Social Security and Minorities: Current Benefits and Implications of Reform

Published by the Government Accountability Office on 1999-02-10.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                               United States General Accounting Office

GAO                            Testimony
                               Before the Subcommittee on Social Security, Committee
                               on Ways and Means, House of Representatives

For Release on Delivery
Expected at 1:30 p.m.
Wednesday, February 10, 1999
                               SOCIAL SECURITY AND

                               Current Benefits and
                               Implications of Reform
                               Statement of Cynthia M. Fagnoni, Director
                               Income Security Issues
                               Health, Education, and Human Services Division

Social Security and Minorities: Current
Benefits and Implications of Reform

               Mr. Chairman and Members of the Subcommittee:

               Thank you for inviting me here today to speak about minorities and Social
               Security. Social Security has had a significant and positive effect on the
               nation’s elderly. Since 1959, poverty rates for the elderly have fallen from
               35 percent to 10.5 percent, thanks largely to this social insurance program.
               Nevertheless, elderly African-Americans and Hispanics are much more
               likely to be living below the poverty line, even with the program’s
               important benefits. For example, 28 percent of African-Americans and
               27 percent of Hispanics aged 65 and older have incomes below the poverty
               threshold, compared with 11 percent of similarly aged Caucasians.1

               My remarks today focus on (1) how minorities currently fare under Social
               Security, (2) how they might be affected by some of the proposed changes
               in benefits to restore the program’s solvency, and (3) how minorities might
               fare under a system restructured to include individual accounts. The
               information I am providing today is based on preliminary findings from
               work we are currently doing for Representative Charles B. Rangel,
               Ranking Minority Member of the full Committee on Ways and Means.

               In summary, while Social Security’s benefit and contribution provisions
               are neutral with respect to race, ethnicity, and gender, we found that
               because of certain socioeconomic characteristics, minorities have
               benefited from the Social Security program. Because minorities are more
               likely than whites to have lower lifetime earnings, they are advantaged by
               Social Security’s progressive benefit formula that provides larger relative
               benefits for lower-paid workers. Moreover, blacks in particular are more
               likely to receive other important Social Security benefits, such as
               disability, that help protect against lost earnings. Certain reforms that
               would reduce benefits to help restore solvency could have a
               disproportionate effect on low-wage earners, including blacks and
               Hispanics, depending on how they are structured. For example, raising the
               age of retirement would lower the average lifetime benefits of blacks
               relative to whites because of blacks’ lower life expectancy.

               Restructuring Social Security to include individual accounts would also
               likely have varying effects on different racial and ethnic groups. However,
               our analysis indicates that education and family income are better
               predictors of individuals’ investment behavior than race. Individuals with

                Most of the data sources we relied on used the terms blacks, whites, and Hispanics. Therefore, for the
               remainder of this testimony we use the same terms. Although we recognize that there are other
               minority groups, such as Asians and Native Americans, for the most part the data were not broken
               down finely enough for us to look at them separately.

               Page 1                                                                           GAO/T-HEHS-99-60
             Social Security and Minorities: Current
             Benefits and Implications of Reform

             less education and lower incomes tend to invest more conservatively than
             those with more education and higher incomes. Because blacks and
             Hispanics are more likely to have less education and lower incomes, they
             would likely earn smaller returns on their accounts, although they would
             bear less risk. These results suggest that if individual accounts were
             adopted as an element of comprehensive Social Security reform, investor
             information and education would be needed to help low-income
             individuals with their investment decisions.

             The Social Security program is the foundation of the nation’s retirement
Background   income system. Since 1940, Social Security has been providing benefits to
             the nation’s eligible retired workers and their dependents. In addition to
             retired worker benefits, Social Security protects covered workers who
             have severe disabilities and their dependents through the Disability
             Insurance (DI) program. Also, spouses and children of deceased workers
             may receive Social Security survivor benefits. As a social insurance
             program, Social Security allows workers to pool the risks they face from a
             loss of earnings that results from retirement, disability, or death.

             Social Security’s benefit formula redistributes income from high-wage
             earners to low-wage earners to help keep low-wage earners out of poverty.
             Benefits are based, in part, on an individual’s earnings, but when
             calculating actual benefits, Social Security uses a progressive formula that
             replaces a relatively larger portion of lifetime earnings for people with low
             earnings than for people with high earnings. To calculate Social Security
             benefits, Social Security uses average indexed monthly earnings, defined
             as a worker’s lifetime covered earnings over his or her 35 highest earnings
             years. A progressive benefit formula is applied to these lifetime earnings to
             determine the benefit that would be payable to the worker at age 65. The
             benefit is then adjusted for the age at which the worker first receives the

             The Social Security system currently faces a long-term solvency problem.
             As you know, the Social Security trust funds are predicted to begin paying
             out more in annual benefits than they collect in taxes in 2013 and are
             expected to be depleted by 2032.2 A number of proposals have emerged to
             resolve this financing problem, with a great deal of variety in terms of both
             how the Social Security program would be structured and who would be

              The relevant figures include both the Old Age and Survivors Insurance program and the Disability
             Insurance program.

             Page 2                                                                          GAO/T-HEHS-99-60
                       Social Security and Minorities: Current
                       Benefits and Implications of Reform

                       eligible for benefits.3 Some of these proposals would restore solvency
                       within the existing program structure, while others call for some form of
                       restructuring to include individual accounts as an element of reform. Many
                       major proposals would provide a significant defined benefit as a base with
                       voluntary or mandatory individual accounts included as an element of the
                       plan.4 In the current national debate over how best to restore Social
                       Security’s long-term solvency, some researchers have argued that
                       minorities, particularly blacks, would fare better under a system that
                       included some individual account element.5 They argue that certain
                       minorities are more likely to have specific characteristics that result in
                       their receiving lower benefits than others under the current system.

                       Although Social Security’s benefit and contribution provisions are neutral
How Minorities         with respect to race, ethnicity, and gender, some researchers have
Currently Fare Under   questioned how well some minorities, especially blacks, have fared under
Social Security        the existing Social Security system because they have lower life
                       expectancies. Differences in life expectancy affect the length of time that
                       individuals from different racial and ethnic groups can expect to pay into
                       the Social Security system and collect retired worker benefits. For
                       example, white males born in 1998 can expect to live for 74 years, black
                       males for 64.3 years, and Hispanic males for 75 years. These differences
                       become much less pronounced, but still exist, for individuals who survive
                       to age 65. At age 65, in 1998, white men can expect to live 2.3 years longer
                       than black men, and Hispanic men can expect to live 2.9 years longer than
                       white men. The projections of life expectancy for white, black, and
                       Hispanic women at age 65 are 19.5, 17.6, and 22.2 years, respectively.

                       However, life expectancy is only one of many factors that affect the level
                       of benefits that people receive from Social Security, relative to what they
                       contribute. Social Security’s progressive benefit formula has particular
                       importance for blacks and Hispanics because they tend to have lower
                       lifetime taxable earnings than whites. The consensus among researchers is
                       generally that the progressivity of the benefit formula outweighs the
                       negative effect of lower life expectancy for blacks in terms of what they
                       receive from Social Security relative to what they contribute. Hispanics’
                       longer life expectancy, combined with the progressive benefit formula,
                       indicates that they fare even better than blacks under Social Security.

                        The President’s recent Social Security reform proposal, for example, would extend Social Security
                       solvency until 2055. It would not, however, fundamentally reform the Social Security benefit program.
                       Defined benefit refers to a benefit based on a specific formula linked to a worker’s earnings and years
                        W. Beach and G. Davis, “Social Security’s Rate of Return,” Heritage Center for Data Analysis, Heritage
                       Foundation, Washington, D.C., 1998.
                       Page 3                                                                           GAO/T-HEHS-99-60
                       Social Security and Minorities: Current
                       Benefits and Implications of Reform

                       None of the currently available studies have included disability or
                       survivors benefits in their assessments of the benefits minorities receive
                       from Social Security.6 Blacks rely more heavily than others on these
                       features of the program, which provide important protections against the
                       loss of earnings caused by disability or death. While blacks currently make
                       up 12 percent of the U.S. population, they are overrepresented in these
                       beneficiary categories. For example, blacks make up 23 percent of child
                       beneficiaries (as children of retired workers, disabled workers, or
                       deceased workers), 18 percent of disabled workers, and 14 percent of
                       survivors of deceased workers. Put another way, 47 percent of black
                       beneficiaries are receiving either disabled or survivor benefits, while only
                       28 percent of whites are receiving benefits in these categories. In contrast,
                       blacks make up only 8 percent of all retired worker beneficiaries, while
                       whites make up 90 percent of this category.7

                       The changes contained in various Social Security reform proposals could
How Minorities Might   have disproportionate effects on minorities but these would vary
Be Affected by         depending on the nature of the reforms. Many reform proposals include
Various Reform         provisions that would reduce current benefit levels by, for example,
                       increasing the number of years of taxable earnings used to calculate
Proposals Within the   benefits from 35 years to 38 or 40 years. Even a proportional reduction in
Existing Program       benefits such as this could have a more serious effect on minorities since
                       their lower overall incomes put them much closer to or below the poverty
Structure              line to begin with.

                       Many Social Security reform proposals include a provision to raise the
                       normal age of retirement to age 70. Some proposals would also increase
                       the early retirement age from 62 to 65. Any increase in the age at
                       retirement would decrease the number of years during which individuals
                       would collect benefits while increasing the number of years they would
                       pay Social Security taxes. Because blacks, on average, already can expect
                       to spend fewer years in retirement than whites as a result of their shorter
                       life expectancy, they would experience a greater relative reduction in
                       benefits, compared with whites, from an increase in the Social Security

                        We are currently working with a special data set, provided by the Social Security Administration and
                       the Bureau of the Census, that will allow us to make more complete estimates of minorities’ total
                       returns to Social Security, including disability and survivors benefits. This information will be
                       forthcoming in a report to Representative Charles B. Rangel, Ranking Minority Member of the House
                       Committee on Ways and Means, later this year.
                        Hispanics were not reported separately and are included in the numbers for whites and blacks. The
                       final 2 percent of retired worker beneficiaries includes Asians and Pacific Islanders, American Indians
                       and Alaskan Natives, and a subset of the total number of beneficiaries of Spanish origin.

                       Page 4                                                                            GAO/T-HEHS-99-60
                       Social Security and Minorities: Current
                       Benefits and Implications of Reform

                       retirement age. Given Hispanics’ longer life expectancy, the negative effect
                       of raising the retirement age would be smaller in relative terms. At the
                       same time, an increase in the ages of early and normal retirement would
                       have implications for the DI program. Raising the early and normal
                       retirement ages would create a financial incentive for individuals in poor
                       health to apply to the DI program because the gap between disability
                       benefits and retired worker benefits would increase. Moreover, as
                       individuals stay longer in the labor force, more older workers will become
                       disabled. Assuming that current disability trends continue, proportionately
                       more of these disabled workers would be black.

                       Many reform proposals would fundamentally restructure Social Security
How Minorities Might   by creating retirement accounts that individuals would own and manage.
Fare Under a System    Many proposals would provide a defined benefit but would also include an
Restructured to        individual account feature. For example, the plan put forth by the National
                       Commission on Retirement Policy includes a minimum benefit provision
Include Individual     that is set at the poverty line for individuals who have worked for 40 years
Accounts               and directs 2 percentage points of the payroll tax into individual savings
                       accounts. Because no research has previously been done on minorities’
                       investment patterns, we have estimated the effect of race on individual
                       investment behavior. Using national survey data, we estimated the
                       probability that people with Individual Retirement Accounts (IRA) would
                       invest their accounts in stocks and mutual fund shares.8 Our preliminary
                       results indicate that individuals with higher family income and more years
                       of education are more likely to invest in more volatile but potentially
                       higher-yielding assets such as stocks and mutual funds. On average, blacks
                       and Hispanics have lower family incomes and fewer years of education
                       than do whites. We found that controlling for these and other
                       characteristics, black IRA holders are still somewhat less likely to invest in
                       stocks and mutual fund shares than whites.9 We also found that Hispanic
                       IRA holders are neither more nor less likely than whites to invest their
                       accounts in stocks or mutual fund shares, once we controlled for the other
                       demographic characteristics.

                        We used a cross-section of people from Census’ 1992-93 Survey of Income and Program Participation.
                       Because of data limitations, we were able to look only at the investment decisions of people with IRAs.
                       In the full sample, blacks and Hispanics were less likely to have an IRA account than whites. In
                       general, respondents with IRAs had higher family income, had completed more years of education,
                       were older, were more likely to be married, and had fewer children than those without IRAs.
                        This result was significant at the 90-percent confidence level. The analysis did not control for
                       differences in levels of wealth, which would also explain some of the differences in investment

                       Page 5                                                                             GAO/T-HEHS-99-60
              Social Security and Minorities: Current
              Benefits and Implications of Reform

              Individuals who chose a relatively low-risk investment strategy for their
              retirement income accounts would be likely to earn lower rates of return
              over longer periods of time but would not be as exposed to large losses
              from riskier assets. While it is true that in the past U.S. stocks have almost
              always posted higher returns over time than less risky assets, there is no
              guarantee that they will always do so, especially for shorter investment

              Our analysis also revealed that blacks and Hispanics are much less likely
              to have interest earnings from any other type of savings vehicles such as
              savings accounts, money market funds, certificates of deposit, or mutual
              fund accounts. Individuals unfamiliar with making investment choices may
              need assistance in understanding and managing their individual account
              investments. Providing low-income and less well-educated individuals who
              have limited investing experience—including some blacks and
              Hispanics—with appropriate information may be particularly challenging.
              Nevertheless, information that covers general investment principles and
              financial planning advice would be essential in helping all investors to
              better manage their accounts. It is not clear who would provide such
              information to workers under a restructured Social Security system that
              included mandatory individual accounts. Within the private pension
              system, there are mechanisms for people to learn more about investing.
              For example, some employer-sponsored pension plans provide written
              material or contract with a financial planning service to give employees
              information about investing. It might be possible to draw from these
              experiences in structuring an investor education program for Social
              Security. The nature and extent of these information and education
              efforts, when combined with the design of related investment options,
              would be especially important to helping maximize the effectiveness of,
              and minimize the risk associated with, individual accounts under the
              Social Security system.

              The Social Security system has benefited minorities through a benefit
Conclusions   formula that favors lower-paid workers and through important social
              insurance features, including disability benefits. Because blacks and
              Hispanics are more likely to have lower overall incomes than whites,
              certain reforms, such as increasing years of covered earnings, would have
              a more serious effect on them, because they are already closer to the
              poverty line. Because blacks and Hispanics on average have lower
              incomes and are less well educated than whites, the creation of mandatory
              individual accounts could also decrease their benefits relative to those of

              Page 6                                                        GAO/T-HEHS-99-60
           Social Security and Minorities: Current
           Benefits and Implications of Reform

           whites if they invested more conservatively. Our work suggests that
           providing information and education would be essential, especially to
           low-income individuals who would be making investment decisions for the
           first time. Investor education that covers general investment principles
           and financial planning advice might help all new investors to better
           manage such accounts.

           This concludes my prepared statement. I would be happy to answer any
           questions you or other Members of the Committee may have.

(207029)   Page 7                                                  GAO/T-HEHS-99-60
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