Social Security: Proposed Changes to the Earnings Test
CRS Report for Congress
Social Security: Proposed Changes
to the Earnings Test
Debra Whitman
Specialist in the Economics of Aging
Domestic Social Policy Division
Summary
On April 7, 2000, President Clinton signed H.R. 5, the Senior Citizens’ Freedom
to Work Act. The new law (P.L. 106-182) eliminated the Social Security earnings test
— which reduces the benefits of recipients who work and earn more than a specified
amount — for recipients between the “full retirement age” (currently age 65 and six
months) and age 70, effective January 1, 2000. In the 109th Congress, Representatives
E. Clay Shaw and Gene Green have introduced bills (H.R. 750 and H.R. 276,
respectively) that would eliminate the earnings test for recipients age 62 and older. This
report will be updated periodically.
Background
With variations, the earnings test has been part of the Social Security program since
its beginning. It reduces the benefits of recipients under a certain age who earn income
from work in excess of a certain sum (the “exempt amount”). It does not apply to
disabled recipients.1 The original rationale for the test was that, as a “social insurance”
system, Social Security protects workers from certain risks, among them the loss of
income due to their retirement, and therefore benefits should be withheld from workers
who show by their substantial earnings that they have not in fact “retired.”
Old Law. Before passage of P.L. 106-182, the law provided different tests for
recipients under and over the full retirement age. Recipients who would not attain the full
1 However, in the disability program earnings above a certain amount indicate ability to engage
in “substantial gainful activity” (SGA) and therefore disqualify a person from receiving benefits.
For non-blind recipients, that amount is set by regulation at $830 a month. Before enactment of
P.L. 104-121, SGA for the blind was tied to the monthly earnings test (the annual exempt amount
divided by 12) for those who have attained the full retirement age. P.L. 104-121 removed this
linkage. Instead, the SGA level for the blind continues as before (i.e., adjusted annually to reflect
growth in average wages — it is $1,380 a month in 2005). For more information, see CRS
Report RS20479, Social Security: Substantial Gainful Activity for the Blind.
Congressional Research Service ˜ The Library of Congress
retirement age (currently age 65 and six months) in the current calendar year and had
earnings in excess of their annual exempt amount ($12,000 in 2005) lost $1 of benefits
for each $2 of excess earnings. Recipients who had attained the full retirement age in the
current or previous calendar year, and who had earnings in excess of their annual exempt
amount ($31,800 a year in 2005), lost $1 of benefits for each $3 of excess earnings (see
following examples). The exempt amounts rise each year at the same rate as average
wages in the economy. The test did not apply to recipients over age 69.
Age 65 and six months in 2005:Under Age 65 and six months in 2005:
Earnings .............. $35,000Earnings .............. $35,000
Exempt Amount.........31,800Exempt Amount.........12,000
Difference .............. 3,200Difference ............. 23,000
Reduction in benefit.......1,066Reduction in benefit......11,500
(one-third of difference)(one-half of difference)
New Law. Effective January 1, 2000, the earnings test does not apply to recipients
beginning in the month that they attain the full retirement age. In that year, for months
before attainment of the full retirement age the old law continues to apply (e.g., in 2005,
these individuals can earn up to $31,800 in the months before attainment, and for earnings
above this amount, they lose $1 in benefits for each $3 of earnings). The old law also
continues to apply to years in which recipients have not attained the full retirement age
(i.e., in 2005, they lose $1 of benefits for each $2 of earnings in excess of $12,000). The
full retirement age is gradually rising, reaching 66 in 2009 and 67 in 2027, and the age for
which the earnings test ceases to apply is rising accordingly.
Recent Legislation
The test has always been one of the most unpopular features of the program, and
proposals to liberalize or eliminate the earnings test are perennial. In 1996, P.L. 104-121
increased the annual earnings test limit, for those attaining the full retirement age, over
a period of seven years, reaching $30,000 in 2002.
H.R. 5. On February 16, 2000, the Social Security Subcommittee of the House
Committee on Ways and Means approved H.R. 5, the Senior Citizens’ Freedom to Work
Act, which eliminated the Social Security earnings test for recipients who have reached
the full retirement age, effective in 2000. According to the Social Security
Administration, the bill will increase Social Security’s outlays by $17 billion over five
years and $26 billion over 10 years. The Congressional Budget Office estimates that the
bill will cost $ 19.7 over five years and $22.7 billion over 10 years. These costs would
reduce projected unified budget surpluses over this period by the same amount, but,
because Social Security is scored as an off-budget item, there would be a negligible effect
on projected on-budget surpluses. In the long range, the cost would be negligible because
of offsetting effects. (Retirees will no longer receive delayed retirement credits, which
under current law compensate for the benefits lost to the earnings test applied to workers
above the full retirement age, and the savings from this would offset the cost of
eliminating the earnings test.) It was estimated that initially about 600,000 recipients
would be affected by the elimination of the test. H.R. 5 continued the severance between
the earnings test and the SGA level of the blind enacted in P.L. 104-121.
A concern with the bill was that one of its effects would be to reduce benefits for
workers turning age 65 in 2000. (Workers receive the higher exempt amount and the one
for three reduction not in the month they actually attain the full retirement age, but at the
beginning of that year. Simply eliminating the test for those above the full retirement age
would mean that in the year of attainment, for months before attainment of age 65 the
lower exempt amounts and the one for two reduction would apply.) A provision added
in the Chairman’s mark would, for 2000 only, allow workers turning age 65 to continue
to receive the current-law higher exempt amount and the one for three reduction rate for
months before they turn age 65. The House of Representatives approved H.R. 5 on March
On March 22, 2000, the Senate approved H.R. 5 by a vote of 100-0. A manager’s
amendment changed the House provision affecting workers turning age 65 in 2000 to
make it applicable to all future workers for the year they reach the full retirement age (i.e.,
after 2000 workers would continue to receive the current-law higher exempt amount and
the one for three reduction rate for months before they turn the full retirement age). On
March 28, 2000, the House of Representatives approved the Senate version of H.R. 5 by
a vote of 419-0. President Clinton signed the measure into law on April 7, 2000.
Legislation in the 108th Congress. H.R. 75, introduced by Representative
Shaw, would gradually raise the exempt amount for recipients under the full retirement
age over the period 2004 through 2008, and would repeal the test entirely in 2009. H.R.
2311, introduced by Representative Sessions, and H.R. 3098, introduced by
Representative Gene Green, would repeal the earning test for recipients who have attained
the age of 62, effective in 2004.
Legislation in the 109th Congress. H.R. 750, introduced by Representative
Shaw as part of his larger reform bill, would gradually raise the exempt amount for
recipients under the full retirement age over the period 2005 through 2011, and would
repeal the test entirely in 2011. H.R. 276, introduced by Representative Gene Green,
would upon enactment repeal the earning test for recipients who have attained the age of
62. H.R. 335, introduced by Representative Lynch, would exempt payment for care
giving from the earnings test for beneficiaries who are employed by a eligible child care
provider.
Arguments for Liberalizing or Eliminating the Earnings Test. A common
complaint among affected recipients is that they are being denied a benefit that they have
“bought and paid for.” Social Security has always been described as a program in which
benefits are paid as an “earned right” rather than as a welfare program. The concept that
workers earn rights to benefits through a lifetime of “contributions” to the program,
avoiding any perceived stigma of collecting “handouts” or submitting to a demeaning
“needs test” is often cited as one of the reasons for broad public acceptance of the
program. Thus, to some critics it seems inappropriate to impose what appears to them to
be a form of needs test, which deprives workers of benefits that they have “earned.” As
this thinking goes, many workers have been led to regard Social Security as a
government-run savings plan. Their acceptance of the payroll tax is facilitated by the idea
that they will get the money back some day, and they do not readily accept the rationale
that access to “their” money should be withheld just because they continue to work.
The test is criticized as a severe disincentive for the “young retired” to work. Critics
say that not only do they suffer a reduction in their standard of living because of the test,
the country loses valuable experience and skills as well. They see the test as a relic of the
Great Depression, when concern over massive joblessness led to a perception that retired
workers should be discouraged from rejoining the workforce. Moreover, they see the test
as inconsistent with other federal policies, and contrary to the recommendations of
gerontologists and others concerned with the health of the elderly, that strive to increase
hiring and retention of older workers. Even if on a purely economic basis the penalty the
test imposes is not high enough to support a rational decision to not work, opponents
argue that the test creates a psychological barrier that dampens the desire to work.
The disincentive effect is magnified when viewed on an after-tax basis. The
beneficiary who works loses not only 50% or 33% of his or her benefit above the exempt
amount due to the earnings test; he or she must pay Social Security taxes and probably
Federal and State income taxes as well. The result can be a high effective marginal tax
rate, exceeding 100% in extreme cases. One result of this disincentive is that some seek
lower paying or part-time work to limit their earnings, and thus do not employ the full
value of their skills that could enhance the nation’s productivity and economic output.
Another can be to encourage being paid “under the table.”
Critics of the test maintain that it discriminates against younger retirees who must
work to supplement their benefits. Others who have alternative forms of income such as
private pensions can still receive full benefits. If an individual receives a fairly small
Social Security benefit that he must supplement through work, some consider it unfair to
reduce that benefit once he earns more than what critics see as modest amounts — only
$11,640 a year for those under the full retirement age. They sometimes state the question
another way: why should income from investment be treated more favorably than that
from earnings, especially since most investment income is received by upper-income
persons who also usually have higher Social Security benefits? Thus, it is claimed that
the earnings test is inequitable to persons who need additional income in retirement.
Furthermore, critics say that in addition to being complicated and difficult for the
individual to understand, the test is complex and costly to administer. For example,
before enactment of P.L. 106-182, it was responsible for more than one-half of retirement
and survivor program overpayments. Elimination of the test would thus hold down
administrative expenses, and recipients would be less confused and less tempted to cheat
on reporting their earnings. The complexity of the current law also causes a “notch”
effect, in that workers who are born late in the year have an advantage because in the year
they attain the full retirement age they have more months in which they have the benefit
of the higher earnings threshold of $31,800 compared to those born early in the year.
Finally, critics of the test maintain that repealing it not only would have no long-
range costs, it would have positive budgetary and economic effects. They argue that
people would work more and pay more Social Security and other taxes, offsetting the
increase in benefit payments. They contend that many people deliberately keep their
earnings below the limit, or that because of the existence of the test, have chosen to do
part-time, lower paying work rather than work in skilled professional jobs that typically
require full-time employment. The effect, they argue, is to lower the output and earnings
of productive young retirees significantly. They maintain that if the potential output of
these workers were realized, the benefit to the economy would substantially increase
government revenues — not only directly in the form of taxes but also in the form of
rippling “multiplier” effects. Furthermore they claim that the overall costs to the
government would be relatively modest. Similarly, because of offsetting effects, the long-
range costs of repealing or reducing the earnings test are said to be negligible. For
example, one reason the earnings test was repealed for workers who have attained the full
retirement age was that in the long range it had negligible cost. Under current law
workers who do not receive benefits after their full retirement age receive a “delayed
retirement credit” (DRC), which increases their benefits by a certain percentage for each
month they do not receive benefits. When the DRC increases to two-thirds of 1% per
month in 2008, its value will be approximately actuarial; that is, the additional benefits
a person would receive over his or her lifetime due to the DRC would be approximately
equal to the value of the benefits lost due to the earnings test. Thus, the long-range cost
of eliminating the earnings test for those above the full retirement age was offset by the
savings produced by fewer payments of DRCs. Similarly, if the test were repealed for
retirees under the full retirement age, there would be only a very small long-range cost to
the program (0.01 % of taxable payroll), again because of offsetting effects. Workers and
their spouses who retire before the full retirement age have their benefits “actuarially
reduced,” meaning that a person will receive approximately the same value of benefits
over a normal lifetime regardless of whether he or she began to receive benefits before or
at the full retirement age. Workers who retire today exactly at age 62 receive 75% of the
benefit they would receive at the full retirement age. However, if benefits are withheld
because of the earnings test, under the law their benefits are recomputed at the full
retirement age to remove the actuarial reduction for those periods in which they did not
receive benefits. Thus, similarly to the case with the DRCs, the long-range cost of
eliminating the earnings test for those below the full retirement age would be almost
entirely offset by the savings produced by eliminating the recomputation of benefits at the
full retirement age.
Arguments Against Liberalizing or Eliminating the Earnings Test. Those
who defend the earnings test take the position that benefits should be paid only when the
risks insured against by the Social Security program actually occur (e.g., the loss of earned
income when one retires). As the program does not pay disability benefits to those who
are not disabled, nor Medicare benefits to those who are not ill, similarly it should not pay
full benefits to those who are not truly “retired.” They point out that the program is not
intended to be a savings plan that provides an annuity upon retirement but rather is
intended to be a form of insurance that provides benefits upon the occurrence of the
contingency insured against (loss of income due to the retirement of the worker).
Even so, proponents say, the provision already has been liberalized to the point
where most working recipients are better off in retirement than younger workers. Take
the example of someone born in 1940 who files for retirement at age 65 and six months
in 2005 but continues to work. He or she would receive his or her full Social Security
benefit which, in combination with his or her earnings, would provide more income than
before he or she “retired” (and this does not count the value of Medicare coverage and the
tax breaks from receiving tax-advantaged Social Security benefits and extra deductions
for the elderly).
Thus, defenders of the test maintain that, contrary to allegations that the test causes
hardship, on the whole it actually is fairly generous, and to liberalize or abolish it would
further erode the concept that Social Security is designed to replace lost earnings. They
assert that repeal or further liberalization of the test would benefit mainly the well-off,
particularly people who want to continue to work full time at their regular jobs. Rather,
it would pay a premium to people who are fortunate enough to be able to work after
becoming eligible for retirement, as opposed to those who are forced to retire because of
health or other compelling reasons.
There are some who, while they supported repeal of the earnings test for those who
have reached the full retirement age, oppose total repeal of the test. Their main concern
is that many people will end up poor in old age because of the permanent reduction in
their benefit that occurs when one files for early retirement. Because the incentive to file
for benefits at age 62 would be so high, they believe virtually everybody would choose
to do so, and find when they do cease work that their permanently reduced benefit is now
inadequate. They are particularly concerned that this would have a detrimental effect on
elderly widows, already the poorest of Social Security recipients, because if their spouses
retired early they will receive a survivor benefit that also is permanently reduced.
Another argument is that, although eliminating the earnings test has no appreciable
cost over 75 years, the offsetting savings that cause this effect will lag behind the
expanded cost of the program for many years. Thus, to some extent the extra outgo will
exacerbate the potential strain Social Security may cause on the rest of the budget in 2018
when its tax revenues are projected to fall below its outlays, and it also would have some
effect at the time when Social Security is projected to become insolvent in 2042. Much
before then, the “baby boom” generation will begin to retire. Some believe that one way
to ease the burden this would impose on society is to reduce the debt the government
owes to the public by running budget surpluses over the next decade or two. It is argued
that this will increase national savings and economic growth so that the nation could more
easily afford to support the large numbers of retirees, and also would have room to borrow
again from the public if necessary. However, increases in Social Security expenditures
would mean that less of the publicly held debt would be retired during this period. If one
views retirement of the publicly held debt as a means for the country to afford the
retirement of the baby boom, then such action would weaken this goal. It also could open
the door to other program liberalizations if they were cost-neutral to the program in the
long-range due to offsetting measures that would not take effect for many years.
In regard specifically to P.L. 106-182, some analysts express regret that, with the
need for reform of the program so paramount, Congress’ first step was to liberalize
benefits. Even some proponents of repealing the test say that it would have been better
to include a package that addresses the program’s long-range solvency. They point out
that enacting a single popular measure like repealing the test takes away an item that
would “sweeten the pot” and force more difficult choices in shoring up Social Security.
Finally, proponents of the test fear that its repeal would serve as a vehicle for altering
the philosophical basis of the program. Today, Social Security has a mixture of social and
insurance goals that are considered incomparable to a private annuity or insurance system.
Paying benefits regardless of earnings clearly would appear to make the program seem
more like an annuity, and could reinforce questions about the other redistributive aspects
of Social Security. Thus, advocates of the program’s current structure sometimes regard
elimination of the earnings test as a “Trojan Horse.”