Why WEP?
Filed Under (Retirement Policy, Uncategorized) by Jeffrey Brown on Aug 23, 2010
One of the most despised provisions of the Social Security regulations is known as the WEP – an acronym for the “Windfall Elimination Provision.” This provision is poorly named, poorly designed, and poorly understood. But that does not mean it should be eliminated. While the Social Security Administration does a truly horrible job of communicating it, the WEP (or something like it) has a legitimate reason for existing.
What is the WEP? It is a provision in the law that alters the way Social Security benefits are calculated for individuals who work for state and local employers who do not participate in the U.S. Social Security system. For example, the earnings of employees of public universities and public schools in Illinois – who participate in Illinois SURS and Illinois TRS – are not covered by Social Security.
Illinois is not alone. Approximately one fourth of all public employees in the U.S. do not pay Social Security taxes on the earnings from their government job according to the U.S. Government Accountability Office (GAO). This includes approximately 5.25 million state and local workers, as well as approximately 1 million federal employees hired before 1984.
However, many of these public employees – including the author of this blog – will still qualify for Social Security benefits, either as a result of switching between covered and uncovered employment at some point in their career or because they simultaneously work two or more jobs that span both covered and uncovered employment. For example, a teacher in the State of Illinois may spend his summers working in covered employment. Alternatively, a professor may spend part of her career working at a private university covered by Social Security, and part of her career working for a state university that is not covered.
If Social Security benefits were calculated as a simple “linear” function of lifetime earnings, this would not present any problems. If you earned 50% of your lifetime income in Social Security, you would just get 50% of the benefit that you would have earned had all your earnings been covered. The only thing Social Security would need to know is how much you paid into Social Security. Whether you have other “uncovered” earnings would be irrelevant.
But Social Security does not have a “linear” benefit formula. Rather, it is explicitly designed to offer a higher ratio of benefits-to-taxes-paid for low income workers than it offers to higher income workers. It is designed this way in an attempt to redistribute income from the rich to the poor.
And therein lies the problem. If Social Security only observes part of a person’s total earnings (e.g., they know someone’s earnings from a summer job, but not their university salary), then they might mistakenly classify this person as a low-income individual, even though they might be a high income individual who just had a small part of their earnings covered by Social Security. As a result, blindly applying the same benefit formula to this person gives them a benefit that is too high relative to other individuals who have the same total lifetime earnings! In essence, we would be paying too much to people who only worked a small part of their career under Social Security.
In order to adjust for this, the Windfall Elimination Provision (WEP) was enacted as part of the 1983 Social Security Amendments. This provision is meant to downward-adjust the Social Security benefits of affected workers in order to eliminate the “windfall” (a poor choice of words, I am the first to admit!) that arises when, for example, an individual with high lifetime earnings (based on both covered and uncovered earnings) would appear as if he or she were a low earner when evaluated solely based on covered earnings.
It is easiest to see the problem that would be created if there were no WEP provision in place through an example. Consider the three individuals shown in the table below. “Larry” is a very low income worker who works his entire life under Social Security, with an average lifetime monthly earnings of only $500 per month. Using the 2008 benefit formula, Larry would have a full benefit $450, or 90% of his pre-retirement income. “Mo” is a higher income worker with all of his earnings covered under Social Security, thus having an average monthly income while working of $5,000. Under the benefit rules, Mo would have a full benefit of $1891.34, or a 38% of their working life income. Thus far, this example simply illustrates the “redistributive” nature of the benefit formula, as Larry receives a higher replacement rate than does Mo, owing to the fact that Larry has lower lifetime earnings.
Social Security Primary Insurance Amount If No WEP Adjustment Applied
|
Average earnings covered by SS |
Average earnings not covered by SS |
Average total earnings |
Benefit if SS formula applied to covered earnings |
Benefit as % of income if no WEP adjustment |
Larry |
500 |
0 |
500 |
450 |
90% |
Mo |
5000 |
0 |
5000 |
1891 |
38% |
Curly |
500 |
4500 |
5000 |
450 |
90% |
Now consider Curly, a public employee. Curly’s total lifetime earnings of $5000 are identical to Mo’s. Had all of Curly’s earnings been covered by Social Security, Curly would have the same 38%replacement rate as Mo. However, only 1/10th of Curly’s earnings were in employment covered by Social Security; the rest were in non-covered public employment. If Social Security applied the standard benefit formula to Curly’s covered earnings without any WEP adjustment, Curly would receive a monthly benefit of $450, equivalent to Larry. This provides Curly with a ratio of benefits to (covered) earnings of 90%, which is substantially more generous than the 38% ratio provided to Mo, even though Mo and Curly have identical lifetime earnings. To use the language of the provision designed to address this issue, Curly would receive a “windfall.” The WEP adjustment is designed to calculate Curly’s benefits differently, so that they end up looking more like Mo’s, since they both have similar lifetime incomes.
In short, because Social Security is a redistributive program, there is a real need for something like the WEP. Most people affected by it, however, hate it. And who can blame them given that SSA does a terrible job of explaining it? In essence, instead of telling a retiree that “your benefit will be $800,” SSA tells them “your benefit would be $1100, but because of the WEP, it is only $800.” But for the individual in question, the $1100 benefit is a red herring. In no way, shape or form is the $1100 benefit a relevant amount to start with. So SSA’s poor communication and negative framing raises a lot of hackles unnecessarily. As a result, thousands of letters are written to elected officials every year demanding that it be repealed. And, every year, bills are introduced in Congress to eliminate it. And every year, those bills fail as they should.
This is not to say that the WEP is perfect. Far from it. I have written more extensively elsewhere that the WEP calculation may be close to correct on average, but it is almost certainly wrong for each individual. Sadly, it hits lower income individuals harder than it should, and does not hit most high income individuals hard enough. There is a “right” way to calculate the WEP, but implementing it requires that SSA have a full history of both covered and uncovered earnings, but they did not collect the uncovered earnings in a systematic way until the early 1980s. As such, we probably have to wait another 10 years before they can implement the fix. In the meantime, SSA could do themselves and a lot of elected officials a huge favor by taking the time to adequately educate affected individuals on the rationale for this program.