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Mr. Chairman and Members of the Subcommittee, I am pleased to be here this morning to discuss the Congressional Budget Office's (CBO's) estimate of the budgetary effects of holding a new open season, during which federal employees covered under the Civil Service Retirement System (CSRS) could switch to the Federal Employees Retirement System (FERS). Among the issues I will cover in this statement are:

• The major features of each retirement system,

• CBO's estimate of the budgetary effects of the proposed open season,

• The sources of differences between CBO's estimate and the Administration's, and

• The long-term budgetary implications of the proposal.

MAJOR FEATURES OF CSRS AND FERS

CSRS is a defined-benefit retirement plan under which employees earn benefits based on their age, years of service, and earnings. Those employees are generally not covered by Social Security, but they may participate in the Thrift Savings Plan (TSP) with their own voluntary contributions--up to 5 percent of earnings. Such contributions are not matched by any government payment. Workers covered by CSRS and their employing agency each make matching retirement contributions--generally 7.0 percent of earnings, although the Balanced Budget Act increased both rates for the 1999-2002 period. After retirement, benefits are indexed annually by the increase in the consumer price index (CPI).

FERS, which went into operation in 1987, is designed to give workers similar coverage to pension plans in the private sector: Social Security provides a base of retirement income, supplemented by a smaller defined-benefit plan (FERS) and a defined-contribution plan (TSP). The employing agency contributes 1 percent of earnings to TSP for all FERS employees and matches employee contributions up to 5 percent of earnings. Employees may contribute an additional 5 percent of earnings to TSP, but those contributions receive no government match. FERS benefits are not indexed for inflation before the annuitant reaches age 62. After age 62, benefits are adjusted annually by the rate of increase in the CPI minus 1 percentage point.

In general, covered employees pay 0.8 percent of their salary to FERS, and agencies pay 10.7 percent of covered payroll. In addition, both the worker and the agency pay 6.2 percent of wages to Social Security (up to a maximum earnings level of $65,400 in 1997). All contributions to TSP are deposited in a nonbudgetary account for which the federal government's responsibility is purely fiduciary.
 

CBO'S ESTIMATE FOR A NEW OPEN SEASON

CBO estimates that relatively few CSRS employees--about 11,500, or only 1 percent--would switch to FERS if given the opportunity. That estimate is based on the patterns observed in the first open season (in 1987) and an assessment of the characteristics of the employees who would be eligible to switch. In general, CBO assumed that employees with a certain number of years of service would switch at half of the rate observed in 1987. For example, 1.0 percent of CSRS employees with 30 or more years of service switched to FERS in 1987; the rate assumed in CBO's estimate is 0.5 percent.

Table 1 in the cost estimate appended to this statement displays the effect of the proposed open season on the federal budget. In total, CBO estimates that the proposal would raise net federal costs by approximately $250 million over the next 10 years. That figure reflects increases in discretionary spending and decreases in direct spending and revenues.

First, CBO estimates that the proposal would cost federal agencies $660 million over the next decade for additional contributions to retirement trust funds and the Thrift Savings Plan. For the most part, those costs would be paid out of agency appropriations and would be subject to the statutory limits on total discretionary appropriations.

In addition, the open season would reduce direct spending by $434 million during the 1998-2007 period, primarily as a result of agencies' increased retirement contributions, which are recorded in the budget as offsetting receipts. The Social Security trust funds would receive additional contributions of $288 million, and the CSRS trust fund would receive an extra $141 million. In total, benefit payments of CSRS, FERS, and Social Security would change little over that period.

Finally, total federal revenues would fall by about $25 million over the period because the additional employee contributions to the Thrift Savings Plan would not be subject to income tax in the year in which they were made. Allowing workers to switch from CSRS to FERS would also result in a small reallocation of revenues from the CSRS trust fund (an on-budget account) to Social Security (an off-budget account). Total retirement contributions by employees would remain essentially unchanged, although a negligible loss would occur for workers with earnings above the maximum taxable wage for Social Security.
 

COMPARISON WITH THE ADMINISTRATION'S ESTIMATE

In the President's cancellation notice and veto message, the Administration estimated that a new open season would reduce revenues for the CSRS trust fund by $854 million over the 1998-2002 period and result in additional costs to federal agencies of $1.3 billion. CBO estimated the decline in CSRS revenues over that period to be $139 million and the increase in agency costs (excluding the Postal Service) to be $262 million. The President's announcements contained no mention of the effects of the provision on direct spending or Social Security.

According to the Office of Management and Budget, the Administration's estimate was based on the assumption that 60,000 workers, or 5 percent of the eligible workforce, would take advantage of a new opportunity to switch retirement plans. In particular, all CSRS workers with at least 37 years of federal service (30,000 workers) were assumed to switch. If CBO had used the same assumption of 60,000 workers switching plans, our estimate would have been similar to the Administration's. We would have projected a $725 million decline in CSRS revenues over the 1998-2002 period and a $1.4 billion increase in retirement costs for federal agencies.

Although the number of workers who change plans is five times larger in the Administration's estimate than in CBO's, it is certainly not implausible. Employees would decide to switch based on a number of factors that are specific to them as individuals--for example, the degree to which they are willing to be exposed to various risks (such as longevity, inflation, and fluctuations in the stock market), their potential amount of Social Security spousal benefits, and the expected length of their career with the federal government. Back in 1987, analyses by the Office of Personnel Management and Congressional support agencies indicated that 30 percent to 40 percent of workers would have found it financially advantageous to switch to FERS. Only 4 percent did so, however. Some analysts argue that the remaining CSRS employees would be more likely to move to FERS today because of the strong performance of the stock market, the downsizing of federal agencies, and the familiarity developed with FERS over the decade since the last open season But CBO assumes that because today's CSRS employees all chose not to switch 10 years ago, they would switch at a lower rate than in 1987.
 

LONG-TERM BUDGETARY IMPLICATIONS

Whether a new open season would increase or decrease federal costs in the long run is uncertain, because it depends on the characteristics of the workers who would change retirement plans. For some categories of employees, the answer is obvious; for others, it is not so clear.

Two groups of employees would clearly cost the taxpayer more if they switched to FERS than if they remained in CSRS. Workers who have earned the maximum CSRS benefit--generally reached after 42 years of service--are among those most likely to switch plans. They could begin to accrue additional retirement benefits from FERS, take advantage of the government's matching contributions to TSP, and avoid Social Security's government pension offset if they worked for five more years. They would also receive a tax cut if their earnings were above the maximum taxable wage for Social Security. For them, federal pension benefits, agency contributions to TSP, and perhaps Social Security benefits all would be higher.

The other group of employees most likely to benefit from switching plans is workers who might be eligible for modest CSRS benefits but who could escape Social Security's government pension offset by working for five years under FERS. The government pension offset reduces the Social Security spousal benefit by two-thirds of the amount of any government pension received based on employment not covered by Social Security. For example, a widow who receives a monthly CSRS payment of $1,200 would not be entitled to any Social Security benefits based on her deceased husband's earnings if those benefits were $800 or less. CSRS workers who are precluded from receiving a significant Social Security benefit by the government pension offset might find it beneficial to switch to FERS. For such people, the reduction in their federal employee pension would be more than offset by higher benefits from Social Security and TSP.

Two categories of workers might consider switching to FERS even though they would accrue retirement benefits at a lower rate than under CSRS. Some might want to switch primarily because they are attracted by the market rates of return available in TSP. Transferring to FERS would provide them with the government's matching contribution as well as the opportunity to contribute up to 10 percent rather than 5 percent of their salary. The extraordinary returns in the stock market in recent years may have led them to conclude that TSP would perform well enough to offset any reduction in their pension. Thus, although the government would pay less in retirement benefits for those employees, their expected income could still increase.

Still other workers might choose to switch because they are risk-averse and fear continued federal downsizing and reductions in force. Those workers may consider it prudent to obtain Social Security coverage and build a larger TSP balance as insurance against losing their job or being stuck in an undesirable job.

The long-run federal cost of a new open season depends on the relative sizes of those groups of employees and the accuracy of their retirement planning. On balance, however, it seems likely that federal costs would rise--primarily because of higher Social Security benefits.
 

SUMMARY

The Treasury and General Government Appropriations Act for fiscal year 1998 includes a provision that would provide an open season for federal employees covered by the Civil Service Retirement System (CSRS) to switch into the Federal Employees' Retirement System (FERS). Under this provision, the open season would run from July 1, 1998, to December 31, 1998.

CBO estimates that, if this provision takes effect, federal agencies would bear costs totaling $660 million over the next ten years for additional contributions to retirement trust funds and to the Thrift Savings Plan (TSP) for federal employees. These costs would be paid out of agency appropriations and would be subject to limits in law on aggregate discretionary appropriations. We estimate that the open season provision would reduce direct spending by $434 million over the 1998-2007 period primarily because of increased agency retirement contributions to the Civil Service and Social Security trust funds, which would be reflected in the budget as an increase in offsetting receipts. Finally, we estimate that increased participation in the TSP would reduce revenues by $25 million over the same period.

CBO believes that the effects of this provision on the pay-as-you-go scorecard should be limited to the changes in on-budget revenues. CBO estimates that such revenues would decline by $151 million over the 1998-2002 period and by $312 million over the 1998-2007 period.
 

ESTIMATED COST TO THE FEDERAL GOVERNMENT

Table 1 displays CBO's estimate of the budgetary effects of the retirement provision of Public Law 105-61 through fiscal year 2007. Including discretionary appropriations, we project that this provision would have a net cost of $251 million over the next 10 years.
 

BASIS OF ESTIMATE

Number of Employees Switching

CSRS employees had a previous opportunity to switch to FERS during a six-month open season in 1987. About 86,000 employees--4.1 percent of all eligible employees--switched to FERS during this first open season. CBO estimates that approximately 11,500 people--fewer than one percent of all CSRS employees--would take advantage of this new opportunity to switch to FERS. This estimate is substantially lower than the 1987 figure for three reasons. First, it reflects the assumption that those CSRS employees who were most likely to switch to FERS did so in 1987. CBO assumed that "switch rates" in each year of service category (15 to 19 years, 20 to 24 years, etc.) for the 1998 open season would be half of the 1987 rates. Second, CSRS employees now typically have at least 14 years of service, and switch rates in 1987 were highest for CSRS employees with fewer than 10 years of service. Finally, the total number of CSRS employees, including Postal Service employees, is much lower now than in 1987 (1.2 million compared to 2.1 million).

The 1998 open season would extend from the last quarter of fiscal year 1998 to the first quarter of fiscal year 1999. CBO assumed that employees would apply to switch at a uniform rate--that is, about 2,000 applications would be submitted each month. In 1987 an employee's switch to FERS became effective in the first pay period after his application to switch was received; CBO assumed that applications for the 1998 open season will be processed similarly. Thus the transfers would occur roughly equally in fiscal years 1998 and 1999, and fiscal year 2000 would be the first full year under FERS for all of the switching employees.

Effects on Discretionary Spending

Increased Employer Contributions. CBO estimated the aggregate salary base for switching employees by multiplying the number of people switching in each service category by the average salary for CSRS employees in that category. Agency retirement contributions for most employee groups are currently 8.51 percent of employee pay for CSRS workers and 10.7 percent for FERS employees. Employing agencies would thus have to contribute an additional 2.2 percent of employee pay for workers who switch to FERS. This amount would rise to 3.7 percent in calendar year 2003 because employer contributions for most CSRS workers will decrease to 7.0 percent under provisions in the Balanced Budget Act of 1997. Thus, the increase in agencies' retirement contributions was calculated as 2.2 percent of the aggregate salary base through calender year 2002 and 3.7 percent thereafter, totaling an estimated $141 million over 10 years.

In addition to the increase in contributions to the retirement trust fund, agencies would also have to pay 6.2 percent of the salaries of the new FERS enrollees (up to the $68,400 maximum taxable salary) to the Social Security trust fund. CBO estimates that these payments would total $287 million over the 1998-2007 period.

Increased TSP Contributions. CSRS workers may wish to switch to FERS in order to expand their participation in the Thrift Savings Plan. CSRS employees currently do not receive government matching funds on their TSP contributions and cannot contribute more than 5 percent of their pay. CBO assumed that TSP contributions for switching employees would rise from 4 percent (the current average for CSRS employees who participate in TSP) to 7 percent. Although employee contributions to TSP are not reflected in the federal budget, the switching employees would become eligible for the full 5 percent government match. CBO estimates that the government's outlays for these additional matching payments, calculated as 5 percent of the aggregate salary base for switching employees, would total $232 million over 10 years.

Including contributions to the Civil Service retirement fund, the Social Security trust fund, and the Thrift Savings Plan, the bill would increase federal agencies' costs on behalf of each employee who switched to FERS by more than 13 percent of the employee's salary, or an average of about $6,500 per employee in 2000. In total, agencies' costs for these employees would increase by $9 million in fiscal year 1998 and $660 million over the 1998-2007 period. Such outlays are classified as discretionary spending, which is capped through 2002 by the Balanced Budget Act of 1997. Under these caps, agencies would be required to cut back on their personnel or other spending in order to pay for the increased costs for employees switching to FERS.

Effects on Direct Spending and Revenues

Receipts to Trust Funds. The increases in agency contributions--other than to TSP--would be reflected in the budget both as additional agency outlays and as offsetting receipts to the trust funds. Thus, receipts to the Civil Service trust fund would increase by $141 million over 10 years, and receipts to the Social Security trust fund would increase by $287 million over that period.

FERS and CSRS Pension Payments. CBO's estimate assumes that few of the employees switching to FERS would retire within the next five years. This assumption is based on two factors: (a) few of the employees switching would have more than 30 years of service, and (b) employees switching to FERS to avoid the Social Security government pension offset must first work at least five years under FERS. CBO assumed that switching workers would begin to retire at the very end of fiscal year 2003, with the first substantial pension payments taking place in 2004. The government's outlays for FERS benefits for switching workers would be less--by an estimated $32 million through 2007--than the reduction in payments for CSRS benefits. This savings reflects the differing accrual rates for annuity payments under CSRS (2 percent per year) and FERS (1 percent per year).

Social Security Benefits. Employees who switch to FERS and work at least five years under that system will not be affected by Social Security's government pension offset and may receive a spousal benefit. In addition, workers may also be eligible for survivor benefits. CBO assumed that retiring workers would receive an average Social Security benefit of approximately $250 a month beginning in fiscal year 2004.

Revenue Loss. Income used for TSP contributions is exempt from income tax. The 3 percentage point increase in TSP contributions for switching employees would thus lower taxable income and revenue. CBO estimated the additional amount exempt from income tax as 3 percent of the aggregate salary base, and the corresponding revenue loss as 19 percent of that amount, or $25 million over ten years.

Shift in Employee Contributions. CSRS employees switching to FERS would contribute 7.0 percent of their pay towards retirement on earnings up to the Social Security maximum wage level--$68,400 in 1998--and 0.8 percent on earnings above that level. These are the same percentages they would contribute under CSRS for salaries up to $68,400. But, under FERS, 6.2 percentage points (of the 7.0) would go to the Social Security trust fund instead of the Civil Service trust fund. This change would shift revenues from one fund to the other but would have no significant net budgetary impact.
 

PAY-AS-YOU-GO CONSIDERATIONS

Under the procedures established by the Balanced Budget and Emergency Deficit Control Act of 1985, changes in on-budget direct spending caused by provisions in appropriation bills are effectively counted as increases or decreases in discretionary spending for purposes of determining compliance with the discretionary caps. For the current year and the budget year, such changes are added to the estimated discretionary budget authority and outlays attributed to the appropriation bill. For subsequent years, they are reflected on the discretionary side of the budget by adjusting the caps.

Changes in revenues, however, are not counted in determining compliance with the discretionary caps. Therefore, CBO believes that the on-budget revenue impacts of appropriation bills should be recorded on the pay-as-you-go scorecard.

The following table summarizes the on-budget revenue effects of the retirement provision in Public Law 105-61. Those effects include (1) the loss of income tax revenue resulting from the increase in employees' contributions to the TSP, and (2) the loss of on-budget revenue resulting from the switch of 6.2 percentage points of employees' contributions from the Civil Service trust fund to the off-budget Social Security trust fund. These two changes produce an estimated loss of on-budget revenues totaling $312 million over the 1998-2007 period, as shown in the table below. For purposes of enforcing pay-as-you-go procedures, only the effects in the budget year and the succeeding four years are counted.
 

The estimate of pay-as-you-go effects does not include discretionary outlays or off-budget revenues or outlays, which are not governed by the pay-as-you-go process. Thus, agency contributions from appropriated funds and Social Security revenues and benefit payments are excluded from this calculation.
 

ESTIMATE PREPARED BY:

Eric Rollins
 

ESTIMATE APPROVED BY:

Robert A. Sunshine,
Deputy Assistant Director for Budget Analysis