Optimal Funding of Social Insurance Plans ISSA Conference for Actuaries and Statisticians Helsinki,

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Optimal Funding of Social Insurance PlansISSA
Conference for Actuaries and StatisticiansHelsink
i, Finland May 2007

• Alice H. Wade, Deputy Chief ActuaryUnited States
  Social Security Administration

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Objectives for Funding Social Insurance

• Meaningful retirement income
• At a price society is willing to pay
• Flexibility for changing attitudes
• Decisions through the political process

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US Social Security Cost rising Above Currently
Scheduled Tax Rates
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Why, and What to Do ?

• Aging populations largely from low fertility
• With fewer workers per beneficiary ---
• Need lower benefits or higher taxes
• The political balance will determine the outcome

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Benefit Replacement Rates Peak in 1980
Reductions Since Then
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Crosscurrents in Funding and Benefits

• Desire minimal benefit adequacy
• So benefits higher relative to taxes for low
  earners
• Comes at the cost of inequity for higher
  earners
• Also, inequity across generations is assured with
  pay-as-you-go financing

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Advance Funding in an Advanced Economy

• Well developed markets in equilibrium
• People are saving what they want to
• Additional savings schemes are unlikely to affect
  change in total saving and investment
• Additional savings require lower consumption in
  the near term
• Thus economic growth is unlikely to be affected

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Effect On Social Security

• However, by investing in equities with a higher
  expected rate of return, the system has the
  opportunity to improve overall rate of return.
• True whether have Trust Fund investment or
  personal account investment
• But this would be largely if not completely a
  swap---Social Security holding more equities and
  others holding less

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Investment in equities would be expected to
increase the return over just Government Bonds,
but this would not be certain
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Parameters for Change to Improve Financing?

• Assuming PAYGO financing, must lower scheduled
  benefits or raise scheduled revenue
• Choice 1) what is the desired balance between
  benefit levels and tax levels
• This is a decision for the political process
• Choices will vary over time and over generations

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Parameters for Change

• Choice 2) individual equity versus social
  adequacy
• Will benefits or taxes be regressive or
  progressive
• Progressivity of benefits may look different on a
  monthly benefit basis versus a lifetime basis

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Parameters for Change

• Choice 3) How predictable should benefit and tax
  levels be?
• Automatic provisions adjusting retirement age or
  tax rates make financial status more predictable
• But these approaches make the tax rates and
  benefit levels less predictable and knowable in
  advance

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Approaches for Restoring Solvency

• Index the normal retirement age (NRA) for
  increasing life expectancy
• But changes in birth rates have more profound
  impact that is not readily addressed with an
  indexing provision
• To restore solvency by raising NRA alone would
  require increase from 66 now to 76 by 2080

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Approaches for Restoring Solvency

• More widely accepted is a change in the indexing
  of benefits.
• Changing indexing across generations from average
  wage indexing to price-level indexing would
  eliminate the financing shortfall
• But benefit replacement rates would be cut in
  half every 63 years
• Only 30 reduction is needed by 2080, so could
  return to wage indexing after about 32 years.

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Price Indexing Across Generations
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Approaches for Restoring Solvency

• Progressive Price Indexing
• Could allow wage indexing to continue below some
  level, like the 30th percentile
• Then reduce benefit for the highest earners as in
  full price indexing
• And allow reductions to be scaled in between.
• Would eventually produce a flat benefit for top
  70 percent of workers
• Reduce deficit by 75, if disabled are excluded
  65 of deficit would be eliminated

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Approaches for Restoring Solvency

• Additional Revenue---
• Raise 12.4 tax rate to 14.5 percent immediately
  by 2080 more increase would be needed for total
  increase of 5.4 percent
• Or could wait until 2040 and raise tax rate each
  year to what is needed 4.3 percent in 2040 up to
  5.4 percent in 2080

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Options for tax rate increases
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Approaches for Restoring Solvency

• Could eliminate the limit on earnings taxed,
  currently about 98,000
• This would eliminate the 75-year shortfall is no
  additional benefits accrued
• If additional benefits accrued at the lowest
  marginal rate (15) then about 75 of the
  75-yeardeficit would be eliminated

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Approaches for Restoring Solvency

• Creative Revenue Option
• Redirect inheritance tax to Social Security.
• This tax is being phased down by 2009 to 45 on
  estates over 3.5 million
• Proposal would keep these levels and direct
  revenue to Social Security
• Would eliminate 25 of 75-year deficit
• Currently estate tax is scheduled to disappear in
  2010, then return for estates over 1 million

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Conclusion

• In well developed economies, there is little
  difference in economic impact of PAYGO versus
  advance funded systems
• Total cost each year must be met that year from
  then current revenue essentially from current
  workerstax them, borrow from them, or sell them
  financial assets
• Real optimal funding is what society wants and
  must be determined by elected policymakers---actua
  ries just help them in this process