Social Security: Challenges & Opportunities

Jeffrey R. Brown

January 13, 2005

Outline

1. What is the problem?

2. What solutions are available?• Approaches that do not solve the problem• Approaches that do solve the problem

3. The role of personal accounts

Workers per Beneficiary

0

2

4

6

8

10

12

14

16

18

3.3 today2.0 in 2040

16 in 1950

5 in 1960

Social Security Finances as % of Covered Earnings

8

10

12

14

16

18

20

2018

Expenditures

Tax Revenue

2042

CASH DEFICITS

Options for Restoring Fiscal Balance

1. On pay-as-you-go basis• Increase taxes • Reduce benefits (or benefit growth)

2. Pre-fund• Save more today to reduce future burden• Trust Funds vs. Personal Accounts

Four Different Approaches

Two that do NOT restore fiscal balance The “Do Nothing” approach The “Free Lunch” approach

Two that DO restore fiscal balance Reduce benefit growth (President’s Commission) Increase taxes (Diamond-Orszag)

The “Ostrich Strategy,” aka,The “Do Nothing” Plan

“There is no problem” “No immediate danger” “We can grow our way out” “The forecasts are

unreliable” “Minor tweaks will solve it”

“The higher return on stocks will save the system”

“No cuts in benefit growth are necessary”

“We can guarantee present law benefits with no new revenue”

Free

The “Free Lunch” Plan

Slowing Benefit Growth: The President’s Commission

Don’t touch benefits of today’s seniors Price index future starting benefits

– Future retirees would get at least as much as today’s retirees, adjusted for inflation

Puts system on permanently sustainable path within existing payroll tax rates

Raising Taxes: Diamond-Orszag

Reduce benefit growth– Longevity indexing

Increase taxes– Tax rate increase for longevity– Increase maximum earnings subject to tax– “Universal legacy charge,” aka, tax increase– “Legacy tax above earnings cap”

Tax increases account for approximately 85% of improvement in actuarial balance

Cost of D-O versus Current Law(as % of GDP)

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

2003

2007

2011

2015

2019

2023

2027

2031

2035

2039

2043

2047

2051

2055

2059

2063

2067

2071

2075

Cos

t rat

e as

per

cent

of G

DP

D-O CostCL Cost

CBO Estimates of Economic Impact(as of 2080 relative to TF financed baseline)

President’s Commission Plan would:– Increase GDP by 3 – 4% – Increase national wealth by10 – 12% – (Minimal effect on labor supply)

Diamond-Orszag Plan would:– Reduce GDP by 1.5% – Lower national capital stock by 0.8% - 1.4% – Reduce labor supply by 1.8 – 1.9%

Why Personal Accounts?

Provide opportunity for ALL Americans to participate in financial markets and build wealth

Improve work incentives

Provider superior mechanism for the country to save for the future and reduce future burden