time employment: Not only do older Americans retire earlier than they used to, but those who do keep working often work part-time (fewer than 35 hours per week). The prevalence of part-time work rises significantly with age. Although fewer than 7 percent of men aged 25-59 and employed in the nonagricultural sector work part-time, 16 percent of those aged 60-64, 42 percent of those 65-69, and well over half of the employed men aged 70 or over do (U.S. Bureau of Labor Statistics 1994c, table 33). There is even a noticeable increase between those aged 60 and 61 (12 percent part-time) and those 62-64 and therefore eligible for social security retirement benefits (21 percent part-time) (unpublished B.L.S. statistics). For women, part-time work is more prevalent at all ages. About 20 percent of employed women aged 25-59 work part-time, along with a third of those aged 60-64, 57 percent of those aged 65-69, and two thirds of the employed women aged 70 or over. The increase at age 62 is even more pronounced -- from 28 percent at ages 60 and 61 to over 40 percent among those 62-64. The vast majority of the older Americans who work part-time say they are doing so voluntarily. Since 1970, the increase in the importance of part-time work among older employed workers has been significant, from 38 to 48 percent for men and from 50 to 60 percent for women. In this sense, the long term early retirement trend may be continuing still, but through reduced hours rather than labor force withdrawal. The nature of retirement: The stereotypical retirement involves a move directly from full-time career employment to complete labor force withdrawal. Although this type of retirement is common, research has shown that many older Americans do not leave the labor market when they leave their career jobs. Gradual or partial retirement -- the use of bridge jobs -- is an important phenomenon in America. Among wage and salary workers in the 1970s, for example, more than a quarter did not retire completely in one move (Quinn et al. 1990). A few of them dropped to part- time status on their career jobs, but most found new jobs. Among the self-employed, only half retired abruptly from full-time career work. Of those who did not, half dropped to part-time hours on the same job, and the other half found new employment. Most of those who change jobs also change occupation and industry, and most move down the socioeconomic ladder -- from skilled to unskilled and from white collar to blue collar. Some evidence suggests that those at the ends of the economic spectrum are the most likely to utilize bridge jobs (ibid.). Poor people may do so because they have to, lacking pension coverage and personal savings, and often eligible for only modest social security benefits, while wealthy people may do so because they want to, enjoying interesting jobs with important non-pecuniary benefits. If there is a labor market trend toward a more bimodal set of jobs, as argued below, then this phenomenon of gradual retirement may become more important in the future. More current data suggest that partial or gradual retirement remains widespread. Ruhm (1995) finds that between 30 and 40 percent of those aged 58 through 63 and employed in 1989 were working on a post-career "bridge" job, and the proportion is higher than for workers the same age in 1969. Quinn (1995) finds considerable bridge employment in the initial (1992) wave of the new Health and Retirement Survey. The importance of ages 62 and 65 in retirement decisions suggests that many older Americans are being influenced by social security provisions. Labor supply transitions at these and earlier ages, like 55 and 60, suggest a similar role for employer pensions. Because much of this report will focus on social security and employer pensions, the Panel turns now to a detailed description of how these programs might affect the labor supply of older Americans and the nature of the evidence that they do. Social security incentives: Most Americans are affected by social security (OASDI) throughout their lives, contributing taxes while employed and receiving benefits when retired. Some receive benefits earlier, through the survivors or disability programs. Both contributions and benefits depend on covered earnings, so there is a relationship between the two. When assessing the impact of the system on an individual or a cohort, economists tend to view the system in a life-cycle framework, and consider the contributions and benefits in tandem. The extent to which citizens do the same is unclear. Labor supply decisions depend on individual preferences and budget constraints -- the options people face in the labor market. Social security can affect budget constraints in several fundamental ways. It can increase or decrease one's lifetime wealth, depending on whether the value of the benefits received exceeds the value of the contributions made. (It can also change how one can use that wealth, by providing a (nearly) universally available indexed annuity at retirement.) It can also alter the pattern of compensation over time, increasing compensation at some ages and reducing it at others. Finally, for those who are credit constrained, the availability of an income flow from retirement benefits (usually at age 62) is important. In theory, all of these factors should influence labor supply, and considerable empirical research suggests that they do. Wealth effects of social security: The simplest economic explanation for the post-World War II early retirement trend is that the nation has grown wealthier over time. Americans can afford to start work later, work fewer hours per year and retire earlier than they once did. Recent cohorts of retirees have worked in a generally robust economy and have enjoyed significant increases in the value of their real estate. Their wealth was further augmented by the social security system, because the retirement benefits being paid to these cohorts will exceed the present value of their and their employers' contributions. For example, government estimates show that a man who lived to and retired at age 65 back in 1980 after a lifetime of average earnings would expect to receive retirement benefits worth nearly $98,000 (all these figures are in 1992 dollars), more than $70,000 greater than the $26,000 in contributions made by him and his employer, and assumed to be invested in government securities. His benefits were worth 3.7 times the taxes paid. Women retiring in 1980 after a lifetime of average earnings gained even more because of their longer life expectancies in retirement: their benefit/tax ratio was 4.4 and their net gain nearly $90,000. Lower-earners had an even higher benefit/tax ratio, while high-wage workers earning at the social security tax ceiling had lower ratios (3.35 and 3.96, for high- wage men and women retiring in 1980) but higher absolute dollar gains (about $87,000 and $110,000, respectively). People retiring more recently have experienced lower benefit/tax ratios; nevertheless, in 1992, new retirees ratios all still exceeded 1.00 for men and women, for minimum, average and maximum earners (ibid.); the smallest absolute gain (for a male maximum-earner retiring in 1992) was still nearly $25,000. More comprehensive computations have been made by Steuerle and Bakija (1994), who estimate the net gain or loss from participation in the social security retirement and survivors' programs (the disability component is excluded), with and without adjustment for the chance of death after age 21. They compare hypothetical recipients reaching age 65 in five-year intervals beginning in the 1940s and forecast until the year 2050 (Steuerle and Bakija, Table A.3). They assume that taxes and benefits currently in place are maintained even though the system cannot remain solvent with this structure. Twelve combinations are considered, using three earnings histories (low, average and high) and four family structures (single men, single women, 1-earner and 2-earner couples). The results show that 11 out of 12 of these hypothetical recipients retiring at age 65 in 1995 will enjoy a positive net transfer from OASI. All three two-earner couples are net winners, with net transfers ranging from $57,000 to $85,000 (in 1993 dollars); the highly paid 1-earner couple nets $140,000. The only net loser is the high-wage single man (with no survivors' benefits), whose expected retirement taxes exceed his lifetime benefits by about $10,000 (ibid, Table 5.1 or Table A.3) Net social security transfers peaked prior to the 1983 Social Security Amendments and are now in decline. High-wage, two-earner couples and high-wage single women retiring at 65 in 2005 will be paying in more than they receive in benefits given current law (respectively, -$19,000 and -$28,000); high-wage single men retiring at age 65 will receive about $73,000 less than they contributed (ibid., Table A.3). What effects did these large positive net transfers have on older cohorts behavior, and what effects will some large negative transfers have on future workers? These questions are difficult to answer. Although economic theory, common sense and casual empiricism suggest a link between wealth and retirement, the size of the effect has been difficult to pin down. One observation that suggests an important effect is the fact that the largest declines in the labor force participation rates of older men occurred just after significant increases in real social security benefits (about 50 percent) were legislated between 1968 and 1972. Skeptics point out, however, that retirement patterns did not change dramatically during the 1950s despite the fact that aggregate social security wealth rose rapidly as coverage was increased (Moffitt, 1984). Recent research suggests that social security might account for at most one-third of the labor force participation decrease over time (Hausman and Wise 1985; Ippolito 1990). Compensation effects of social security: In addition to influencing lifetime wealth, social security also alters the pattern of compensation with age, and eventually can decrease the net compensation of older workers. Many defined-benefit employer pension plans do the same, and the effects can be significant. Social security and most defined-benefit employer pensions promise a stream of benefits once certain conditions are met. The value of this stream of future income is conveniently summarized by its present discounted value (PDV), which is the size of the asset today that would be required to generate this stream of income in the future. Prior to the age of eligibility, the value of the future benefit stream increases with additional work -- social security "wealth" is on the rise. By working, one earns twice -- the paycheck and the increase in the PDV of future social security benefits. But once the worker is eligible to receive benefits, this can change. Those who delay receipt of social security (for example, by continuing to work full time) forego current benefits. This loss must be compared to the gains from the fact that future social security benefits will be higher because of the additional year of work. Which stream is worth more (a smaller annual benefit, beginning now, or a larger annual benefit, beginning (say) a year from now) depends on whether the future benefit increments are sufficient to compensate for the initial year of benefits foregone. If the delayed stream is worth more, then one still gains twice by working -- the paycheck and the positive social security wealth accrual. But if the delayed stream is worth less, then one loses social security wealth by continuing to work, and one's true net compensation is the paycheck minus the amount of the wealth loss (the decline in the PDV). If forgoing one year s benefits is just offset by the future increments earned, then the PDV of the benefit stream is the same regardless of the age of initial receipt. Social security benefits claimed at age 62 are only 80 percent of what that same earnings record would yield at age 65 (the "normal" retirement age). This decrement can be viewed as a 20 percent penalty for receipt at age 62 (about a 7 percent penalty for each year of receipt prior to age 65), or, equivalently, as a similar reward (slightly higher on the age-62 base of 80 percent) for each year of delay past age 62. For the average person, using single life actuarial tables and ignoring survivor benefits, this penalty/reward is approximately actuarially fair. But individual life expectancies differ by gender, race, ethnicity, health status, and other personal characteristics, so a reward that is actuarially fair on average will be inadequate or excessive for many others, thereby either encouraging or discouraging retirement at age 62. At social security s normal retirement age, currently 65, the rules change. For each year that benefit receipt is delayed after age 65, future benefits are increased by 4.5 percent. This is the delayed retirement credit (DRC). For many, a 4.5 percent reward is inadequate to compensate for a year of forgone benefits. The DRC is currently legislated to increase by 0.5 percent every other year until it reaches 8 percent (close to actuarially fair, on average) early next century. Until it does, the social security incentives will tend to discourage work on average after age 65. How important are the effects of social security rules on worker behavior? There appear to be important effects because labor supply behavior changes dramatically at key social security ages. These effects can be seen in Figure II-4, which shows participation rates by gender and age in 1993. For both men and women, the largest declines occur at ages 62 and 65 -- the ages of eligibility for early and normal social security benefits. For men, labor force participation rates drop by 12 points at age 62 and by 10 points at age 65; for women, they drop by 9 and 7 points, respectively. The declines at these ages are higher than those at the other ages around them. Figure II-5 shows retirement hazard rates, defined as the fraction of those who are in the labor force in one year who leave during the following year. Sharp peaks appear at ages 62 and 65, and the pattern shifts over time. In the early years, the age-65 peak dominated, but by 1986, more retirements had shifted to age 62, and both hazard rates were about the same. These patterns led Hurd (1990: 596) to conclude that "(t)he peak at age 65 is probably due to a combination of social security, pensions, and possible mandatory retirement, but it is difficult to think of any explanation for the peak at 62 except for the availability of social security benefits." A different view of the same phenomenon appears in Figure II- 6, which plots "annual exit rates," the difference between labor force participation rates at adjoining ages. The 1960 data are of special interest because men could not claim social security retirement benefits until age 65 then, and the data show no retirement peak at age 62. After early retirement benefits were permitted for men in 1961, an age 62-peak appeared and grew with each succeeding decade, while the age 65 peak declined monotonically. This evidence suggests that "(i)t is difficult to account for the double-peaked pattern in the 1970-1990 graphs, and the increased popularity of departure from the labor force at age 62, with any explanation that does not assign a central role to social security." (Leonesio 1991: 5) Extensive econometric studies have confirmed that the financial incentives in social security and employer pensions do influence the timing of individuals' retirement decisions (Hurd 1990; Quinn, et al. 1990). Using behavioral models based on the longitudinal Retirement History Study of the 1970s, several analysts have simulated the impact of social security reforms, including an increase in the delayed retirement credit at age 65 (currently under way), a delay in the age of normal retirement (which will begin in 2003), and an across-the-board reduction in benefits. These studies predicted changes in retirement behavior in the expected direction, but modest in magnitude -- on the order of months, not years (Burtless and Moffitt 1984; Fields and Mitchell 1984b; Gustman and Steinmeier 1985; Gohman and Clark 1989). A shortcoming of these studies is that they all assume that changes in social security would not affect other essential economic variables like pensions or wages. If these important retirement determinants did respond to changes in the social security environment, then the effects of social security changes could differ from those found in this research. Another aspect of the system thought to influence work decisions is the social security "earnings test." Benefits decline as recipients earn over an exempt amount. In 1995, those aged 62-64 lose $1 for each $2 earned over $8,160, and those aged 66-69 lose $1 for each $3 earned over $11,280. Because of benefit recalculations and the rewards for delayed receipt, however, the benefits forgone are partially, entirely or more than entirely returned via higher benefits later. The earnings test disappears entirely at age 70, and recipients can collect benefits regardless of earnings. Although these effects will diminish in importance in the future, as the delayed retirement credit increases, they appear to have had some effect on reported behavior in the past. Earnings of older workers tend to cluster just below the amount at which social security benefits would be reduced, as shown in Figure II-7 (Burtless and Moffitt 1984; Leonesio 1991). Considerable research has established that social security rules contain significant retirement incentives (or work disincentives), for nearly everyone after age 65, and for some, depending on life expectancy, before that. Behavioral equations explaining individual retirement decisions suggest that people behave as though they understand and respond to these incentives. The higher the penalty associated with continued work, the more likely people are to leave their jobs and the labor force. Pension incentives: Defined-benefit pension plans are similar to social security in that they promise a stream of future benefits once certain requirements are met. Benefits are usually based on some combination of years of service and earnings, often averaged over the last few years of employment. Like social security, the value of a pension stream is conveniently described by its PDV, the size of the asset today required to provide the promised benefits. (The same caveats regarding life expectancies apply.) Also like social security, this PDV can rise or fall with continued work after the age of eligibility, depending on the details of the pension plan. If the PDV rises (that is, if future increments from delayed receipt exceed the benefits initially foregone), then accrual is positive; if the PDV is falling, then pension accrual is negative, and true compensation is less than the paycheck by the amount of the pension wealth lost. It is difficult to summarize the incentives provided by defined-benefit pensions, since there are hundreds of thousands of them, each with its own rules and regulations. Nonetheless, considerable research has shown that many do penalize work at older ages, often after the age of earliest pension eligibility. In an early attempt to quantify pension incentives, Fields and Mitchell (1984a) examined the details of 14 specific plans and estimated the incentives facing an average worker at each age between 60 and 68. They found that the PDV of pension rights tended to rise and then fall, peaking between the ages of 60 and 65. With a sample of men from one of the plans, they estimated total lifetime income (from age 60 on) for hypothetical retirement ages between 60 and 68 - the sum of the PDVs of earnings, social security and pension benefits. The increase in this total after an additional year of work is the true compensation for working that year. Fields and Mitchell found that this sum fell each year after age 60, and at age 68 was less than 40 percent of what it had been 8 years earlier. This is a substantial pay cut. More recently, Kotlikoff and Wise (1989) studied nearly 1,200 pension plans and found that accruals for the typical plan were negative for those who worked past the normal retirement age defined in the plan. In many cases, accruals were negative after the earliest age of pension eligibility, encouraging retirement at that point. It was not unusual for the annual loss in pension wealth to equal 30 percent of annual wages. Research shows that many workers respond to these pension incentives by leaving career jobs and often the labor force as well before these pay cuts occur (see Quinn, et al. 1990, for a summary of this literature). For example, Burkhauser (1979) showed that auto workers were more likely to leave the firm the larger the pension wealth loss associated with continued work. Rhine (1984) found that employees in companies with attractive early retirement benefits were more likely to retire earlier than those in companies without such inducements. Fields and Mitchell (1984a) compared retirement incentives and individual behavior, and found that those with the most to gain by postponing retirement tended to retire later. Similarly, Kotlikoff and Wise (1989) studied the employees of one particular firm for which they knew exact pension details, and showed that departure rates at specific ages coincided precisely with the discontinuities in worker compensation caused by social security and pension plan rules. Departure from the firm does not necessarily imply departure from the labor force. Herz (1995: table 1) has documented a significant increase over the past decade in the percentage of early male pensioners (men aged 50-64 and receiving pension income) who remain in the labor force, often part time. Other explanations for early retirement: Age 62 is now the most popular age of initial social security receipt; 72 percent of new beneficiaries claim benefits prior to age 65, and more than half claim them as soon as they can, at age 62 (U.S. House of Representatives 1994:18, 22). Clearly, something is happening at this age. Because social security rules are close to actuarially fair at that age, on average, it is difficult to lay all the blame there. (This explanation may make sense after age 65, but most Americans have already retired by then.) What then can explain the prominence of age 62 retirements? One explanation may be a liquidity effect -- many older Americans do not have sufficient savings to finance retirement prior to social security receipt and are unable to borrow against future income to do so. If so, income flows and consumption decisions are not separate, as simple life-cycle models assume. What might be happening at age 62, then, is the aggregation of people who would prefer to retire earlier but cannot, lacking enough wealth to tide them over until they become eligible for retirement benefits. If this hypothesis is correct, then the early retirement spike should be more prominent for low wealth individuals than for those with ample assets, a hypothesis that is confirmed by the data. Specifically, people with low wealth in the Retirement History Survey had two retirement spikes (a large one at age 62 and a smaller one at 65), while people with high wealth had only one spike, at age 65 (Kahn 1988). Another reason for the concentration of retirements at age 62 may be confusion about social security and pension incentives. Many people "may not understand how their current earnings affect their future benefits. It is possible, therefore, that social security is discouraging labor supply (prior to age 65) only because its provisions are poorly understood" (Blinder, Gordon and Wise 1980:441). In a similar vein, Mitchell (1988) found that workers covered by pension plans had considerable misinformation about their plans' provisions, especially concerning the requirements for early retirement. Different life expectancies or interest rates may also explain some retirement behavior. Whether future benefit increments adequately compensate for benefits foregone depends on how long one expects to claim benefits and the relevant interest rates for discounting. The lower the life expectancy, or the higher the discount rate, the less likely delaying retirement will pay. Retirement studies use average life expectancies by age, rather than predictions based on the individual's health status, and common interest rates, rather than specific rates relevant to different socioeconomic or tax-bracket group. Those in poor health are known to retire earlier than others, holding other factors constant. In addition to a direct health effect, they may be responding to financial incentives to retire that do not appear to researchers using average life expectancies. Finally, social security rules may influence societal perceptions about an appropriate retirement age. Before social security retirement benefits were permitted at age 62 (1956 for women; 1961 for men), 65 was generally accepted as an appropriate retirement age in the United States. This acceptance was reflected in mandatory retirement rules and in the provisions of many private pension plans, which is no longer the case. Mandatory retirement has been all but eliminated, and most defined-benefit pension plans permit and encourage retirement well before age 65. These changes may well be related to the social security change. As the major source of retirement income and as a public policy reflecting national norms about retirement, social security may have impacts well beyond those generated by its benefit calculation rules. To what extent would additional changes in social security rules have an impact on future retirement trends? Once already legislated changes in the delayed retirement credit are enacted, the benefit structure will be close to actuarially fair, on average, from age 62 on. Delays in the age of "normal retirement" are then just thinly disguised across-the-board benefit reductions -- waiting longer for a given benefit is the same as receiving a lower benefit at any given age. Empirical evidence suggests that the impacts of such changes would be small, at least in the short run, although these studies are all partial equilibrium in nature. A delay in the age of earliest eligibility (age 62), on the other hand, is likely to be much more important, as it was when age 62 eligibility was introduced. It would affect those who are liquidity constrained, increase the financial burden on firms who want to induce early retirement on their own, and might well affect societal expectations and norms over time. Barriers to work in old age: Most of the recent retirement literature in economics has taken a supply side perspective -- workers are assumed to choose among various options, based on their preferences and the financial options and incentives they face. There is also a much smaller demand-side literature, which asks whether older workers face particular obstacles or restricted job opportunities as they age (Straka 1992; Hutchens 1994). Several interesting differences arise in the labor market experiences of older workers. Although their official unemployment rates tend to be lower than those of the labor force as a whole, older Americans are more likely than others to be discouraged workers -- out of work but no longer looking and therefore not officially counted as unemployed. Although older workers (in the mid-1980s) were about as likely as younger workers to be laid off, those who were laid off were much more likely to end up out of the labor force -- about one-third of those aged 55 to 64, three-quarters of those 65 or older, compared with fewer than 10 percent of those 20 through 54 (Herz and Rones 1989). Older workers who are laid off or fired are more likely than others to experience long spells of unemployment, and they suffer greater earnings reductions if they do find work (Shapiro and Sandell 1987). Older workers may face declining job prospects as they age for several reasons. Some may suffer age discrimination per se, but others face sources of labor market adversity, sometimes privately efficient, that happen to increase with age. For example, firms with large fixed costs of hiring or training may prefer younger workers who offer more potential years of employment over which to amortize the fixed costs. In some cases, long-term, mutually beneficial implicit contracts between employers and employees may require cessation of employment or a significant cut in pay late in life. Lazear (1979) has argued that firms might lower turnover costs by paying workers less than their contribution to the firm during the early years of employment, and then more than their contribution near the end. Some compensation is delayed to encourage long tenure with the firm. If this pattern of compensation reduces turnover costs and the gains are distributed between the employer and the employees, then both parties can benefit. But at the point when lifetime compensation and lifetime contribution are equal, the employment contract must be terminated or the worker's compensation decreased to the level of his or her contribution. Although this agreement looks discriminatory at the end, it may have benefited the workers over the life cycle. This theory offers an explanation both for mandatory retirement, now generally outlawed, and for pension plans that penalize workers who stay on the job "too long." An additional problem may be the full-time/part-time mix of jobs that are available. Many older workers would like to retire gradually, which often means a period of part-time work before complete labor force withdrawal. In a recent survey of older Americans, 21 percent of the working men (aged 55-64) and 43 percent of the working women (aged 50-59) wanted to work part time (and the proportion increased with age), but only 6 and 19 percent, respectively, were actually doing so (Quinn and Burkhauser 1994b: table 1). Given these preferences, why are more older Americans not working part time? There are several possible reasons. Compensation is often poor on the jobs that are available, and many employers are reluctant to hire older workers at all. Workers who move from full time to part time usually do so at considerably lower wage rates and with fewer benefits (Gustman and Steinmeier 1985; Jondrow, Brechling and Marcus 1987; Quinn et al. 1990; Kramer 1995). Lower pay for these older workers is not necessarily evidence of discrimination. Workers who switch jobs lose specific human capital -- the expertise acquired on the old job that is not relevant on the new one (Shapiro and Sandell 1985). Their productivity can therefore decline when they move, but for reasons having nothing to do with age. Fixed hiring, training and employee benefit costs are amortized over fewer hours, both because of the worker's part-time status and because older workers have fewer years of service to offer to the firm. If so, firms may have to offer lower wages in order to make the arrangement profitable. As a result, firms often offer part-time employment in jobs that require relatively little supervision or training, and exclude fixed-cost benefits from the compensation package. A final obstacle is employer attitudes toward older workers. Although employers speak highly of older workers' strong work ethic, loyalty and dedication, many fear that older workers are difficult to train and do not cope well with the technological aspects of many jobs (American Association of Retired Persons 1989; Belous 1990). In summary, older workers do face labor market obstacles as they age. Many who remain on their career jobs face declining compensation, as defined-benefit pensions or social security wealth decline in value with continued employment. Switching jobs is difficult because many employers are not eager to hire older workers, for reasons that may or may not be accurate. Part-time work usually results in lower pay, fewer benefits and reduced economic status. In a detailed survey of these issues, Straka (1992) concludes that without the elimination some of these demand side obstacles, attempts to increase the working lives of older Americans through antidiscrimination legislation or supply side measures may be ineffective. Conclusions: The labor market for older Americans has undergone significant change in the post-World War II period. The most dramatic change has been the trend toward earlier labor force withdrawal for men, which lasted until the mid-1980s. For women, the early retirement trend has largely been offset by the simultaneous increase in the participation rates of married women. Considerable evidence indicates that the growth of and financial incentives imbedded in social security and many (defined-benefit) employer pension plans played an important role in this movement toward earlier retirement. Many older Americans do not retire in one move, directly from full time career employment to complete labor force withdrawal. Rather, some retire more gradually, taking bridge jobs in the interim. These are often part time jobs, sometimes involving self-employment, and usually involving a change of industry and/or occupation. The bridge jobs generally pay less than the career jobs did, and are lower down the socioeconomic scale. B. The Changing Nature of Employment Broad trends in the labor market will affect those approaching retirement age today as well as those whose retirement decisions are far in the future. Job mobility can influence the relative attractiveness of different types of pensions, and changes in the distribution of earnings can have implications for future elderly poverty rates. The Panel discusses several relevant labor market trends and asks what they might suggest for the future. The recent and current emphasis on corporate downsizing, combined with a recession in the early 1990s, has contributed to a perception that the American workforce is increasingly mobile and that jobs are less stable than they were in the past. Recent layoffs, including middle management positions in blue-chip firms once noted for their loyalty to workers, have strengthened these perceptions. The evidence backing these perceptions is mixed. Although there does appear to be a secular growth in the importance of part-time and contingent workers (those hired for a fixed term), aggregate evidence does not indicate that average job tenure for the American workforce is on the decline. Contingent and part-time workers: These workers lack a permanent full-time attachment to a single job. They may work part time on one or more jobs, may work as temporary employees through an employment agency, or may be subcontractors or independent professionals. Temporary employees, probably fewer than 3 percent of the workforce, fill in for a short time on jobs that have been vacated or created to meet a short-term increase in demand. Many are supplied by agencies that employ the individuals and contract out their services. Agencies that originally specialized in providing clerical help now provide a wide range of skilled and semi-skilled workers. Leased employees are placed in jobs lasting a year or more, and have become a popular way for firms to fill jobs without providing benefits or making long-term commitments. Independent contractors are self-employed people who work on a contract basis for one or more employers. Growth in these categories reflects employers' interest in having greater labor supply flexibility without the employee benefit obligations associated with career workers. Self-employment, which overlaps with the independent contractor sector, accounts for about 9 percent of the total workforce, a proportion which has changed little over the past several decades (Quinn 1995). The self-employed have to provide their own benefits beyond social security. The self- employed today have the lowest rates of pension coverage (16 percent in 1992) of any broad category of American workers. The proportion of the workforce working part time has stabilized in recent years following significant growth during the prior decades. It grew from 15 to 20 percent between 1969 and 1983, and has remained about 19 percent since then (Saltford and Snider 1994: Table 1). Job tenure and mobility: Despite the broad press coverage that corporate downsizing and interrupted careers have received, aggregate government statistics do not support the notion that job tenure is declining. For example, over the past 15 years, the fraction of workers remaining on the same job for more than eight years has remained constant -- 30 percent in 1979 and 31 percent in 1983, 1987, and 1991 (Council of Economic Advisors 1994: 126; see also Diebold et al. 1994). Americans are mobile, but they have always been so. These aggregate numbers, however, might be concealing offsetting changes underneath. For example, the increasing proportion of older workers (who tend to have longer job tenure) might be masking declining tenure statistics within age cohorts. Age- and gender-specific tenure statistics suggest otherwise, however, because they appear to be fairly stable for men in all age groups and slightly increasing for women (Yakoboski and Silverman 1994: table 16). It is still possible that the aggregate statistics conceal offsetting changes within certain demographic of socioeconomic subgroups of the population. For example, there is evidence that black workers, low-seniority workers and workers without any college education have experienced a decline in job stability, but there are much more conflicting signals on the college-educated population (Diebold et al. 1994; Farber 1995; Marcotte 1995; Swinnerton and Wial 1995). The most recent recession (1990-91) appears to have affected college educated workers and older workers more than previous recessions had (Farber 1993; Gardner 1995). This raises the possibility that the public perception of increasing mobility is caused by the recent experience of members of the labor force who traditionally enjoyed the most stable employment patterns. If so, the aggregate data may be concealing an erosion of the kind of job attachment that is associated with retirement income accumulation. The Council of Economic Advisors (1994:126) has summed this issue up nicely. "Whether or not job security is decreasing, two things are clear. First, there has always been a great deal of instability in the U.S. labor market. Second, there is no question that there is a perception that job security is decreasing. This may be due entirely to the normal increases in job losses during the recent recession, to media accounts of mass layoffs at companies that used to offer unusually stable jobs, or to increases in job stability that simply are not reflected in aggregate statistics." Additional research is certainly needed on this issue. Quality of jobs: Many analysts have argued that traditional middle class jobs are on the decline in America, and that recent job growth has been concentrated at the extremes -- low-wage, low-skill personal service workers at one end and highly-skilled, professional and technical workers at the other (e.g., Bluestone and Harrison 1982; Harrison and Bluestone 1988; Levy and Murnane 1992; Rosenthal 1995). The middle seems to be shrinking, with the decline of average-wage, blue-collar, unionized workers in manufacturing jobs. As late as 1965, nearly 30 percent of the full-time workforce was in manufacturing jobs while fewer than 15 percent were in services. Twenty-five years later, the positions were reversed: only about 17 percent of employees were in manufacturing and 25 percent were in services in 1991 (Anzick 1993). Jobs in the professional service sector have grown rapidly. These include professional and technical positions that require high levels of skill and creative problem-solving ability, much of which is provided through college and graduate school education, rather than through on-the-job training. These are engineers, lawyers, investment bankers, consultants, writers, designers, and a host of other occupations involved with the manipulation, analysis and communication of abstract concepts. This group has experienced real pay increases over the past decade. Many can maintain flexible working careers, controlling their hours and extending their productive worklife into old age if they choose. Gittleman and Howell (1995) use 17 measures of job quality and cluster analysis to group more than 600 jobs covering 94 percent of the American work force into 6 categories, or contours. They find that "the distribution of employment over the period 1973-90 shifted sharply away from the two middle- quality contours toward the two highest-quality contours.... [Although] the two lowest-quality contours showed no decline in employment share... [there was] a sharp drop in the quality of low-skill jobs." (p. 420) Rosenthal (1995) analyzed data on 278 occupations and found that the majority of jobs created between 1983 and 1993 were in the highest and the lowest paying quartiles. Racial diversity: The population reaching retirement age in the next century will be much more diverse racially than are current cohorts of retirees. The Census Bureau projects that between 1990 and 2030 the older (65+) white population will grow by about 90 percent, while the older black population will increase by almost 250 percent, and the older Hispanic population (of any race) by nearly 400 percent (U.S. Senate 1991:14). As a result, the proportion of elderly who are minority will double from 14 percent in 1990 to a quarter by 2030, and then increase to nearly a third by the year 2050 (ibid., chart 1-8). As shown below, minority populations have been underrepresented among those covered by pensions and overrepresented in the poverty populations. Income distribution: One result of the growing divisions in the U.S. workforce has been an increase in income inequality, which is found for a variety of income concepts, household units and measures of inequality (Karoly 1993). There is general agreement that the primary cause of this has been increased labor market inequality -- a widening gap between the hourly wages and annual earnings of those at the extremes of the pay distribution (Levy and Murnane 1992; Danziger and Gottschalk 1993; Gottschalk and Danziger 1995). Over the past two decades, median real family income in the United States has been stagnant, growing at only 0.2 percent in the entire 20 years between 1973 and 1993, after having more than doubled between 1947 and 1973. (CEA 1994:115; CEA 1995:176). This overall stagnation, however, conceals dramatic changes. Between 1973 and 1993, the real incomes of the richest quintile of American families grew by 25 percent, while those of the middle quintile were virtually constant and those of the lowest quintile actually fell 15 percent (CEA 1995: 178). Studies of wage growth reveal similar patterns. Among both men and women, the distribution of real wages has become more unequal. "Between 1973 and 1993 real hourly wages of full-time male workers at the 10th percentile...declined 16 percent, while real hourly wages at the median fell 12 percent. Over the same two decades, workers at the 90th percentile eked out a wage gain of 2 percent. The net effect is that levels of wage inequality for men have been greater in recent years that at any time since 1940. Women received wage increases throughout the wage distribution, but the gains were concentrated at the top. Women at the 10th percentile earned 6 percent higher wages, while those at the 90th percentile had gains of 24 percent" (CEA 1995:176). A major cause of this widening of earnings and therefore income inequality has been increasing returns to education and experience during the 1980s. The college-to-high-school wage premium for young workers increased more than 100 percent between 1974 and 1992, and the ratio of the wages of experienced to inexperienced workers has risen as well (CEA 1994: 117; see also Murphy and Welch 1993). In addition, inequality has increased in the earnings of those within education, experience and skill classes. The ratio of 90th to 10th percentile wages has increased within the distributions of high school graduates, college graduates, young (inexperienced) and old (experienced) workers. Those in the upper percentiles have experienced significant growth in real wages while those in the lower ends have seen only slight growth or declines (Gottschalk and Danziger 1995). Many factors have been cited to explain these changes in earnings inequality, including skill-biased technical change (for example, the importance of computer literacy), declining unionization, the erosion of the real minimum wage, changes in industrial structure (the deindustrialization mentioned above), immigration of low skilled labor, and increased international competition in product markets. Although debate continues about the relative importance of these factors, a general consensus exists that the earnings and therefore the income distribution in the United States has changed dramatically over the past two decades. The earnings distribution has became more unequal both because of a growth at the top and a decline in both absolute and relative earnings at the bottom. Implications for pension coverage and retirement income adequacy: With the exception of the increasing labor force participation of married women, little in the labor market trends discussed suggests that pension plan coverage will increase dramatically in the near future. Middle class unionized jobs have declined, and they were frequently associated with pension coverage. In service industry jobs, coverage is much less likely. If the importance of the contingent economy and part- time work increase further, long-term job attachment may diminish, signaling a shift in the obligation to prepare for retirement from employers to individuals (Allen and Freeman 1994). This shift can already be seen in the dramatic growth of defined-contribution pension plans, discussed in Section II-C below. Finally, the increase in earnings and income inequality is a concern, both because of its current implications and because it bodes ill for retirement income adequacy in the future. C. Trends in Employer Sponsored Pensions and Retiree Health Benefits Recent changes in employer provided pensions are examined in this section. Although the proportion of people in the labor force who participate in a pension has changed very little, a shift toward defined-contribution plans as the primary form of employer-sponsored retirement plan has occurred, along with a dramatic increase in the number of workers participating in 401(k) plans. Funding and tax regulations are discussed along with concerns about the allocation of risk between employers and employees, which differs by pension plan type. New federal regulations along with changing economic conditions explain many of these trends. The tax and regulatory environment of employer sponsored pensions: The Internal Revenue Code provides favorable tax treatment for savings in the form of employer sponsored qualified pension plans. Employer contributions to a qualified retirement plan are deductible as a business expense. Neither these contributions nor the earnings of the pension fund are counted as part of the employee's taxable income until the pension funds are distributed. Employees may sometimes also make after tax contributions to qualified plans. In that case, the contributions are taxed when earned, not when distributed; however, fund earnings on these contributions are not taxed until they are distributed. If employers establish plans under sections 401(k) or 403(b) of the Code, employee contributions avoid current taxation. The federal government encourages pensions through this preferential tax treatment, the objectives of which include increasing individual savings for retirement and encouraging national savings. To qualify for this preferential treatment, pension plans must conform to a series of government regulations concerning vesting, participation, funding limits, discrimination in terms of coverage and benefit levels, and the purchase of insurance from the Pension Benefit Guaranty Corporation (PBGC). These issues are discussed below. Tax preferences decrease tax revenues. This loss in government revenue is called a tax expenditure. The pension tax expenditure is the largest calculated by the government, and was estimated at $57 billion in the Fiscal Year 1993 federal budget, about half of which was due to public-sector plans (Salisbury 1993, 1994). Some think that this tax expenditure is too large for a program that covers only half of the labor force, and that pension contributions or at least the earnings of pension funds should be taxed currently. Others respond that employer pensions encourage saving and provide a major component of retirement income for millions of retirees and therefore should continue to be encouraged. Pension tax expenditures are predominantly a middle to upper income class benefit. Those with incomes below $30,000 filed 42 percent of the taxable returns in 1992, but received less than 9 percent of the pension tax expenditures (Salisbury 1993; table 7). (They also had less than 8 percent of the total tax liability in 1992.) Whether the middle or upper class benefits more depends on the comparison made. If these tax preferences are viewed as simple expenditures, they appear to go disproportionately to the upper class. For example, the 5 percent of the (taxable) households with (1992) income above $100,000 received 20 percent of the pension tax expenditure; the 24 percent with incomes between $50,000 and $100,000 received 43 percent. But the value of the income exclusion is higher for upper income taxpayers not only because they are more likely to participate in employer pensions, but also because they face higher marginal tax rates and pay more taxes. When the tax preferences are viewed not as expenditures but as tax reductions, a different story emerges. Those at the bottom end receive little or no tax relief because they already pay little or no federal income tax. Those with income above $100,000 reaped 20 percent of the pension tax expenditure, but paid more than 40 percent of the taxes paid (ibid.). Those earning $50,000 to $100,000 enjoyed 43 percent of the tax expenditure, but had only 33 percent of the tax liability. And those earning between $30,000 and $50,000 paid 18 percent of the taxes, but enjoyed 28 percent of the tax liability. The ratio of pension tax expenditures to total income taxes paid is the highest for those with incomes between $30,000 and $50,000 per year. Had these pension incentives been eliminated and nothing else changed, those earning between $30,000 and $50,000 would have seen their federal income taxes increase by 18 percent; those in the highest category ($200,000+) would have suffered a 3 percent tax increase. Tax changes enacted in 1993 reduced the maximum compensation that any employee can be deemed to receive for tax deferral purposes from $235,840 to $150,000, which will lower the relative tax expenditure for high earners (Liston and LaBombarde, 1994). Changes in pension plan coverage and type: Employer provided pension plans are an important source of retirement income to millions of older Americans. Using income data from the Current Population Survey, Grad (1992) reports that income from public and private pensions and annuities provided 18 percent of the aggregate income of couples and unmarried persons aged 65 or older in 1990 (exactly half the proportion provided by social security), an increase of 2 percentage points since 1976. The importance of pension income to the elderly generally rises with income level -- from 3 and 8 percent in the lowest two quintiles to 16 percent in the middle quintile, and then to 22 and 20 percent in the top two quintiles. The percentage of the elderly receiving any pension and annuity income tells a similar story. It has risen over time, from 31 to 44 percent between 1976 and 1990, and it increases with income level, rising from 8 to 50 percent between the 1st and 3rd quintiles, and then to 67 percent in the highest 2 quintiles (ibid.). Coverage and participation among current workers: There are several sources of data on pension coverage (Beller and Lawrence 1992). The most commonly used is the Current Population Survey, which often includes special supplements on pension issues. Another is the Form 5500 report sent annually by all private pension plans to the Internal Revenue Service. A third is the IRS Annual Tax File, a sample of those who have filed tax returns in a given year (Schieber 1995). Estimates of pension coverage rates depend on the data source used, the definition of coverage adopted (usually, currently participating in a plan) and the population being described. Populations of interest include all workers, all wage and salary workers (excluding the self-employed), all private wage and salary workers (excluding government employees), all full-time private wage and salary workers (excluding part-time workers) and the ERISA work force (which includes all those aged 21 or older who have worked for an employer for at least a year, and who work at least 1,000 hours annually). The proportion of workers participating in a pension plan increased rapidly between the end of World War II and the mid- 1970s, but has remained relatively stable since then (Andrews 1985; Bloom and Freeman 1992; Turner and Beller 1992; Silverman and Yakoboski 1994). Analysis of Current Population Surveys between 1972 and 1993 indicates that pension participation among full-time private wage and salary workers ranged between 48 and 50 percent during this period (U.S. Department of Labor 1994b). Participation among full-time male workers has declined slightly from 54 to 51, percent while coverage of full-time females increased from 38 to 48 percent. Yakoboski et al. (1994: Tables 1 and 2), using 1993 CPS data, report participation rates of 44 percent for all civilian workers and 47 percent for civilian, nonagricultural, wage and salary workers. Among the latter, the participation rate is 43 percent for those working between 1500 and 1999 hours per year, and 58 percent for those working 2000 or more hours. Of the ERISA work force (see definition above), 56 percent participated in an employer-sponsored plan in 1993. Coverage is higher among men (50 percent of the nonagricultural wage and salary work force) than among women (44 percent), and higher among those covered by a union contract (79 percent) than others (40 percent). Participation increases dramatically with education (Reno 1993: Table 2.9) and with annual earnings, from only 8 percent of those earning less than $10,000 per year, to 61 percent of those earning between $20,000 and $25,000, and 80 percent of those earning $50,000 or more annually. Participation in pension plans also rises with age and with tenure as workers meet eligibility conditions and advance into better jobs where employers are more likely to offer pensions. Among civilian, nonagricultural wage and salary workers with less than one year of tenure in 1993, only 11 percent participated in an employer pension (Yakoboski et al. 1994: Table 2). This increases to 35 percent for those with 1 to 4 years of tenure, 60 percent for those with 5 to 9 years, and reaches 80 percent for those with 15 or more years of service. In 1993, the participation rate for wage and salary workers between the ages of 21 and 30 was only 34 percent, compared to 53 percent for those aged 31 to 40 and over 60 percent for those aged 41 to 60 (ibid.). The fact that pension participation increases with age suggests that lifetime pension participation rates will exceed the point- in-time coverage rates shown in any cross-sectional data, since the latter includes many younger workers currently uncovered who are likely to enjoy pension coverage as they progress in their careers. Pension coverage is also related to firm size. Only 10 percent of workers in firms with fewer than 10 employees participated in a pension in 1993, compared with 50 percent for persons in firms with 100 to 249 employees, and 67 percent for those with more than 1,000 employees (ibid.). Pension coverage is much higher in the government sector. In 1988, for example, while 48 percent of the full-time private sector employees were covered by pensions on their current jobs, 87 percent of the full-time federal government workers were covered, as were 86 percent of the full-time state and 88 percent of full-time local government employees (Turner and Beller 1992: Table B2). Yakoboski et al. (1994) estimate that 79 percent of all federal workers participated in an employer-sponsored pension plan in 1993, as did 74 percent of all state and local workers. In 1993, 63 percent of all private full time wage and salary workers were employed by firms offering a pension and 50 percent were actually participating in a pension (U.S. Department of Labor 1994b). This implies that 80 percent of these workers employed by firms with pension plans actually participated in these plans. Among those offered a pension but not participating, 39 percent did not participate because they had not yet met the service conditions while another 31 percent chose not to contribute to the plan. Other reasons for lack of participation included 6 percent who were in jobs not covered by the employer sponsored plan and 7 percent who did not work enough hours, weeks or months per year to qualify for participation. In a recent paper, Schieber (1995) argues that the CPS data on which so much the pension information is based significantly understate the receipt of employer-sponsored retirement income. There are several possible reasons for this. One is that persons receiving lump-sum pension distributions may invest these funds in financial instruments, and then report the income in subsequent years as interest or dividends rather than as pension income. Alternatively, recipients of lump-sum pension payments could use the funds to pay off consumer debt or a mortgage, and report no "income" in later years at all. Another possibility is that some people who receive pension annuity checks from a third-party payers (such as insurance companies) do not report them as pension income on surveys. Schieber uses the IRS Annual Tax File to estimate the receipt of pension, annuity and IRA income for elderly (over 65) federal income tax filers. His research is most useful at the middle and upper parts of the income distribution, where most households would be expected to file federal income tax forms. Schieber finds that slightly over three-quarters of the filing units in the upper two IRS quintiles reported pension income, compared to an estimate of two-thirds from the CPS as reported by Grad (1992). In addition, Schieber finds that the amounts of pension income reported in the CPS is smaller than in the IRS files, and claims that "the CPS fails to measure as much as one-third of the total income that is being paid out in the form of pensions and annuities directly and also fails to attribute other income for the elderly that comes from the employer based retirement system to the plans responsible for that income (p. 29)." Although the differences in samples and income definitions make the sources of these discrepancies impossible to identify, the IRS data suggest, as do the National Income and Product Accounts data, that the CPS estimates understate the importance of the pension income received by older Americans. Types of pension plans: Employer-provided pension plans are typically divided into two types, defined benefit and defined contribution, although recent changes in the structure of some pension plans have created hybrid plans that blur this traditional distinction. Defined-benefit plans promise retirement benefits based on a predetermined formula, while defined-contribution plans provide for a specified contribution each pay period. These plans differ with regard to the types of financial risks borne by the employer and the employee, the effect of mobility on the value of the pension, the effect of changes in pension rules on the value of benefits, responsibility for the investment of pension funds, their influence on worker behavior and the effect of government regulation on the administrative cost of the plans. One of the most important trends in employer pensions is the movement towards greater use of defined-contribution plans as the primary employer- sponsored retirement plan (Clark and McDermed 1990; Turner and Beller 1992; U.S. Department of Labor 1994b). The proportion of primary pension plans with more than 100 participants that are defined-benefit has declined in all industries and in all size groups (Clark and McDermed 1990; Clark et al. 1994). The proportion of all plans that were defined- benefit fell from 28 percent in 1984 to only 14 percent in 1991 (U.S. Department of Labor 1994a). Non 401(k) defined-contribution plans have remained at approximately 70 percent of all plans while 401(k) plans have increased from 3 percent of all plans in 1984 to 16 percent in 1991. The increasing importance of 401(k) plans is even more dramatic when the number of participants is examined. As a percentage of all pension participants, those in 401(k) plans have increased from 12 percent in 1984 to 31 percent in 1991, while defined-benefit participants have declined from 50 percent of the total to 42 percent. Participants in non 401(k) defined- contribution plans declined from 38 to 27 percent during the same period. The dramatic growth in 401(k) plans is further shown in the actual number of plans and participants. In 1984, about 17,000 such plans covered 7.5 million workers. By 1991, almost 115,000 401(k) plans covered nearly 20 million participants. Participation rates in 401(k) plans are relatively high. In 1993, more than one-third of all private sector workers were offered the opportunity to participate in a 401(k) plan, and of those offered a plan, two thirds choose to participate. The proportion of those offered who participate increases sharply with age, rising from 34 percent of those under 25 to 57 percent of those aged 25 to 29, 69 percent among those aged 30 to 34, and between 70 and 79 percent of workers between the ages of 35 and 64. This rate also rises with years of service and annual earnings. The median percent of pay contributed to 401(k) plans is 6 percent for both men and women, and does not vary much by age or annual earnings. Despite the relatively high participation rate for a voluntary plan, there are many workers covered by these plans who choose not to participate -- the other third. If 401(k) plans are the only retirement plans offered by an employer, their optional nature leads to substantially lower participation than if all eligible workers are required to participate, as is the case in many defined-benefit plans. Cost of employer pensions: Economists generally agree that, over the long run, workers bear most of the cost of employer pension contributions through lower wage earnings. The tradeoff between wages and employee benefits has long been recognized in collective bargaining, compensation decisions made by business managers, and the selection of jobs by workers (Rosen 1974; Smith 1979; Brown 1980; Woodbury 1983). Research suggests that workers accept a portion of their total compensation in the form of future pension benefits when the effective price of these benefits if bought through the employer is less than what it would cost the worker. Greater value from employer-provided pensions is attributable to quantity discounts, risk pooling, and the preferential tax treatment of both pension contributions and the investment returns. Factors that increase the cost of employer pensions (like costly government regulations) will tend to reduce the demand for this benefit. Characteristics of defined-benefit and defined-contribution plans: In a defined-benefit pension plan, the plan sponsor promises to pay a retirement benefit based on a specified formula. The size of the benefit depends on eligibility and participation requirements, vesting standards, the benefit formula, and often the employee's recent earnings history (see below). In defined- contribution plans, employers and employees make periodic contributions into a pension account for individual workers. In 1991, about 70 percent of those in defined-benefit plans offered by medium and large firms had to meet some age and/or service requirement in order to become eligible to participate in the plan. The most frequently used eligibility standard, covering about a third of participants in defined-benefit plans, was age 21 with one year of service, the maximum permitted by federal regulations. The current participation requirements are reasonable guidelines that do not significantly affect the retirement income of those who do not achieve coverage while limiting the record keeping associated with very short term employees. Most defined-benefit plans require 5 years of service before workers become vested in the plan (that is, before they have legal rights to benefits even if they leave the firm). This period has been reduced by government regulations, which currently require that firms provide vesting standards at least as generous as 100 percent after 5 years or a graded vesting schedule with partial vesting after 3 years and 100 percent after 7 years. Because, under current requirements, all full-time covered workers will ultimately receive a pension even if they remain with the firm for only 5 years, further reductions in vesting standards would have only a limited effect on the size of retirement incomes. The normal retirement age of a plan is the age at which a retiree can begin receiving unreduced retirement benefits or benefits based on the prescribed benefit formula in the plan. In most defined-benefit plans, this occurs at a particular age (most commonly, age 65), or when some combination of age and service with the firm (e.g., age 62 and 10 years of service, or age plus years of service equals 85) is achieved (Mitchell 1992: Table 9.4) About 8 percent of participants are in plans that allow retirement with unreduced benefits after a specified number of years of service (usually 30), regardless of age (ibid.). In virtually all plans, workers face early retirement options and can begin receiving benefits prior to the normal retirement age. The most prevalent early retirement age is 55 with 10 years of service. These early retirement features typically provide strong incentives for workers to retire from their career employer prior to the normal retirement age, often at the earliest age of eligibility (Kotlikoff and Wise 1989). With the continued aging of the population, the age for full social security benefits (100 percent of the worker's Primary Insurance Amount) is scheduled to be raised, first to age 66 and later to 67. The age at which maximum benefits can be received from a defined-benefit plan is often tied to the age for full social security benefits. If retaining older workers in the labor force is important, consideration might be given to establishing a minimum retirement age for tax-qualified employer pension plans. In nearly all defined-benefit plans, the benefit depends on years of service. In addition, for more than two-thirds of all participants in defined-benefit plans sponsored by medium and large firms in 1991, benefits also depended on earnings. Among these workers, 80 percent were in final-earnings plans (most commonly, the average of the highest consecutive 3-5 years) and 20 percent were in plans using career average earnings formulas. Participants typically receive a specified percentage of average earnings (however defined) for each year of service. Another quarter of all participants in defined-benefit plans (mostly covered by collectively bargained contracts) were in plans that pay a specified dollar amount per year of service, independent of earnings. Other types of formulas were used in plans that cover about 7 percent of defined-benefit participants. In final earnings plans, for workers who stay with the firm until retirement, the value of initial retirement benefits is protected against changes in the cost of living as long as earnings growth matches or exceeds the rate of inflation. Where retirement benefits are specified in absolute dollar amounts, more common in collective bargaining environments, the real value of initial benefits will decline unless it is periodically increased to reflect changes in the price level. These adjustments are often a topic of negotiation. Participants in defined-benefit plans who leave their career employers prior to retirement age suffer pension losses relative to long tenured workers. This loss in the lifetime value of pension benefits results from the use of final earnings in the benefit formula and the lack of indexation of vested benefits to future inflation or wage growth. This loss in the value of a pension discourages job turnover among persons covered by defined- benefit plans (Allen et al. 1993; see Gustman and Steinmeier 1993 for a contrasting view). Often, early retirement benefits are not fully actuarially reduced relative to normal retirement benefits. In this case, the present value of expected benefits is highest at the early retirement age, and then declines. The magnitude of the subsequent decline depends, in part, on the response of future wages and pension benefits to inflation. The decline in pension "compensation" along with the early availability of pension benefits tends to encourage retirement. The discontinuities in pension compensation as workers age (for example, the increases in pension accrual during the years just prior to eligibility for early retirement benefits and the sharp declines in accruals (and therefore compensation) thereafter) change the financial reward for working each additional year and thereby influence labor supply decisions (Burkhauser 1979; Fields and Mitchell 1984a; Kotlikoff and Wise 1989; Quinn et al. 1990; Ruhm forthcoming). In 1991, 54 percent of all participants in private defined- benefit plans were integrated with social security in the sense that the employer pension provides a smaller proportional benefit to the lower paid, whose social security benefits will represent a greater proportion of their pre-retirement earnings (U.S. Bureau of Labor Statistics 1993). The most prevalent form of integration (covering about two-thirds of those in integrated plans) was the excess method, in which a less generous benefit formula applies to earnings below some specified dollar amount. The remainder were in plans that use the offset method of integration, which reduces pension benefits by some proportion of social security benefits received. The federal government has specified maximum reductions permitted under both types of integration. Defined-contribution plans include savings and thrift plans, profit sharing plans, employee stock ownership plans, money purchase plans, and 401(k) and 403(b) plans. The benefits at retirement depend on past contributions and the rate of return on accumulated pension funds. Many plans allow for individually- directed accounts so that participants can decide how pension funds are invested. Defined-contribution plans tend to have less restrictive vesting standards: 31 percent of defined-contribution participants are in plans that allow for immediate vesting (this is required for 401(k) plans and common in 403(b) plans). Virtually all plans allow for lump sum distributions at retirement or at termination of employment, which employees can (but often do not) then roll over into other plans or into individual retirement accounts. Pension compensation in defined-contribution plans is more explicit than it is in defined-benefit plans, because it is simply the employer's contribution to the pension fund. Therefore, these employer pension costs are more visible to workers than are the employer costs associated with defined-benefit plans. Traditionally, employer contributions are a percent of annual earnings and are unaffected by age and years of service, although basing contributions on age or service is becoming more common. Funds are generally deposited in individual accounts whose value is disclosed to the worker, and they are viewed as belonging to the worker. A worker who leaves the firm prior to retirement retains ownership of the entire vested value of the pension fund. Pension assets can either remain with the plan sponsor or be distributed to the departing worker as a lump-sum that can then be rolled over. In either case, the worker continues to receive all future returns on the pension assets. Because of these factors, individuals with defined-contribution plans tend not to suffer losses in pension wealth with job changes that those with final- pay defined-benefit plans do, and mobility rates are therefore less likely to be affected. Annual benefits are determined by the size of the pension account and the age of the recipient when benefits commence. To hold the asset value of the expected benefit stream constant, defined-contribution plans have implicit actuarial adjustments for different retirement ages. (Of course, the size of the pension account continues to grow if the worker remains on the job and new contributions are made.) Thus, defined-contribution plans are less likely than defined-benefit plans to influence retirement decisions. One problem associated with any plan with a lump-sum payout is that the lump-sum must be turned into an annuity if it is to provide a guaranteed (nominal) income flow over the recipient's remaining lifetime. Annuities indexed to the Consumer Price Index are unavailable (other than social security), and the ability to buy even fairly priced nominal annuities in the private market is a concern given the problems of adverse selection and group size. In addition, life expectancies vary by gender, ethnicity and other personal characteristics. Therefore, a key factor in the conversion of a pension accumulation to an annuity is the size and composition of the pool of persons with whom one is grouped. Risks associated with pension plans: Defined-benefit plans differ from defined-contribution plans in who bears various types of risk. Some of the risks are specific to the individual worker, and some are broader, applying to the firm, the industry or the economy as a whole. For example, workers with earnings-dependent pensions face the risk of uncertain future wages, especially those whose benefits will depend on their average wages during their last few years of work. Those whose benefits will depend on wages averaged over their careers face the risks of inflation during the work life, which can seriously erode the real value of early years' earnings. The risk to pensions from job turnove