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

Unlike nearly all private-sector workers and federal employees, some workers employed by state and local governments--about 25 percent--are not covered by Social Security. Under federal law, state and local governments can opt to enroll their employees in the Social Security program or they can opt out if they provide a separate retirement plan for those workers instead. State and local governments may also have their employees participate in Social Security and be part of a separate retirement plan. In contrast, all federal employees hired after December 31, 1983, are covered by Social Security and pay the associated payroll taxes. Furthermore, all state and local government employees hired after March 31, 1986, and all federal government employees are covered by Medicare and pay taxes for Hospital Insurance (Medicare Part A).

Under this option, Social Security coverage would be expanded to include all state and local government employees hired after December 31, 2011. Consequently, all newly hired state and local government employees would pay the Social Security payroll tax, which funds the Old-Age, Survivors, and Disability Insurance programs. In 2012 and thereafter, that tax will be 12.4 percent of earnings, half of which is deducted from employees' paychecks and half of which is paid by employers. (As a result of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 [Public Law 111-312], the share of the Social Security tax that employees pay was reduced from 6.2 percent of covered earnings to 4.2 percent for 2011 only.) If implemented, this option would increase revenues by $24 billion from 2012 through 2016 and by a total of $96 billion over the 2012-2021 period. (The estimates include the reduction in individual income tax revenues that would result from a shift of some labor compensation from a taxable to a nontaxable form.) Paying the Social Security payroll tax for 10 years generally qualifies workers (and their dependents) to receive Social Security retirement benefits; other work requirements must be met for employees to qualify for disability benefits or, in the event of their death, for their dependents to qualify for survivors' benefits. Although extending such coverage to all newly hired state and local employees would eventually increase the number of Social Security beneficiaries, that increase would have little impact on the federal government's spending for Social Security in the short term. Over the 2012-2021 period, outlays would increase only by a small amount because most people who would be hired by state and local governments over that period would not begin receiving Social Security benefits for many years. (The estimates do not include any effects on outlays.)

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

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

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

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