Evaluating Proposals for Social Security Reform

1
Evaluating Proposals for Social Security Reform
Social Security University February 24,
2005 Presented by Michael Tanner, Director of
Health and Welfare Studies The Cato Institute,
Washington, D.C. www.socialsecurity.org
2
Challenges Facing Social Security

• Its going broke Social Security will begin
  running payroll tax deficits within 15 years. By
  2041, it will be legally and financially unable
  to pay full promised benefits, resulting in cuts
  of 25 percent or more.
• Its unfair Social Security often discriminates
  against working women divorcees African
  Americans and younger Americans.
• It hurts wealth creation asset ownership brings
  a host of economic and social benefits. Social
  Security discourages saving by the poor, reducing
  wealth accumulation and increasing economic
  inequality.
• Its risky workers have no legal right to their
  benefits, even after a lifetime of contributions.
  The lack of a legal obligation encourages the
  government to make promises it cannot keep, and
  to delay action on reform.

3
Doing nothing is not an option

• Many honest people oppose personal accounts. Its
  not just politics.
• But rejecting accounts doesnt get you off the
  hook Social Security still needs to be reformed.
  One way or another, Social Securitys financing
  problems must be resolved.
• Responsible opponents of personal accounts have
  their own ideas.
• If we choose not to implement personal accounts,
  what are the other options open to us?
• What are the costs and benefits, and the risks
  and rewards, of these non-account reform
  proposals?

4
What are the alternatives?

• Only three options
• a) Raise Taxes
• b) Reduce Benefits
• c) Invest Privately
• 1) Government
• 2) Individuals
• -- Bill Clinton,July 27, 1998

5
The Menu for Reform

• Increased funding to raise pension reserves is
  possible only with some combination of additional
  tax revenues, reduced benefits, or increased
  investment returns from investing in higher yield
  assets
• Henry Aaron, Brookings
  Institution
• Testimony to Congress
• January 19, 1999

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Proposals Without Individual Accounts
7
Rep. Peter DeFazios Plan

• Tax Increase Lifts cap on payroll taxes, which
  currently apply only to first 84,900 in wages.
  12.4 percent tax would apply to all of workers
  wages, but workers wouldnt receive credit for
  extra taxes. A worker earning 150,000 would pay
  an extra 8,100 in taxes each year, but receive
  no extra benefits.
• Government Investment Requires the government to
  invest 40 percent of the trust fund in private
  stocks and bonds.
• Benefit Cuts Bases benefits on workers 38
  highest earning years, vs. 35 under current
  system.
• Tax exemption Exempts first 4,000 in wages from
  payroll taxes.
• Miscellaneous
• Increases benefits 5 percent for retirees over
  age 85.
• Allows parents three child care years without
  affecting their benefits.

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Orszag-Diamond Plan

• Increase employee share of the payroll tax very
  gradually from 6.2 percent in 2005 to 7.1 percent
  in 2055
• Raise the cap on taxable earnings to cover 87 of
  earnings
• Impose an additional tax on earnings above the
  maximum taxable earnings base, starting at 3
  percent and gradually rising to 3.5 by 2080.
• Introduce mandatory Social Security coverage for
  newly hired state and local government workers.

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Orszag-Diamond Continued

• Reduce benefits slightly for all workers. For
  today's average-earning workers will be the
  following 45-year-old, .06 percent 35-year-old,
  4.5 percent 25-year- old, 8.6 percent.
• Create a third bend-point to further reduce
  benefits for upper income workers.
• Assumes Trust Fund assets, but includes no
  mechanism for funding them.

10
Henry Aaron and Robert Reischauer Plan(Brookings
Institution/Urban Institute)

• Tax increases
• Transfer around 100 billion of general revenues
  each year for the next 20 years.
• Increase payroll tax ceiling to cover 90 percent
  of wages (raises ceiling to approx 105,000).
• Government investment
• 20 percent of the trust fund in the stock market.
• Benefit cuts
• Increase the normal and the early retirement age
  to 67 and 64 by 2011, then increase annually for
  longevity.
• Make 85 percent of Social Security benefits
  subject to income taxes eliminate exemptions of
  25k for singles and 32k for couples.
• Reduce the spousal benefit from one-half to
  one-third of the primary earners benefit.
• Increase the benefit computation period from the
  35 to 38 highest earning years.

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SABO PLANMartin Sabo (D-Minn.)

• Increase Interest Rate Paid to Bonds in Trust
  Fund

12
Social Security Finances Before Sabo Plan
Social Security Begins Running Cash-Flow Deficits
by 2018
13
Social Security Finances After Sabo Plan
Social Security Begins Running Cash-Flow Deficits
by 2018
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What About Raising the Cap?
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(No Transcript)
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Summary

• It is possible to achieve solvency without
  personal accounts, and some non-account plans do
  so. However
• Many non-account plans dont reach permanent
  solvency, and some dont even extend Social
  Securitys life through 75 years.
• Non-account plans rely on tax increases and
  benefit reductions that most Americans oppose.
• Non-account plans dont give workers a legal
  right to their benefits, dont allow for
  inheritances and wealth-building, and do little
  to shield Social Securitys finances from raids
  to cover other spending.
• Non-account plans dont eliminate many of the
  unfair aspects of Social Securitys benefit
  structure that can disadvantage working women,
  divorced workers, younger workers and African
  Americans.
• But if these are the plans that personal account
  opponents favor, they should not be afraid to
  submit them for head-to-head debate.

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Personal accounts basics

• Workers could invest part or all of their payroll
  taxes in accounts holding diversified stock and
  bond mutual funds. Higher returns on market
  investments would increase benefits for the
  worker.
• Workers choosing accounts would give up part of
  their traditional benefits. This offset would
  reduce pressure on the current systems finances,
  since it would have to pay out fewer benefits.
• At retirement, workers could purchase an annuity
  giving a guaranteed monthly income, or take
  gradual withdrawals of their money.
• If the worker died before the account was
  exhausted, the remainder would pass onto his
  spouse, children or a chosen charity.

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Proposals With Personal AccountsIssues to
Consider

• Single-Tier or Two-Tier System
• Size Matters
• Payable or Promised Benefits
• Transition Financing
• -- internal or external

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Size Matters

• Arguments for small accounts
• privatization
• Diversification of risk
• Short-term cash flow costs
• Arguments for big accounts
• Wealth accumulation
• Minimize administrative costs
• Single-Tier system
• Build enthusiasm
• Easy to understand
• Progressive accounts?

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Kolbe and Boyd (Stenholm), 21st Century
Retirement Security Act

• Account Size 3 percent of the first 10,000 of
  taxable earnings and 2 percent of the remaining
  taxable earnings. Accounts are mandatory.
• Voluntary additional contributions up to 5,000.
  Matched for low-income workers up to 600.
• Changes in existing program
• Speed up increase in retirement age
• Increase wage cap
• COLA changes
• Guarantees benefits equal to 100 of poverty

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Graham, Social Security Solvency and
Modernization Act of 2003 (S 1878)

• Account Size 4 percent of taxable earnings up
  to 1,300. Commission to decide if account size
  increases.
• Allows additional contributions of up to 5,000
  per year. For low earners, there would be
  government matching up to 500.
• Change benefit formula from wage-indexed to
  price-indexed
• Workers who choose to remain in current systen
  given two options
• - payable benefits
• -promised benefits with increased tax
• Benefit guarantee of 120 of poverty
• May Lift Tax Cap

22
Shaw, Social Security Guarantee Plus Act of 2003
(HR 75)

• Account Size 4 percent of taxable earnings up
  to 1,000.
• However, not really carve-out. Accounts
  financed out of General Revenues through tax
  credit.
• Retirement annuity based on combination of
  accounts and traditional Social Security.
  Guarantees promised level of benefits
• Inheritable only prior to retirement. No true
  ownership.

23
Ryan-SununuSocial Security Personal Savings and
Prosperity Act

• Account Size 10 percent of the first 10,000 of
  their taxable earnings, plus 5 percent of taxable
  earnings in excess of 10,000
• Guarantees promised level of benefits
• Transition largely financed by promised
  reductions in government spending (1 reduction
  from baseline projections).
• Short-term debt held off-budget

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Sam Johnson Individual Social Security
(Investment Program Act, HR 530).

• Account Size 6.2
• Individuals who choose individual accounts will
  receive a recognition bond based on past
  contributions to Social Security. Workers
  choosing individual accounts will forgo accrual
  of future benefits from traditional Social
  Security
• The remaining 6.2 percentage points of payroll
  taxes will be used to pay transition costs and to
  fund disability and survivors benefits. Once, far
  in the future, transition costs are fully paid
  for, this portion of the payroll tax will be
  reduced to the level necessary to pay survivors
  and disability benefits.

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Johnson Plan Continued

• Guarantee of benefits equal to 100 of poverty
• If an individual accumulates sufficient funds
  within their account to allow them to purchase an
  annuity that will keep them above a minimum
  income level in retirement they will be able to
  opt out of the Social Security system in its
  entirety.
• Workers who choose to remain in the traditional
  Social Security system will receive whatever
  level of benefits Social Security can pay with
  existing levels of taxation. Benefit formula
  changed from wage-indexing to price indexing

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President Bushs Plan

• Over 55, remain in current system
• Voluntary for workers under 55
• 4 Accounts, initially capped at 1,000
• Cap increases by 100 per year (above rate of
  wage growth)
• TSP-style investment options (lifecycle fund as
  default)
• At retirement, must annuitize up to poverty
  level.
• unspecified changes in benefits under
  traditional program.

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The Choice?

• Only three options
• a) Raise Taxes
• b) Reduce Benefits
• c) Invest Privately