The Social Security Reform Debate

1
The Social Security Reform Debate

• John Turner
• AARP Public Policy Institute
• 10th International Pension Seminar
• Tokyo
• November 22, 2005

2
The Social Security Problem

• In 2041, the Social Security trust fund is
  projected to have insufficient funds to fully pay
  old-age benefits.
• The system will be able to pay about 75 percent
  of promised benefits at that point, and those
  benefits will be higher than the benefits paid in
  2005.
• These projections were done by the actuaries
  of the Social Security Administration.

3
The Future is Uncertain

• Another agency of the federal government, the
  Congressional Budget Office, using a different
  approach and assumptions, projects that Social
  Security will have sufficient funds until
  2051for 46 years.

4
A Crisis?

• In 2051, the youngest of the baby boomers will be
  86 years old.
• This is a problem, but it is not a crisis.

5
In Perspective

• Expressed as a fraction of GDP, the shortfall of
  Social Security financing is 0.7 of GDP.
• By comparison, the funding shortfall for
  Medicare, which is the medical care program for
  persons age 65 and older, is 1.4 of GDP. The
  problem is twice as large, but Congress is not
  focusing on it.

6
The US Debate

• 1. Should Social Security be reformed by
  traditional changes in its benefits and
  financing, or should we add individual accounts?
• 2. If we have individual accounts,
• should they be in addition to Social Security
  benefits or should they reduce Social Security
  benefits?

7
A Key Issue

• A key issue is how large should Social Security
  benefits be in the future.
• Conservatives tend to favor Social Security
  benefits being smaller than do liberals.

8
Social Security Benefits

• In 2004, the average monthly Social Security
  benefit was 926.
• Based on todays cost-of-living, that is not a
  lot of money.

9
The Traditional Approach

• The traditional approach to Social Security
  reform would be to have some combination of
  revenue increases and benefit cuts.

10
The Payroll Tax

• Social Security is financed by a payroll tax on
  earnings up to 90,000 in 2005.
• The tax is 12.4 percent of employee pay, half
  paid by employers and half paid by employees.

11
Increasing Revenue

• Revenue can be increased by raising the payroll
  tax rate and by raising the ceiling on taxable
  earnings.

12
International Comparison

• By international comparisons, the Social Security
  payroll tax of 12.4 is low.
• In Sweden, for example, the tax is 18.5.

13
Raising the Payroll Tax

• No one is advocating totally solving the Social
  Security financing problem through raising the
  payroll tax.
• For perspective, however-- if the tax were raised
  from 12.4 to 14.3, that would solve the
  problem, according to the Social Security
  Administration.
• According to the Congressional Budget Office, it
  would only need to be raised to 13.4.

14
Raising the Ceiling

• One of the proposals for getting more revenue
  into the system is to raise the ceiling on wages
  taxable under the payroll tax.
• Traditionally, the ceiling has been set so that
  90 of the total wages of all workers covered by
  Social Security were liable for the tax.

15
85

• Currently, only 85 of total wages of workers
  covered by Social Security are taxable.
• Raising the ceiling from 90,000 in 2005 to
  145,000 would bring 90 of total wages under the
  ceiling.

16
Raising the Retirement Age

• Currently, workers can receive Social Security
  benefits at age 62.
• While no change in Social Security to help
  restore solvency is popular, raising the early
  retirement age not a popular idea.

17
Arguments For

• People are living longer and healthier
• Jobs are less physically demanding
• People are starting work at older ages due to
  more years in school

18
Arguments Against

• Some people have physically demanding jobs where
  it is difficult to continue working past age 62.
• Some people are disabled and cannot work past age
  62.
• Some people are laid off and cannot find work
  past age 62.

19
International Perspective

• A number of nations have higher early retirement
  ages for Social Security
• For example, in the United Kingdom, the early
  retirement age for Social Security benefits is 65
  for men, and will be raised to age 65 for women
  in the future.

20
Individual Accounts

• Most of the current Social Security debate has
  been over individual accounts.
• President Bush has proposed that individual
  accounts be introduced that would reduce Social
  Security benefits.

21
Types of Individual Accounts
Relationship to Social Security Degree of Compulsion Add On Carve Out
Mandatory Sweden Chile
Voluntary 401(k), TSP UK, US Presidents Commission
22
Carve-Out Individual Accounts

• Carve-out individual accounts are what has been
  proposed by President Bush.
• They make the Social Security solvency problem
  worse by taking money away from Social Security.

23
How They Would Work

• For example, instead of contributing 12.4 to
  Social Security
• workers would contribute 10.4 to Social
  Security and 2 to an individual account.

24
At Retirement

• At retirement, instead of receiving the full
  Social Security benefit
• Workers would receive a smaller benefit,
  calculated so that if they had invested their
  individual accounts in government bonds the total
  benefit from Social Security and the individual
  accounts would be the same.

25
The Ownership Society

• President Bush has argued that this plan would
  expand ownership in American society
• He argues workers would actually own their
  individual account while they do not own their
  Social Security benefit.

26
The Debt Society

• While individuals own their add-on individual
  accounts, their voluntary carve-out accounts are
  more like a loan from the government.
• The government in effect lends to the worker the
  amount he or she would have contributed to Social
  Security. The worker repays the loan at
  retirement by giving back to the government some
  of the benefits he or she would have received.

27
Why look at international experience?

• With international experience, we arent solely
  relying on abstract analysis. We can assess the
  actual functioning of different types of systems.

28
Why Sweden and the UK?

• Sweden and the UK are the best examples for the
  United States.
• Sweden has add-on accounts.
• The UK has carve out accountsthey call it
  contracting out.

29
Sweden - Overview

• Starting in 2000, mandatory add-ons
• 2.5 contributed to mandatory individual accounts
• on top of 16 that is contributed to social
  security

30
Lessons from Sweden

• To reduce administrative costs--Government
  clearinghouse for collection of contributions and
  payment of benefits
• Contributions are credited to workers accounts
  once a year to save on administrative costs18
  months after the start of the year

31
Sweden

• More than 700 investment choicestoo many, most
  new entrants take the default fund
• A positive feature benefits can be taken as ¼,
  ½, ¾ or full benefitsfacilitating partial
  retirement

32
Problems in Sweden

• Most participants have lost money since the
  system was started in 2000.
• The default fund excludes some well-known
  companies, such as Coca-Cola, because of
  opposition to some of their policies.
• The benefits provided are not inflation indexed,
  and a survivors benefit is optional.

33
The UK

• Since 1987, the United Kingdom (UK) has allowed
  employees to voluntarily withdraw from part of
  social security by reducing their contributions
  and receiving reduced benefits. Instead,
  employees contribute to an individual account.

34
UK Overview

• The main points about the UK
• a complex system
• -- the only example among high-income
  countries of voluntary carve-out
  individual accounts
• Japan has such a system but for defined benefit
  plans, not individual accounts

35
UK -- Basics

• Up to 10.5 of taxable earnings diverted into an
  individual account, the amount depending on the
  workers age
• Future social security benefits are reduced

36
Lessons from the UK

• To keep down costs, contributions are credited
  once a year, 18 months after the start of the tax
  year.
• Since the early 1990s, there has been little
  growth in the number of people choosing the carve
  out individual account, despite the growth of the
  labor force.

37
Problems with Choice

• The element of choice raises problems
• Due to a lack of financial sophistication,
  many workers have been made worse off by taking
  the voluntary carve out (VCO) accounts
• The mis-selling scandal12 billion pounds have
  been paid to the victims (24 billion dollars)

38
Problems with the Offset

• The rebate rate paid into the private accounts
  for workers taking the carve out is reset every
  five years
• Two large life insurance companies have recently
  advised their clients to not take the VCO
  accounts and to return fully to social security
  because they feel the government made a mistake
  in setting the level of the rebate rate

39
Conclusions

• Social Securitys financing problems can be
  resolved by traditional approaches, which are to
  raise the payroll tax and lower benefits.
• Carve-out individual accounts would make the
  financing problems worse.

40
Conclusions (2)

• Sweden is a good model for relatively low- cost
  mandatory add-on accounts
• It keeps costs relatively low by using a
  government clearinghouse and by crediting
  accounts only once a year.

41
Conclusions (3)

• The UK indicates problems with voluntary carve
  out accounts --- people are leaving the system
  because of problems in determining the
  relationship between the carve out account and
  the reduction in social security benefits