social security doc of the concord coalition to the president’s commission to strengthen social security august 2001

STSTSTSTSTAAAAATEMENTTEMENTTEMENTTEMENTTEMENT OF OF OF OF OF THE CONCORD COALITIONTHE CONCORD COALITIONTHE CONCORD COALITIONTHE CONCORD COALITIONTHE CONCORD COALITION

TO TO TO TO TO THE PRESIDENT’S COMMISSION THE PRESIDENT’S COMMISSION THE PRESIDENT’S COMMISSION THE PRESIDENT’S COMMISSION THE PRESIDENT’S COMMISSION TTTTTOOOOOSTRENGTHEN SOCIAL SECURITYSTRENGTHEN SOCIAL SECURITYSTRENGTHEN SOCIAL SECURITYSTRENGTHEN SOCIAL SECURITYSTRENGTHEN SOCIAL SECURITY

AUGUST 2001AUGUST 2001AUGUST 2001AUGUST 2001AUGUST 2001

TTTTTable of Contentsable of Contentsable of Contentsable of Contentsable of Contents

Table of Contents i

List of Charts ii

I.I.I.I.I. OverviewOverviewOverviewOverviewOverview 11111

II.II.II.II.II. Putting Social Security rPutting Social Security rPutting Social Security rPutting Social Security rPutting Social Security reform in contexteform in contexteform in contexteform in contexteform in context 44444

III.III.III.III.III. Why rWhy rWhy rWhy rWhy reform is necessareform is necessareform is necessareform is necessareform is necessaryyyyy 55555

IVIVIVIVIV..... Reform CriteriaReform CriteriaReform CriteriaReform CriteriaReform Criteria 88888

VVVVV..... Why therWhy therWhy therWhy therWhy there is no fre is no fre is no fre is no fre is no free lunchee lunchee lunchee lunchee lunch 1010101010

VI.VI.VI.VI.VI. Designing a Personal Designing a Personal Designing a Personal Designing a Personal Designing a Personal Account PlanAccount PlanAccount PlanAccount PlanAccount Plan for Social Securityfor Social Securityfor Social Securityfor Social Securityfor Social Security 1515151515

VII.VII.VII.VII.VII. Possible Changes in the Possible Changes in the Possible Changes in the Possible Changes in the Possible Changes in the TTTTTraditional Prraditional Prraditional Prraditional Prraditional Programogramogramogramogram 2222222222

VIII.VIII.VIII.VIII.VIII. Looking Looking Looking Looking Looking AheadAheadAheadAheadAhead 2626262626

i

List of ChartsList of ChartsList of ChartsList of ChartsList of Charts

Putting Social Security Reform in contextPutting Social Security Reform in contextPutting Social Security Reform in contextPutting Social Security Reform in contextPutting Social Security Reform in context• Senior Benefits Threaten to Crowd all Other Priorities Out of the Budget—From Education to Defense

• Social Security and Medicare Part A Cumulative Cash Deficits

• Beyond our Official National Debt, We have Accumulated a $20 Trillion Mountain of Unfunded

Benefit Liabilities

Why rWhy rWhy rWhy rWhy reform is necessareform is necessareform is necessareform is necessareform is necessaryyyyy

• The Number of Workers Per Beneficiary Is Falling

• Social Security is Projected to Run a Cash Deficit of Over $4 Trillion Between 2016 and 2038—the

Official Date of Trust Fund Insolvency

• Social Security Is Unsustainable In Its Present Form

• Implied Tax Increase Under the Current System

• The Implied Cut in Current Benefits

• It Takes Longer and Longer to Recover Social Security Taxes Plus Interest After Retirement

• The U.S. Personal Savings Rate has Plummeted to New Lows

• Today’s Workers Expect to Rely on Their Own Savings in Retirement, Not Government Benefits

• But Most Workers Clearly Aren’t Saving Enough

• Even Counting Defined Contribution Pensions, the Typical Worker Nearing Retirement has Less than

$50,000 in Financial Assets

Why therWhy therWhy therWhy therWhy there is no fre is no fre is no fre is no fre is no free lunchee lunchee lunchee lunchee lunch

• Projected Social Security Surpluses—the “Lockbox”—are Dwarfed by Projected Social Security

Deficits

• The Myth of the 1.86 Percent Solution

• U.S. Annual Workforce Growth Will Slow Almost to a Halt

• The Trustees May be Greatly Underestimating Future Longevity and the Growth in the Number of Old

Old (age 85 and above)

ii

STSTSTSTSTAAAAATEMENTTEMENTTEMENTTEMENTTEMENT OF OF OF OF OF THE CONCORD COALITIONTHE CONCORD COALITIONTHE CONCORD COALITIONTHE CONCORD COALITIONTHE CONCORD COALITION

TTTTTO O O O O THETHETHETHETHE

PRESIDENT’S COMMISSION PRESIDENT’S COMMISSION PRESIDENT’S COMMISSION PRESIDENT’S COMMISSION PRESIDENT’S COMMISSION TTTTTO STRENGTHEN SOCIALO STRENGTHEN SOCIALO STRENGTHEN SOCIALO STRENGTHEN SOCIALO STRENGTHEN SOCIAL SECURITY SECURITY SECURITY SECURITY SECURITY

AUGUST 2001AUGUST 2001AUGUST 2001AUGUST 2001AUGUST 2001

I. OverviewI. OverviewI. OverviewI. OverviewI. Overview

The Concord Coalition heartily welcomes the effort of this Commission to strengthen Social Secu-rity for future generations. We stand ready to assist you in producing a credible plan for dealing with SocialSecurity’s long-term challenges in a fiscally responsible and generationally fair manner.

The interim report of the Commission makes a compelling case for swift action to close SocialSecurity’s long-term financing gap. At the same time, it highlights the importance of ensuring that reformresults in increased national savings. The next crucial step is to devise a credible solution that meets thechallenges set out in the interim report. Overall, reform must retain Social Security’s beneficial effects forretired and disabled people without overwhelming workers’ paychecks, the budget, or the economy.

The Concord Coalition has devoted much of its time and resources to promoting bipartisan dia-logue on the key long-term challenges facing Social Security, and evaluating potential solutions. Threeconclusions stand out:

Conclusion #1 Conclusion #1 Conclusion #1 Conclusion #1 Conclusion #1 Changing demographics make the curr Changing demographics make the curr Changing demographics make the curr Changing demographics make the curr Changing demographics make the current pay-as-you-go system fiscally unsus-ent pay-as-you-go system fiscally unsus-ent pay-as-you-go system fiscally unsus-ent pay-as-you-go system fiscally unsus-ent pay-as-you-go system fiscally unsus-tainable.tainable.tainable.tainable.tainable.

• As recently as 1960 there were 5 workers for each Social Security beneficiary. Today the ratio is3.4 workers for each beneficiary. As the huge Baby Boom generation retires the ratio will fall to 2to 1.

• This dynamic will have a profound effect on the system’s fiscal sustainability. Social Security willgenerate ample surpluses for the next several years. But in 2008, the year the first baby boomerswill qualify for benefits, the annual cash surplus will begin to shrink, and by 2016 the trusteesproject that Social Security’s cash flow will turn negative.

• From 2016 through 2038 Social Security will need to draw upon interest income and eventuallyliquidation of its trust fund assets—special issue Treasury bonds—to pay benefits. In 2038 the

1

trust fund will be depleted, leaving Social Security with enough annual income to pay just 73percent of benefits.

• ·Redeeming Social Security’s trust fund assets will have an impact on the rest of the budget becausethese assets are also liabilities to the Treasury. To come up with the money for Social Security,Treasury will have to cut other spending, raise taxes, use any surpluses that may exist, or borrowfrom the public.

• Between 2016 and 2038, the year of projected trust fund insolvency, the system faces a cumulativecash deficit of more than $4 trillion in today’s dollars.

• By 2038 the annual cash deficit will reach $330 billion in today’s dollars an amount roughly thesize of this year’s entire budget for national defense.

• Closing the gap that year would require a Social Security payroll tax hike of 40 percent or a nearly30 percent cut in benefits.

• Over the trustees’ 75-year horizon Social Security’s cash deficit of $22 trillion in today’s dollars faroutweighs the cash surplus of roughly $1 trillion through 2016, and the cash plus interest surplus of$3.7 trillion through 2025.

• As a percentage of the economy Social Security will grow from 4.17% today to 6.6% in 2038.

• More importantly, this growth in Social Security’s cost will take place in the context of rising costsfor other senior entitlements. The combined cost of Social Security, Medicare, and Medicaid willgrow from less than 10 percent of the economy today to over 20 percent by 2050. And this assumesno additions to the current programs.

Conclusion #2 Conclusion #2 Conclusion #2 Conclusion #2 Conclusion #2 Incr Incr Incr Incr Increasing savings to addreasing savings to addreasing savings to addreasing savings to addreasing savings to address the looming challenge is essential.ess the looming challenge is essential.ess the looming challenge is essential.ess the looming challenge is essential.ess the looming challenge is essential.

• The Social Security challenge is really a savings challenge. Real resources must be set aside tomeet the huge retirement and health care costs associated with the coming “senior boom.”

• A workable reform plan should pursue two strategies.

• First, reform should ensure Social Security’s fiscal sustainability by reducing its long-term costs.

• Second, it should make the remaining costs more affordable by increasing national savings, andhence the size of tomorrow’s economic pie.

• Increasing savings requires hard choices. Simply counting on robust stock market returns, or pre-sumed fiscal dividends from reform itself, is not a realistic solution.

• There is no free lunch solution. Each reform option involves trade-offs and each comes with afiscal and political price, regardless of whether it aims to prop up the existing pay-as-you-go sys-tem or aims at transitioning to a partially prefunded system.

2

Conclusion #3 Conclusion #3 Conclusion #3 Conclusion #3 Conclusion #3 Generational r Generational r Generational r Generational r Generational responsibility responsibility responsibility responsibility responsibility requirequirequirequirequires that pres that pres that pres that pres that prompt action be taken.ompt action be taken.ompt action be taken.ompt action be taken.ompt action be taken.

• The rationale for reforming Social Security now has nothing to do with today’s retirees or thosewho are about to retire. For them, there is no crisis.

• What’s at stake is the retirement security of future generations those who have many workingyears ahead, or who have yet to enter the workforce. For them, doing nothing is the worst option.

• The issue is what makes sense for the world of 2035, not what made sense in the world of 1935.

• The longer reform is delayed, the worse the problems inherent in the current system will becomeand the more difficult they will be to remedy.

• Delay risks losing the opportunity to act while the baby boom generation is still in its peak earningyears, and the trust fund is running an ample cash surplus.

• Squandering this opportunity would be an act of generational irresponsibility.

3

II. Putting Social Security rII. Putting Social Security rII. Putting Social Security rII. Putting Social Security rII. Putting Social Security reform in contexteform in contexteform in contexteform in contexteform in context

Social Security does not exist in a vacuum. The problems it will face in the future are part of a muchlarger retirement security challenge. And, to be clear, the retirement security challenge is not just to findsome extra cash for Social Security. The challenge is to prepare for the demographic tidal wave that willtransform our work lives, our health care system, our economy, and our culture.

The truth is that America, along with the rest of the developed world, is about to undergo an unprec-edented demographic transformation for whose vast cost it has no idea how to pay. Now is the time to beginpreparing for the aging of America by designing a retirement system that is both more secure for the oldand less burdensome for the young. Demographic and economic circumstances will never again be sofavorable for Social Security reform. With a small (Depression) generation in retirement and a large (BabyBoom) generation still in the workforce, America is enjoying a kind of “Demographic Indian Summer.”However, this window of opportunity is rapidly closing.

The prosperity of recent years has been very welcome. But it has not delayed the coming age wave.Nor has it erased the projected growth in senior benefit costs.

• By 2040, according to current projections, Social Security, Medicare, and Medicaid (whose ex-pected cost growth is due almost entirely to nursing home care) will consume roughly 80 percent offederal budget outlays.

• Since the mid-1990s, the officially projected cost of Social Security as a share of taxable payrollhas actually increased in every year beyond 2030.

• In November 1999, the Technical Panel of the Social Security Advisory Board warned that theofficial projections might greatly underestimate future longevity, and hence future costs.

• Following the recommendation of an official technical panel, the Trustees this year increased theirprojection of Medicare’s long-term cost rate by a staggering 60 percent.

If we reform Social Security today, the changes can be gradual and give everybody plenty of time toadjust and prepare. If we wait much longer, change will come anyway—but it is more likely to be suddenand arrive in the midst of economic and political crisis.

4

Source: Analytical P

erspective, Budget of

the United States, F

iscal Year 2002, page 24.

SeniorSeniorSeniorSeniorSenior B

enefits B

enefits B

enefits B

enefits B

enefits Thr

Thr

Thr

Thr

Threaten to C

reaten to C

reaten to C

reaten to C

reaten to C

rowd all O

therow

d all Other

owd all O

therow

d all Other

owd all O

ther Priorities

Priorities

Priorities

Priorities

Priorities

Out of the B

udget--Fr

Out of the B

udget--Fr

Out of the B

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udget--Fr

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udget--From

Education to D

efenseom

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efenseom

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efenseom

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efense

100%100%100%100%100%

75%75%75%75%75%

50%50%50%50%50%

25%25%25%25%25%

0%0% 0%0%0%1965

2001 2040

1965 2001

20401965

2001 2040

1965 2001

20401965

2001 2040

15%15%15%15%15%

46%46%46%46%46%

77%77%77%77%77%

Spending on Social SecuritySpending on Social SecuritySpending on Social SecuritySpending on Social SecuritySpending on Social Security, M

edicar, M

edicar, M

edicar, M

edicar, M

edicare, and Medicaid,

e, and Medicaid,

e, and Medicaid,

e, and Medicaid,

e, and Medicaid,

as a peras a peras a peras a peras a percent of non-inter

cent of non-intercent of non-intercent of non-intercent of non-interest outlays

est outlaysest outlaysest outlaysest outlays

This chart assum

es that total government spending

will equal 15.9 percent of G

DP in 2001 and 18.3

percent of GD

P in 2040.

SS SSSocial Security and Medicar

ocial Security and Medicar



ocial Security and Medicare P

are P

are P

are P

are P

art t t t t AA AAAC

umulative C

ash Deficits

Cum

ulative Cash D

eficitsC

umulative C

ash Deficits

Cum

ulative Cash D

eficitsC

umulative C

ash Deficits

(I(I (I(I(In Constant 2001 D

ollars, n C

onstant 2001 Dollars,

n Constant 2001 D

ollars, n C

onstant 2001 Dollars,

n Constant 2001 D

ollars, 2001-2075)2001-2075)2001-2075)2001-2075)2001-2075)

$500$500$500$500$500

$0$0 $0$0$0

-$500-$500-$500-$500-$500

-$1,000-$1,000-$1,000-$1,000-$1,000

-$1,500-$1,500-$1,500-$1,500-$1,500

-$2,000-$2,000-$2,000-$2,000-$2,000

2001 2010

2020 2030

2040 2050

2060 2070

20752001

2010 2020

2030 2040

2050 2060

2070 2075

2001 2010

2020 2030

2040 2050

2060 2070

20752001

2010 2020

2030 2040

2050 2060

2070 2075

2001 2010

2020 2030

2040 2050

2060 2070

2075

Calendar

Calendar

Calendar

Calendar

Calendar YY YYY

earearearearear

Source: Social Security Trustees’ Report, M

arch 2001--Intermediate P

rojections.

In Billions of Constant 2001 DollarsIn Billions of Constant 2001 DollarsIn Billions of Constant 2001 DollarsIn Billions of Constant 2001 DollarsIn Billions of Constant 2001 Dollars

-$22.2 trillion Cum

ulative-$22.2 trillion C

umulative

-$22.2 trillion Cum


umulative

-$22.2 trillion Cum

ulativeSocial Security C

ash Deficits

Social Security Cash D

eficitsSocial Security C

ash Deficits



ash Deficits

$1.3 trillion$1.3 trillion$1.3 trillion$1.3 trillion$1.3 trillionC

umulative C

ash Social SecurityC

umulative C


umulative C


umulative C


umulative C

ash Social SecurityA

nd Medicar

And M

edicarA

nd Medicar

And M

edicarA

nd Medicare Surpluses

e Surplusese Surplusese Surplusese Surpluses

-$22.7 trillion Cum


umulative

-$22.7 trillion Cum


umulative

-$22.7 trillion Cum

ulativeM

edicarM

edicarM

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edicarM

edicare Par

e Par

e Par

e Par

e Part t t t t AA AAA

Cash

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Deficits

Deficits

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-$44.9 trillion Cum


umulative

-$44.9 trillion Cum


umulative

-$44.9 trillion Cum

ulativeC

ash Social Security andC




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ssets and Liabilites at the

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rillions of Dollars

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rillions of Dollars

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$25$25$25$25$25

$20$20$20$20$20

$15$15$15$15$15

$10$10$10$10$10

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ssets L

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ssets L

iabilities

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Physical:$1.8

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TT TTTotal:otal:otal:otal:otal:

$2.3 $2.3 $2.3 $2.3 $2.3 TT TTT

rillionrillionrillionrillionrillion

Medicare:

$8.7

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Federal Pensions:$1.6

Other Financial

Liabilities:

$0.2

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ebt:$3.6

TT TTTotal:otal:otal:otal:otal:

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rillionrillionrillionrillionrillion

Unfunded Benefit Liabilities: $19.9 Trillion

Source: OM

B and SSA

All figures are discounted to present value at the end of fiscal year 1999.

III. III. III. III. III. Why rWhy rWhy rWhy rWhy reform is necessareform is necessareform is necessareform is necessareform is necessaryyyyy

For over 60 years Social Security has provided a vital floor of protection. Its broad range of retire-ment, disability, and survivors’ benefits for millions of Americans makes it an important issue for peopleof all ages. But Social Security’s future is neither as bright nor as secure as its past. Changing demograph-ics render the current pay-as-you-go system fiscally unsustainable and generationally inequitable over thelong-term. Reversing this trend will require facing up to some hard choices and making far-sighted deci-sions.

In assessing the case for Social Security reform, it is important to remember why the issue is on thepolitical agenda. There are five major reasons:

1.1.1.1.1. Social Security will impose a mounting fiscal and economic burden long beforSocial Security will impose a mounting fiscal and economic burden long beforSocial Security will impose a mounting fiscal and economic burden long beforSocial Security will impose a mounting fiscal and economic burden long beforSocial Security will impose a mounting fiscal and economic burden long before its ofe its ofe its ofe its ofe its officialficialficialficialficialtrust fund bankruptcytrust fund bankruptcytrust fund bankruptcytrust fund bankruptcytrust fund bankruptcy.....

• According to the program’s Trustees, annual benefits will exceed annual tax revenues by awidening margin beginning in 2016, long before the projected trust fund bankruptcy in2038

• Once Social Security starts running cash deficits in 2016, it will have to redeem its trust-fund assets if it is to continue paying promised benefits.

• But these assets—special issue Treasury bonds—are essentially IOUs from the govern-ment to itself. The same bonds that are assets to Social Security are liabilities to the Trea-sury, which means all of us. To come up with the cash to honor these obligations, Congresswill have to raise taxes, cut other federal spending, borrow from the public, or consume anysurpluses that may exist.

• These are exactly the same choices lawmakers would face in 2016 if the trust funds didn’texist.

• From 2016 to 2038, while Social Security is still technically solvent, the Treasury will haveto come up with over $4 trillion in today’s dollars to redeem the trust fund assets.

• During this same 22 years period taxpayers will also have to come up with over $2 trillionin today’s dollars to cover the projected cash shortfalls in the Medicare Hospital Insurancetrust fund.

• The cumulative cash deficits over the Trustees’ traditional 75-year horizon amounts toroughly $22 trillion in today’s dollars. Adding Medicare to this calculation yields a cumu-lative projected deficit of over $44 trillion.

5

2.2.2.2.2. Absent rAbsent rAbsent rAbsent rAbsent reform, the curreform, the curreform, the curreform, the curreform, the current system will lead to steep tax hikes orent system will lead to steep tax hikes orent system will lead to steep tax hikes orent system will lead to steep tax hikes orent system will lead to steep tax hikes or big benefit cuts. big benefit cuts. big benefit cuts. big benefit cuts. big benefit cuts.

• So long as the trust funds possess assets Social Security has the budget authority to paypromised benefits. Once they are insolvent benefits will have to be cut unless new revenueis raised and allocated to the trust funds.

• The required benefit cuts or tax increases are very large.

• If the status quo is maintained today’s typical 35 year-old can expect to get just 87 cents ofevery dollar in promised benefits; today’s 25 year-old can expect just 72 cents.

• The alternative to a big benefit cut is a steep tax increase.

• By 2038, the projected date of trust fund insolvency, Social Security is projected to cost17.8 percent of payroll an increase of 70 percent over today’s cost (10.5 percent).

• Paying full promised benefits in that year would require a payroll tax increase of roughly 40percent over today’s rate (12.4 percent).

• Thereafter, provided current law benefit promises are not reduced, that burden will continueto rise—all the way to 19.4 percent of payroll by 2075, the Trustees’ time horizon.

3.3.3.3.3. Social Security’Social Security’Social Security’Social Security’Social Security’s pay-as-you-go structurs pay-as-you-go structurs pay-as-you-go structurs pay-as-you-go structurs pay-as-you-go structure undermines savings.e undermines savings.e undermines savings.e undermines savings.e undermines savings.

• Beyond fiscal sustainability, pay-as-you-go financing poses a more basic problem for anaging society: maintaining an adequate level of national savings.

• In the first place, Social Security’s widening cash deficits threaten to trigger a huge newrun-up in the publicly-held debt starting in the 2010s. If the projected Social Security cashdeficits have to be deficit financed the cost to taxpayers will swell by another $6 trillion intoday’s dollars through 2038 due to the added interest cost.

• Moreover, economists widely believe that Social Security’s pay-as-you-go structure dis-courages household savings, and hence capital formation, because it promises householdsfuture benefit income while creating no real economic resources to generate that income.As a result, households put less into other (fully funded) forms of savings.

4.4.4.4.4. The rate of rThe rate of rThe rate of rThe rate of rThe rate of return on payreturn on payreturn on payreturn on payreturn on payroll contributions, oroll contributions, oroll contributions, oroll contributions, oroll contributions, or “moneyswor “moneyswor “moneyswor “moneyswor “moneysworth,” will continue to decline un-th,” will continue to decline un-th,” will continue to decline un-th,” will continue to decline un-th,” will continue to decline un-derderderderder the curr the curr the curr the curr the current system.ent system.ent system.ent system.ent system.

• A fair return on contributions, “individual equity,” is basic to the public’s understanding ofSocial Security. But today, for the first time in the history of the program, large categories ofnewly retiring workers are due to get back less than the market value of prior contributions.

6

• Social Security does and should provide a better deal to some categories of workers, espe-cially low-earners. But among today’s younger Americans, virtually all categories — in-cluding the favored categories — will see a continued decline in the moneysworth of theirpayroll contributions.

• The typical single male retiring in 2035 (today’s 33 year-old) can expect a return on hislifetime Social Security contributions of just one percent. And this assumes that promisedbenefits will be paid in full even beyond the date of trust fund insolvency.

• The problem lies in Social Security’s pay-as-you-go structure. Workers must always diverta part of their contributions to paying off the unfunded claims of the previous generation.

• This structure allowed early cohorts of beneficiaries, rich and poor alike, to receive windfallpaybacks. But there was a trade-off. The decision not to establish a funded system inevita-bly meant that the payback for later beneficiaries would be less than the market return ontheir contributions even less than the return on risk-free Treasury bonds.

5.5.5.5.5. The public is losing confidence in Social SecurityThe public is losing confidence in Social SecurityThe public is losing confidence in Social SecurityThe public is losing confidence in Social SecurityThe public is losing confidence in Social Security.....

• With a growing share of Americans concerned about Social Security’s fiscal sustainabilityand disappointed in its declining moneysworth, surveys show that public confidence in theprogram has declined dramatically.

• This decline in confidence is itself a major problem for a system that depends critically oneveryone’s approval and trust. Social Security is indeed a generational contract in whicheach generation’s welfare depends directly upon the willingness of the next generation toparticipate.

• If the next generation grows disaffected and suspects it is not being treated on an equitablebasis, the survival of the system is thrown into question.

7

The N

umber

The N

umber

The N

umber

The N

umber

The N

umber of

of of of of WW WWW

orkers Per

orkers Per

orkers Per

orkers Per

orkers Per B

eneficiar B

eneficiar B

eneficiar B

eneficiar B

eneficiary Is Falling

y Is Falling

y Is Falling

y Is Falling

y Is Falling

55 55544 44433 33322 22211 11100 0001960 1970 1980 1990 2000 2010 2020 2030 20401960 1970 1980 1990 2000 2010 2020 2030 20401960 1970 1980 1990 2000 2010 2020 2030 20401960 1970 1980 1990 2000 2010 2020 2030 20401960 1970 1980 1990 2000 2010 2020 2030 2040

Calendar

Calendar

Calendar

Calendar

Calendar YY YYY

earearearearear

Ratio of Ratio of Ratio of Ratio of Ratio of WWWWWorkers Perorkers Perorkers Perorkers Perorkers Per Beneficiar Beneficiar Beneficiar Beneficiar Beneficiaryyyyy19601960196019601960

5.1 workers

5.1 workers

5.1 workers

5.1 workers

5.1 workers

per beneficiaryper beneficiaryper beneficiaryper beneficiaryper beneficiary

20012001200120012001

3.4 workers

3.4 workers

3.4 workers

3.4 workers

3.4 workers


20352035203520352035

2.1 workers

2.1 workers

2.1 workers

2.1 workers

2.1 workers


Source: Social Security Trustees’ Report (2001)

Social Security is Pr




Social Security is Projected to R

un a Cash D

eficit ofojected to R

un a Cash D


un a Cash D


un a Cash D


un a Cash D

eficit ofO

verO

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verO

ver $4 $4 $4 $4 $4 TT TTT

rillion Betw

een 2016 and 2038--the Of

rillion Betw


rillion Betw


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een 2016 and 2038--the Official D

ate official D

ate official D

ate official D

ate official D

ate ofTT TTT

rust Fund Insolvency





2000 2005

2010 2015

2020 2025

2030 2035

2000 2005

2010 2015

2020 2025

2030 2035

2000 2005

2010 2015

2020 2025

2030 2035

2000 2005

2010 2015

2020 2025

2030 2035

2000 2005

2010 2015

2020 2025

2030 2035

YY YYYearearearearear

$150$150$150$150$150

$100$100$100$100$100

$50$50$50$50$50

$0$0 $0$0$0

-$50-$50-$50-$50-$50

-$100-$100-$100-$100-$100

-$150-$150-$150-$150-$150

-$200-$200-$200-$200-$200

-$250-$250-$250-$250-$250

-$300-$300-$300-$300-$300

-$350-$350-$350-$350-$350


In Billions of Constant 2000 DollarsIn Billions of Constant 2000 DollarsIn Billions of Constant 2000 DollarsIn Billions of Constant 2000 DollarsIn Billions of Constant 2000 Dollars



ash Deficits



ash Deficits


eficits$4.8 $4.8 $4.8 $4.8 $4.8 TT TTT

rillion, 2016-2038rillion, 2016-2038rillion, 2016-2038rillion, 2016-2038rillion, 2016-2038

Social Security Cash Surplus





$1,069 Billion, 2001-2015

$1,069 Billion, 2001-2015

$1,069 Billion, 2001-2015

$1,069 Billion, 2001-2015

$1,069 Billion, 2001-2015

2000 2010

2020 2030

2040 2050

2060 2070

20752000

2010 2020

2030 2040

2050 2060

2070 2075

2000 2010

2020 2030

2040 2050

2060 2070

20752000

2010 2020

2030 2040

2050 2060

2070 2075

2000 2010

2020 2030

2040 2050

2060 2070

2075YY YYY

earearearearear

2020 2020201818 1818181616 1616161414 1414141212 1212121010 101010

PerPerPerPerPercentage of centage of centage of centage of centage of TTTTTaxable Payraxable Payraxable Payraxable Payraxable Payrollollollolloll

SurplusSurplusSurplusSurplusSurplus

Social Security Benefits





Annual

Annual

Annual

Annual

Annual

Social SecuritySocial SecuritySocial SecuritySocial SecuritySocial Security

Deficits

Deficits

Deficits

Deficits

Deficits


Social Security Is Unsustainable In Its P

rSocial Security Is U

nsustainable In Its Pr


rSocial Security Is U

nsustainable In Its Pr


resent Form

esent Form

esent Form

esent Form

esent Form


Implied

Implied

Implied

Implied

Implied TT TTTax Incr

ax Incrax Incrax Incrax Increase U

nderease U

nderease U

nderease U

nderease U

nder the Curr

the Curr

the Curr

the Curr

the Current System

*ent System

*ent System

*ent System

*ent System

*

20%20%20%20%20%

15%15%15%15%15%

10%10%10%10%10%

5%5% 5%5%5%0%0% 0%0%0%1965

2001 2040

1965 2001

20401965

2001 2040

1965 2001

20401965

2001 2040

7.9%7.9%7.9%7.9%7.9%

10.5%10.5%10.5%10.5%10.5%

17.7%17.7%17.7%17.7%17.7%

Social Security Outlays, as a P

erSocial Security O

utlays, as a Per


erSocial Security O

utlays, as a Per


ercent of cent of cent of cent of cent of TT TTTaxable P

ayraxable P

ayraxable P

ayraxable P

ayraxable P

ayrollollollolloll

*Assum

es that there will be no reduction in prom

ised benefits.

The Im

plied Cut in C

urrT

he Implied C

ut in Curr

The Im

plied Cut in C

urrT

he Implied C

ut in Curr

The Im

plied Cut in C

urrent Benefits*

ent Benefits*

ent Benefits*

ent Benefits*

ent Benefits*


100%100%100%100%100%

80%80%80%80%80%

60%60%60%60%60%

40%40%40%40%40%

20%20%20%20%20%

10%10%10%10%10%

0%0% 0%0%0%A

ge 65A

ge 65A

ge 65A

ge 65A

ge 65A

ge 35A

ge 35A

ge 35A

ge 35A

ge 35A

ge 25A

ge 25A

ge 25A

ge 25A

ge 25N

ewborn

New

bornN

ewborn

New

bornN

ewborn

100%100%100%100%100%

87%87%87%87%87%

72%72%72%72%72%

66%66%66%66%66%

Per

Per

Per

Per

Percent of P

rcent of P

rcent of P

rcent of P

rcent of P

romised B

enefits Social Security Can

omised B


omised B


omised B


omised B

enefits Social Security Can A

fA

fA

fA

fA

fford Under

ford Under

ford Under

ford Under

ford Under O

f O

f O

f O

f O

fficial Pr

ficial Pr

ficial Pr

ficial Pr

ficial Projectionsojectionsojectionsojectionsojections

*Assum

es no change in the contribution rates.

It It It It It TT TTTakes L

ongerakes L

ongerakes L

ongerakes L

ongerakes L

onger And L

ongerA

nd Longer

And L

ongerA

nd Longer

And L

onger TT TTTo Recover

o Recover

o Recover

o Recover

o Recover

Social Security Social Security Social Security Social Security Social Security TT TTTaxes P

lus Interaxes P

lus Interaxes P

lus Interaxes P

lus Interaxes P

lus Interest est est est est A

fterA

fterA

fterA

fterA

fter Retir

Retir

Retir

Retir

Retirem

entem

entem

entem

entem

ent

9090 9090908080 8080807070 7070706060 6060605050 5050504040 4040403030 3030302020 2020201010 10101000 000

YYYYYears ears ears ears ears AfterAfterAfterAfterAfter Retir Retir Retir Retir Retirement Requirement Requirement Requirement Requirement Requiredededededto Recoverto Recoverto Recoverto Recoverto Recover TTTTTaxes Plus Interaxes Plus Interaxes Plus Interaxes Plus Interaxes Plus Interestestestestest

1960 1980

2001 2010

20201960

1980 2001

2010 2020

1960 1980

2001 2010

20201960

1980 2001

2010 2020

1960 1980

2001 2010

2020YY YYY

earearearearear of R

etir of R

etir of R

etir of R

etir of R

etirement

ement

ement

ement

ement

Minim

um E

arnerM

inimum

Earner

Minim

um E

arnerM

inimum

Earner

Minim

um E

arner

AA AAAverage E

arnerverage E

arnerverage E

arnerverage E

arnerverage E

arner

Maxim

um E

arnerM

aximum

Earner

Maxim

um E

arnerM

aximum

Earner

Maxim

um E

arner

Source: Congressional R

esearch Service, June 2001

Source: Bureau of E

conomic A

ffairs (2001)

The U

.S. Personal Savings R

ate has Plum

meted to N

ew L

ows

The U


ate has Plum

meted to N

ew L

ows

The U


ate has Plum

meted to N

ew L

ows

The U


ate has Plum

meted to N

ew L

ows

The U


ate has Plum

meted to N

ew L

ows

12%12%12%12%12%

10%10%10%10%10%

8%8% 8%8%8%6%6% 6%6%6%4%4% 4%4%4%2%2% 2%2%2%0%0% 0%0%0%1980

1982 1984

1986 1988

1990 1992

1994 1996

1998 2001

1980 1982

1984 1986

1988 1990

1992 1994

1996 1998

20011980

1982 1984

1986 1988

1990 1992

1994 1996

1998 2001

1980 1982

1984 1986

1988 1990

1992 1994

1996 1998

20011980

1982 1984

1986 1988

1990 1992

1994 1996

1998 2001

YY YYYearearearearear

Source: 2000 Retirem

ent Confidence Survey (E

BR

I)

60%60%60%60%60%

50%50%50%50%50%

40%40%40%40%40%

30%30%30%30%30%

20%20%20%20%20%

10%10%10%10%10%

0%0% 0%0%0%

53%53%53%53%53%

19%19%19%19%19%

Most Im

porM

ost Impor

Most Im

porM

ost Impor

Most Im

portant Expected Sour

tant Expected Sour

tant Expected Sour

tant Expected Sour

tant Expected Source of R

etirce of R

etirce of R

etirce of R

etirce of R

etirement

ement

ement

ement

ement

Income

Income

Income

Income

Income A

ccording to Curr

According to C

urrA

ccording to Curr

According to C

urrA

ccording to Current

ent ent ent ent WW WWW

orkers,orkers,orkers,orkers,orkers,

2000 Survey Results

2000 Survey Results

2000 Survey Results

2000 Survey Results

2000 Survey Results

TT TTToday’oday’oday’oday’oday’s s s s s WW WWW

orkers Expect to R

ely on orkers E

xpect to Rely on

orkers Expect to R

ely on orkers E

xpect to Rely on

orkers Expect to R

ely on Their

Their

Their

Their

Their O

wn Savings

Ow

n Savings O

wn Savings

Ow

n Savings O

wn Savings

in Retir

in Retir

in Retir

in Retir

in Retirem

ent, Not G

overnment B

enefitsem

ent, Not G

overnment B

enefitsem

ent, Not G

overnment B

enefitsem

ent, Not G

overnment B

enefitsem

ent, Not G

overnment B

enefitsPerPerPerPerPercent of cent of cent of cent of cent of WWWWWorkers Repororkers Repororkers Repororkers Repororkers Reportingtingtingtingting

11 1111%1% 1%1%1%8%8% 8%8%8%

7%7% 7%7%7%

Personal Savings

Personal Savings

Personal Savings

Personal Savings

Personal Savings

Em

ployer Pension

Em

ployer Pension

Em

ployer Pension

Em

ployer Pension

Em

ployer Pension

Other

Other

Other

Other

Other

Social SecuritySocial SecuritySocial SecuritySocial SecuritySocial Security

Em

ployment

Em

ployment

Em

ployment

Em

ployment

Em

ployment

Income Sour

Income Sour

Income Sour

Income Sour

Income Sourcece cecece

But M

ost B

ut Most

But M

ost B

ut Most

But M

ost WW WWWorkers C

learly orkers C

learly orkers C

learly orkers C

learly orkers C

learly Ar

Ar

Ar

Ar

Aren’t Saving E

noughen’t Saving E




nough

Don’t K

nowD

on’t Know

Don’t K

nowD

on’t Know

Don’t K

now

Source: 2000 Retirem

ent Confidence Survey (E

BR

I) 24%24%24%24%24%

21%21%21%21%21%

11 1111%1% 1%1%1%

22%22%22%22%22%

23%23%23%23%23%

35%35%35%35%35%

30%30%30%30%30%

25%25%25%25%25%

20%20%20%20%20%

15%15%15%15%15%

10%10%10%10%10%

5%5% 5%5%5%0%0% 0%0%0%

Am

ount A

mount

Am

ount A

mount

Am

ount Accum

ulated forA

ccumulated for

Accum

ulated forA

ccumulated for

Accum

ulated for Retir

Retir

Retir

Retir

Retirem

ent em

ent em

ent em

ent em

ent According to

According to

According to

According to

According to

Curr

Curr

Curr

Curr

Current

ent ent ent ent WW WWW

orkers, 2000 Survey Results





PerPerPerPerPercent of cent of cent of cent of cent of WWWWWorkers Repororkers Repororkers Repororkers Repororkers Reportingtingtingtingting

Over $100,000

Over $100,000

Over $100,000

Over $100,000

Over $100,000

Nothing

Nothing

Nothing

Nothing

Nothing

$25,000-$50,000$25,000-$50,000$25,000-$50,000$25,000-$50,000$25,000-$50,000

Under $25,000

Under $25,000

Under $25,000

Under $25,000

Under $25,000

Am

ount A

mount

Am

ount A

mount

Am

ount Accum

ulated forA

ccumulated for

Accum

ulated forA

ccumulated for

Accum

ulated for Retir

Retir

Retir

Retir

Retirem

entem

entem

entem

entem

ent

Even C

ounting Defined C

ontribution Pensions,

Even C

ounting Defined C


Even C

ounting Defined C


Even C

ounting Defined C


Even C

ounting Defined C


the the the the the TT TTT

ypical ypical ypical ypical ypical WW WWW

orkerorkerorkerorkerorker N

earing Retir

Nearing R

etir N

earing Retir

Nearing R

etir N

earing Retirem

ent hasem

ent hasem

ent hasem

ent hasem

ent hasL

ess than $50,000 in Financial

Less than $50,000 in F

inancial L

ess than $50,000 in Financial

Less than $50,000 in F

inancial L

ess than $50,000 in Financial A

ssetsA

ssetsA

ssetsA

ssetsA

ssets

Source: Federal Reserve $4,500

$4,500$4,500$4,500$4,500

$22,900$22,900$22,900$22,900$22,900

$36,600$36,600$36,600$36,600$36,600

$37,800$37,800$37,800$37,800$37,800

$45,600$45,600$45,600$45,600$45,600

$45,800$45,800$45,800$45,800$45,800

$60,000$60,000$60,000$60,000$60,000

$50,000$50,000$50,000$50,000$50,000

$40,000$40,000$40,000$40,000$40,000

$30,000$30,000$30,000$30,000$30,000

$20,000$20,000$20,000$20,000$20,000

$10,000$10,000$10,000$10,000$10,000

$0$0 $0$0$0

Median F

inancial M

edian Financial

Median F

inancial M

edian Financial

Median F

inancial Assets in 1998, Including

Assets in 1998, Including




Contributor

Contributor

Contributor

Contributor

Contributory R

etiry R

etiry R

etiry R

etiry R

etirement P

lans like IRA

sem

ent Plans like IR

As

ement P

lans like IRA

sem

ent Plans like IR

As

ement P

lans like IRA

sand 401(k)s, by and 401(k)s, by and 401(k)s, by and 401(k)s, by and 401(k)s, by A

ge of Household H

eadA

ge of Household H

eadA

ge of Household H

eadA

ge of Household H

eadA

ge of Household H

ead

Age of H

ousehold Head

Age of H

ousehold Head

Age of H

ousehold Head

Age of H

ousehold Head

Age of H

ousehold Head

Financial Financial Financial Financial Financial Assets in DollarsAssets in DollarsAssets in DollarsAssets in DollarsAssets in Dollars

Under

Under

Under

Under

Under A

ge 35A

ge 35A

ge 35A

ge 35A

ge 35A

ge 35-44A

ge 35-44A

ge 35-44A

ge 35-44A

ge 35-44A

ge 45-54A

ge 45-54A

ge 45-54A

ge 45-54A

ge 45-54A

ge 75 & O

verA

ge 75 & O

verA

ge 75 & O

verA

ge 75 & O

verA

ge 75 & O

verA

ge 55-64A

ge 55-64A

ge 55-64A

ge 55-64A

ge 55-64A

ge 65-74A

ge 65-74A

ge 65-74A

ge 65-74A

ge 65-74

IVIVIVIVIV. Reform Criteria. Reform Criteria. Reform Criteria. Reform Criteria. Reform Criteria

In assessing whether Social Security reform proposals face up to the real issues or merely concealor shift problems under the pretense of solving them, The Concord Coalition suggests that reform plans beevaluated using the following criteria:

• Does it imprDoes it imprDoes it imprDoes it imprDoes it improve net national savings? ove net national savings? ove net national savings? ove net national savings? ove net national savings? Given demographic trends, the economy in the future willbe called upon to transfer a rising share of real resources from workers to retirees. These resourceswill be much easier to find in a healthy growing economy than in a stagnant one. The best way toachieve economic growth and increase real income in the future is to increase savings today. Sav-ings provide the capital to finance investments, which will enhance productivity and increase theamount of goods and services each worker can produce. Without new savings reform is a zero–sumgame.

• Does it focus on fiscal sustainability ratherDoes it focus on fiscal sustainability ratherDoes it focus on fiscal sustainability ratherDoes it focus on fiscal sustainability ratherDoes it focus on fiscal sustainability rather than trust fund solvency? than trust fund solvency? than trust fund solvency? than trust fund solvency? than trust fund solvency? Trust fund solvency is thewrong goal because it is unrelated to the cost of future benefits or to the manner in which sufficientresources will be found to afford this cost. For example, the trust funds could be made perpetually“solvent” by granting them additional Treasury bonds, or by crediting them with higher interest onthe existing bonds. Such actions would improve trust fund solvency, but they would not make theprogram any more affordable for future workers. Fiscally, what really matters is Social Security’soperating balance that is, the annual difference between its outlays and its dedicated tax rev-enues. Trust fund accounting sidesteps the real issue, which is not how to meet some officialsolvency test, but how to ensure Social Security’s fiscal sustainability and generational fairness.

• Does it rDoes it rDoes it rDoes it rDoes it rely on a hike in the FICAely on a hike in the FICAely on a hike in the FICAely on a hike in the FICAely on a hike in the FICA tax? tax? tax? tax? tax? Hiking payroll taxes to meet benefit obligations is neitheran economically sound nor generationally equitable option and will fall most heavily on the middleclass. Younger Americans in particular may be skeptical of any plan that purports to improve theirretirement security by increasing their tax burden and by further lowering the return on their contri-butions.

• Does it rDoes it rDoes it rDoes it rDoes it rely on new debt?ely on new debt?ely on new debt?ely on new debt?ely on new debt? Paying for promised benefits or the transition to a more funded SocialSecurity system by issuing new debt defeats the whole purpose of reform. To the extent that plansrely on debt financing, they will not boost net savings. And without new savings, any gain for theSocial Security system must come at the expense of the rest of the budget, the economy, and futuregenerations. Resort to borrowing is ultimately a tax increase for our kids.

• Does it rDoes it rDoes it rDoes it rDoes it rely on outside financing?ely on outside financing?ely on outside financing?ely on outside financing?ely on outside financing? Unrelated tax hikes, and spending cuts may never be enacted,or if enacted, may easily be neutralized by other measures. Unless the American public sees a directlink between sacrifice and reward, the sacrifice is unlikely to happen. If projected non-Social Secu-rity budget surpluses are used to help close the financing gap some mechanism should be put inplace to guard against the possibility that these hoped for surpluses will fail to materialize.

8

• Does it use prudent assumptions?Does it use prudent assumptions?Does it use prudent assumptions?Does it use prudent assumptions?Does it use prudent assumptions? There must be no fiscal alchemy. The success of the plan mustnot depend upon large perpetual budget surpluses or lofty rates of return on privately owned ac-counts. All projections regarding private accounts should be based on long-term historical aver-ages, a prudent mix of equity and debt, and realistic estimates of new administrative costs.

Does it maintain the system’Does it maintain the system’Does it maintain the system’Does it maintain the system’Does it maintain the system’s prs prs prs prs progrogrogrogrogressivity? essivity? essivity? essivity? essivity? While individual equity (“moneysworth”) is impor-tant, so too is social adequacy. Social Security’s current benefit formula is designed so that benefitsreplace a higher share of wages for low-earning workers than for high-earning ones. Under anyreform plan, total benefits, including benefits from personal accounts, should remain as progres-sive as they are today.

• Does it prDoes it prDoes it prDoes it prDoes it protect parotect parotect parotect parotect participants against undue risk? ticipants against undue risk? ticipants against undue risk? ticipants against undue risk? ticipants against undue risk? Under the current system, workers face the riskthat future Congresses will default on today’s unfunded pay-as-you-go benefit promises. Whilereducing this “political risk,” reform should be careful to minimize other kinds of risk, such asinvestment risk, inflation risk, and longevity risk — i.e., the risk of outliving ones assets.

• Does it keep Social Security mandatorDoes it keep Social Security mandatorDoes it keep Social Security mandatorDoes it keep Social Security mandatorDoes it keep Social Security mandatory and pry and pry and pry and pry and preserve a full range of insurance preserve a full range of insurance preserve a full range of insurance preserve a full range of insurance preserve a full range of insurance protection?otection?otection?otection?otection?The government has a legitimate interest in seeing that people do not under-save during their work-ing lives and become reliant on the safety net in retirement. Moving toward personal ownershipneed not and should not mean “privatizing” Social Security. Any new personal accounts should bea mandatory part of the system. Moreover, Social Security does more than write checks to retirees.It also pays benefits to disabled workers, widows, widowers, and surviving children. A reformedsystem must continue to provide these important insurance protections.

9

VVVVV. . . . . Why therWhy therWhy therWhy therWhy there is no fre is no fre is no fre is no fre is no free lunchee lunchee lunchee lunchee lunch

Social Security’s dedicated revenues are nowhere near large enough to cover its long-term obliga-tions. This presents policymakers with limited options, none of which is a free lunch:

• Increase contributions to the system• Achieve a higher return on current contributions• Reduce promised benefits• Increase general revenue financing

Borrowing our way out of this problem is not a viable option because the demographic challengefacing the system is not a temporary bulge caused by baby boomer retirements. It is a permanent phenom-enon caused by longer life expectancy. Incurring ever-rising levels of debt to plug the gap would consumethe savings needed to spur economic growth, and impose higher income taxes on future generations.

Increasing general revenue financing of Social Security might appear to be an easy option in timesof budget surpluses. But large perpetual surpluses cannot be counted on, particularly given other budget-ary pressures caused by the coming “senior boom.” More importantly, however, a large expansion ofSocial Security’s general revenue financing would mark a substantial departure from the program’s self-financing tradition. If the link between dedicated contributions and benefits is severed, there will be less todistinguish Social Security from a welfare program, which is one reason the idea has been rejected manytimes in the past. Another problem with this idea is that it would weaken fiscal discipline within thesystem.

Closing the gap by traditional means alone raising taxes on workers and lowering benefits forretirees would inevitably result in a less generous program paid for at an increasingly burdensome cost.This is a generational lose-lose proposition.

Transitioning out of the current pay-as-you-go system into a partially funded system, with or with-out individually owned accounts, inevitably requires some group of workers to pay for the pre-funding ofthe new system while at the same time maintaining funding for those still receiving benefits under the oldsystem. There is no avoiding this transition cost.

Because the present system is fiscally unsustainable, some combination of cost cutting and revenueraising must be enacted. Investment income provides a way to mitigate these changes, however, no con-ceivable rate of return on investments, standing alone, would be enough to fund currently projected ben-efits at today’s contribution rate.

Moreover, if workers are allowed to invest a portion of their payroll taxes in private accounts therewill be that much less revenue left to pay benefits to those in the current program who are already retired,or who are about to retire. As a result, the cash flow deficit, now expected to arrive in 2016 would arrivesooner perhaps as soon as 2007. This would force policymakers to confront the impending gap betweendedicated revenues and promised benefits several years earlier.

10

Adding personal accounts without using the current payroll tax is not a cost free solution either. Itwould require higher payroll contributions or a substantial and permanent infusion of general revenues.

The bottom line is that the system requires new savings and this cannot happen without sacrifice inone form or another. The choice we face is not between guaranteed future benefits under the current systemand a risky path of reform; it is between reform options that, in different ways, attempt to ensure the fiscalsustainability of fair and adequate benefits over the long-term.

Despite widespread recognition that hard choices are unavoidable, this difficult work is forced tocompete for attention with an assortment of arguments for inaction and reform ideas that purport to fix theproblem without asking anyone to give anything up. Here are five of the most frequently used arguments:

Argument #1: Social Security can pay full benefits until the year 2038.Argument #1: Social Security can pay full benefits until the year 2038.Argument #1: Social Security can pay full benefits until the year 2038.Argument #1: Social Security can pay full benefits until the year 2038.Argument #1: Social Security can pay full benefits until the year 2038.

This argument is true as far as it goes, but it does not tell the full story. The Trustees now projectthat Social Security will be “solvent” until the year 2038 — meaning that its trust funds will possesssufficient assets, and hence budget authority, to cover benefits until that date. However, trust fund solvencysays nothing about fiscal sustainability.

The problem is that the trust funds are primarily an accounting device. Social Security’s assetsconsist of Treasury IOUs that can only be redeemed if Congress raises taxes, cuts other spending, usessurpluses, or borrows from the public. Thus, their existence, alone, doesn’t ease the burden of paying futurebenefits. It is true that when trust fund surpluses are used to reduce the publicly-held debt it does result inhigher savings. But experience has shown that trust fund surpluses are just as likely to be spent as saved. Ittherefore cannot be assumed that a trust fund surplus will result in higher savings. Fiscally, it is not thetrust fund balance, but the program’s operating balance that matters — that is, the annual difference be-tween its outlays and earmarked tax revenues. Social Security’s current operating surplus is due to beginfalling in 2008 and turn into an operating deficit in 2016. This deficit will widen to an annual cash shortfallof $330 billion in today’s dollars by 2038, the year the trust funds are projected to be become insolvent.

Argument #2: Argument #2: Argument #2: Argument #2: Argument #2: AAAAA mer mer mer mer mere 1.86 pere 1.86 pere 1.86 pere 1.86 pere 1.86 percent of payrcent of payrcent of payrcent of payrcent of payroll incroll incroll incroll incroll increase would curease would curease would curease would curease would cure the pre the pre the pre the pre the problem.oblem.oblem.oblem.oblem.

A related argument is that a tax hike of merely 1.86 percent of payroll is all that is needed to restoreSocial Security to long-term solvency. This claim is based on the program’s actuarial balance, whichaverages projected trust-fund surpluses and trust-fund deficits over the next seventy-five years. In 2001,Social Security’s actuarial balance was a shortfall of 1.86 percent of payroll. In theory, this is the amountthat Congress would have to raise FICA taxes or cut Social Security benefits, starting immediately, in orderto keep the trust funds solvent until 2075.

The proponents of this idea neglect to mention a couple of important caveats. For one thing,“mere” is a relative term: A tax hike of 1.86 percent of payroll is equivalent to a nearly 10 percent increase

11

in everyone’s personal income taxes. For another, the solution is not permanent: It assumes that thehorizon for trust-fund solvency will forever remain fixed at seventy-five years from today. In other words,it assumes that while we would require the trust funds to be in balance over a full seventy-five years, ourchildren will be satisfied with forty years and our grandchildren will be satisfied with an empty cupboard.

But there’s a more fundamental problem. As noted above, any trust-fund surplus is immediatelylent to Treasury, leaving Congress free to spend the money it is supposedly saving. For the 1.86 percentsolution to ease Social Security’s burden on the economy, legislators would have to allow the program’sextra interest-earning assets to accumulate unspent for thirty years. A proposition that seems unlikely andin any event cannot be guaranteed.

Argument #3: Saving the Social Security surplus in a “lockbox” to eliminate the publicly held debtArgument #3: Saving the Social Security surplus in a “lockbox” to eliminate the publicly held debtArgument #3: Saving the Social Security surplus in a “lockbox” to eliminate the publicly held debtArgument #3: Saving the Social Security surplus in a “lockbox” to eliminate the publicly held debtArgument #3: Saving the Social Security surplus in a “lockbox” to eliminate the publicly held debtcan solve the prcan solve the prcan solve the prcan solve the prcan solve the problem.oblem.oblem.oblem.oblem.

Reducing, or eliminating, the $3.4 trillion publicly held debt would help grow the economy, exertdownward pressure on interest rates, and result in large budgetary savings from lower interest costs. Butdebt reduction cannot solve the problem.

In present value terms, saving the total projected Social Security trust fund surplus through 2015would cover only 44 percent of the cash shortfall between 2016 and 2038, the date of trust fund bankruptcy.It would cover only 17 percent of the projected shortfall over the Trustees’ traditional 75-year time horizon.

Moreover, there is no guarantee that the reduction in publicly-held debt assumed by lockbox propo-nents will actually occur. Promising to devote the Social Security surplus to debt reduction is a fiscallyresponsible goal but it is easier said than done. Regardless of intent, and despite any bookkeeping devicessuch as a lockbox, the government can only save the Social Security surplus if it continues, year after year,to take in more money than it needs to pay all of its other bills without dipping into the Social Security trustfunds.

Success of the lockbox concept is therefore critically dependent on both the accuracy of notori-ously inaccurate long-range budget surplus projections and the willingness of future political leaders tomaintain fiscal discipline.

Argument #4: Argument #4: Argument #4: Argument #4: Argument #4: The The The The The TTTTTrustees arrustees arrustees arrustees arrustees are too pessimistic about the future too pessimistic about the future too pessimistic about the future too pessimistic about the future too pessimistic about the future.e.e.e.e.

Another frequently heard argument is that the Social Security Trustees are too pessimistic—that theprojections are unduly gloomy about future economic growth and that with more realistic assumptions theSocial Security problem disappears.

It is true that the Trustees project that the economy will grow more slowly in the future than it hasin the past. But this is a matter of arithmetic, not pessimism. Economic growth (GDP) depends on workforcegrowth, and this will fall to near zero when the Boomers start retiring.

12

• Since 1973, the U.S. workforce has grown by 1.7 percent per year.

• Over the next seventy-five years, it is projected to grow by just 0.3 percent per year.

• Given the demographics, it is unlikely that GDP growth will not slow.

A more legitimate question is whether the Trustees are too pessimistic about the growth in produc-tivity, or output per worker hour. In the future, the Trustees may have to raise their assumption. Since 1995,productivity has unexpectedly surged. Some believe that this heralds the arrival of a “new economy” inwhich information technologies and globalization will lead to permanently higher rates of productivitygrowth. But there are reasons to be skeptical:

• The new-economy thesis remains just that: a thesis. No one yet knows whether the surge in produc-tivity that began in the mid-1990s will outlast the current business cycle. The Trustees’ currentlong-term assumptions for productivity growth—1.5 percent per year—is right in line with therecord of the past twenty-five years.

• Even if the enthusiasts are right about the new economy, higher growth is no long-term cure-all forSocial Security. When productivity goes up, average wages go up, and this adds to long-term taxrevenues. But when average wages go up, average benefit awards also go up, and this adds to long-term outlays.

• Practically, the only way to get big savings from higher productivity growth is to sever the linkbetween average wages and new benefit awards. The United Kingdom has done this, and thereform stabilized its long-term pension outlook. Without such a fundamental change, higher pro-ductivity growth alone cannot possibly save Social Security.

There is one aspect in which the Trustees are indeed pessimistic—but here greater optimism wouldobviously add to Social Security’s costs. The Trustees project that mortality rates will decline more slowlyin the future than they have in the past—and that longevity will therefore grow more slowly.

• According to the Trustees, life expectancy at age 65 will grow at just half the pace over the nextseventy-five years as it has over the past seventy-five.

• Some biotech optimists are now predicting that a life expectancy of 100 or more is attainable withina generation.

• If anything approaching that came to pass, the entire structure of old-age entitlements would berendered instantly and massively unaffordable.

• But one doesn’t have to agree with these visionaries to conclude that the Trustees are too conserva-tive. Accepting their projections means believing that Americans will have to wait until the mid-2030s to achieve the life expectancy that the Japanese already have today.

13

Argument #5: Investment rArgument #5: Investment rArgument #5: Investment rArgument #5: Investment rArgument #5: Investment returns preturns preturns preturns preturns provide a “pain frovide a “pain frovide a “pain frovide a “pain frovide a “pain free” solution.ee” solution.ee” solution.ee” solution.ee” solution.

Moving toward a more funded Social Security system could indeed have enormous benefits: notjust higher returns to retirees, but greater national savings and productive investment, and hence greaterwage growth for workers in the years before retirement. It would also be the surest method of locking upthe Social Security surplus because it would prevent the government from spending the money on otherprograms. But it cannot be supposed that directly funding more of Social Security’s benefits is a way toavoid the hard choices. It is the hard choice:

• The challenge is that, until the transition is complete, workers will have to pay more, retirees willhave to receive less, or both. Reform plans that do not face up to this transition cost will not resultin new net savings or a larger economy. Any gains for future beneficiaries will necessarily come atthe expense of future taxpayers.

• It is neither realistic, nor economically sound to count entirely on the historic spread between theinvestment returns on stocks and bonds to fund a reform plan without cost reductions or highercontributions.

• Projected budget surpluses provide a tempting source of funding for personal accounts. But pro-jected surpluses are far from reliable. More importantly, even if the future unfolds exactly as pro-jected, the surpluses won’t last forever. And when they vanish Congress will have to fund the newSocial Security accounts by selling bonds to the public (i.e., borrowing) unless taxes are raised orspending is cut. In that case, all the plan will have created is another unfunded entitlement.

• The fundamental issue is not whether the system should be public or private, but the extent towhich it should be unfunded or funded. Unfunded personally owned accounts would neither add tonational savings nor reduce the burden of today’s system on future generations, even if they earn ahigher rate of return than the current pay-as-you-go system. A new system of unfunded accounts,like trust fund solvency, avoids the real challenge, which is to ensure that adequate resources are setaside to meet the cost of future benefits.

14


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VI. Designing a Personal VI. Designing a Personal VI. Designing a Personal VI. Designing a Personal VI. Designing a Personal Account Plan forAccount Plan forAccount Plan forAccount Plan forAccount Plan for Social Security Social Security Social Security Social Security Social Security

The inherent problems in Social Security’s pay-as-you-go financing have led manyto conclude that the program should be transitioned into a partially funded system in whichsome portion of workers’ payroll tax contributions are saved and invested in personallyowned accounts. Indeed, this Commission has been specifically charged with developingsuch a plan.

There are several attractions of personally owned accounts. Properly designed andimplemented, they could provide:

• Higher returns on workers’ contributions, which increase the resources available topay Social Security benefits.

• A means of prefunding benefit promises, which are now unfunded.

• Greater national savings and productive investment, and hence greater wage growthfor workers in the years before retirement.

• Private ownership of assets. The current system provides a statutory right to ben-efits that Congress can cut at some future date. And, at death, workers cannot be-queath Social Security benefits to their heirs. On the other hand, personally ownedaccounts would offer workers ownership of constitutionally protected property, whichcould be passed on to their heirs.

• A “lockbox” no politician can pick. Using the currently projected Social Securitysurplus as a start-up fund for the new accounts would ensure that politicians couldnot spend it.

• A savings-oriented use for non-Social Security surpluses. Allowing, or mandating,such supplemental funding would provide a powerful political incentive to attainthese surpluses since the public would have a personal stake in them. This wouldhelp enforce fiscal discipline.

• An answer to those who warn that paying off too much publicly-held debt will forceus to make exorbitant payments to redeem outstanding bonds from reluctant sellersor force the government to acquire substantial private sector investments.

The challenge of moving to a partially funded system is that until the transition iscomplete workers will have to pay for two two two two two retirements: their own, which would have to beprefunded, and that of current retirees, who will continue to rely on pay-as-you-go benefits.Workers will thus have to save more, retirees will have to receive less, or both.

Without new new new new new savings, without real real real real real funding, a plan cannot increase the productivityof tomorrow’s workers, and thus becomes a zero-sum game of pushing liabilities from one

15

pocket to another or from one generation to another.

Two approaches to personal accounts that The Concord Coalition has expressedreservations about are the so-called “clawback” plans, and those that call for the issuance of“recognition bonds.” The common flaw is that these plan do nothing to reduce SocialSecurity’s long-term cost. Instead, they bank on large fiscal and economic dividends thatmay or may not materialize to guarantee all currently promised benefits.

The “clawback” idea

In this approach part of the projected budget surpluses would be diverted into per-sonal accounts, which would be invested in stocks or other private assets. When workersretire, the government would claim most of the proceeds of the accounts to pay current-lawbenefits, which would remain unchanged. It is assumed in these plans that over time higherinvestment returns and stronger economic growth from the new investments would entirelyclose Social Security’s financing gap. In the meantime, for approximately 40 years, SocialSecurity would have to rely on an infusion of general revenues to pay promised benefits.Here are some major concerns with this approach:

• By not reducing Social Security’s long-term cost or dedicating any new revenues tothe program, it relies entirely upon investment gains the spread between stocksand bonds to close the current funding gap.

• Buying stocks on a large scale, as personal account holders would do, and sellingbonds on a large scale, as the government would have to do to redeem the trust fundbonds, would cause the yield of bonds to rise and the yield on stocks to fall narrowing the favorable spread on which the plan depends.

• Because the “clawback” mechanism cannot yield significant revenues in the short-term, the system would still face huge deficits for decades. These deficits wouldhave to be covered by general revenues.

• While in theory, the system could become self-sustaining in 50 years or so, theamount of deficit spending needed in the interim could swamp the budget and theeconomy long before that time arrives.

• It is unclear who owns the money. If the government has such a large claim on thepersonal accounts, it would be determined that the government owns them—and ifit does, what is to prevent Congress from borrowing against them?

• In any event, the public may grow cynical about “personal accounts” that are claimedby the government upon retirement.

16

The “recognition bond” idea

Another idea calls for diverting some or all of the current FICA tax into personalaccounts while issuing “recognition bonds” to the public — that is, formal Treasury debt—to guarantee benefit claims under the old system. Once again, because these plans neitherrequire new contributions nor restrain the cost of Social Security’s existing benefits, they donot raise national savings.

• The problem with issuing debt is that is undermines a major purpose of reform byoffsetting (or even more than offsetting) any additions to private savings.

• It would also burst the nation’s current popular and procedural firewalls againstexcess federal borrowing. If we can borrow trillions to finance Social Securityreform, why not borrow trillions for any purpose at all?

• By translating existing implicit Social Security liabilities (which have no constitu-tional protection) into formal Treasury debt (which does), they would in effect ren-der Social Security benefits unreformable. Short of default on the national debt,Congress could never again make any change to what is now a legislated outlay.

A Checklist of QuestionsA Checklist of QuestionsA Checklist of QuestionsA Checklist of QuestionsA Checklist of Questions

While The Concord Coalition has expressed support for some form of personal ac-counts, we have never subscribed to the view that this is a simple or “pain free” solution.The following questions are a checklist of choices that must be made in designing any suchplan for Social Security.

1. 1. 1. 1. 1. What perWhat perWhat perWhat perWhat percentage of pay should be devoted to individual accounts?centage of pay should be devoted to individual accounts?centage of pay should be devoted to individual accounts?centage of pay should be devoted to individual accounts?centage of pay should be devoted to individual accounts?

The size of the contribution to personal accounts is perhaps the key decision. Theadvantage of a small plan 2 percent or less of taxable payroll is that it minimizes thetotal burden placed on workers, and preserves a large share of the current Social Securitysystem. Over a working lifetime even small contributions can produce sizeable benefits.

The case for a larger plan is that introducing a new system requires a critical mass ofresources sufficient to swiftly and adequately replace the current system with a superiorone. In the long run, it may be best to enact major changes now and pay for the transitioncosts up front.

2. Should the contributions r2. Should the contributions r2. Should the contributions r2. Should the contributions r2. Should the contributions replace oreplace oreplace oreplace oreplace or be added to the existing Social Security tax? be added to the existing Social Security tax? be added to the existing Social Security tax? be added to the existing Social Security tax? be added to the existing Social Security tax?

One approach to funding personal accounts is to add new mandatory contributionson top of the existing payroll tax (i.e., an “add-on” plan). The other prominent approach isto fund personal accounts out of the existing payroll tax (i.e., a “carve-out” plan). The two

17

approaches differ in the trade-off they make between two objectives:

• The carve-out approach guarantees that no extra compulsory contributions of anykind will be added to the Social Security system.

• But there is an unavoidable trade-off in not requiring any new contributions. Whileit is possible for a carve-out plan to give workers bigger benefits than the currentsystem can afford, it is not possible for it to give workers bigger benefits than thecurrent system promises.

• The add-on approach meets a different objective. The increased funding would makeit possible for every to worker be at least as well off in total benefit dollars in retire-ment under the new system as under the old. In effect, it would fund the unfundedpromises of the current system.

• The much better benefit adequacy of the add-on option is not without a cost—namely,the extra contributions required of all workers.

• Is it worth paying a bit more to achieve these superior results? In the end, after allthe shell games are played out, this is the central choice the American public mustconfront.

No reform plan can fund currently promised benefits at the current contribution rate— and still abide by honest accounting and prudent assumptions. The public will not findit an easy choice to make. But it won’t be nearly as unpleasant as the consequences ofdoing nothing. Either option is preferable to the alternative if we leave Social Security onautopilot—draconian benefit cuts or massive tax hikes and a system that will satisfy no one.

3. 3. 3. 3. 3. WWWWWill the new system raise national savings?ill the new system raise national savings?ill the new system raise national savings?ill the new system raise national savings?ill the new system raise national savings?

Today’s public policies, including Social Security reform, should be directed at build-ing national savings and investment to spur the productivity increases needed for tomorrow’slabor force to support the retirement and health care costs of the population’s much higherpercentage of retirees. Plans that require huge general revenue contributions, or the issu-ance of new debt, are unlikely to increase net national savings.

Personal accounts are more likely to lock up budget surpluses for savings than plansthat purport to save money within government owned accounts. So long as the governmentretains ownership of the funds it may spend them and credit itself with an IOU as hap-pened every year from the 1983 reforms until 1999.

It cannot be assumed, however, that the entire amount devoted to personal accountswill add to national savings. Some workers would undoubtedly save less in other areas ifforced to contribute more through a payroll deduction. The actual offset would depend

18

critically upon the extent to which households see the new system as a substitute for otherforms of voluntary savings. For below-to-median income households without pension cov-erage, the offset may be negligible since most of these households can’t save much less thanthey do already. But for more affluent households, the offset may be sizeable.

4. 4. 4. 4. 4. TTTTTo what extent would the new plan ro what extent would the new plan ro what extent would the new plan ro what extent would the new plan ro what extent would the new plan requirequirequirequirequire financing fre financing fre financing fre financing fre financing from outside the Social Secu-om outside the Social Secu-om outside the Social Secu-om outside the Social Secu-om outside the Social Secu-rity system?rity system?rity system?rity system?rity system?

Cashing in on fiscal dividends is a good example of a more general problem withmany reform plans: They are designed so that their sacrifice is hidden from the public.To this end, reforms often resort to some combination of two strategies: Issuing govern-ment debt, usually with the promise to pay it off later, and raising taxes or cutting spend-ing outside the Social Security system.

The problem with issuing debt is that is undermines a major purpose of reform byoffsetting (or even more than offsetting) any additions to private savings. It would alsoburst the nation’s current popular and procedural firewalls against excess federal borrow-ing.

The problem with raising taxes or cutting spending outside the system is that itcreates no direct link between sacrifice and reward. The proposed savings measures maynever be enacted—particularly if, as in many plans, they are just vague injunctions to cut“government waste.” And even if they are, they many not be effective. If (for example) weenact a national sales tax to help fund personal accounts, the public will be likely to viewthis as a substitute for existing taxes and demand an offsetting tax cut. Once again, a largerdeficit (or smaller surplus) may neutralize the private saving boost.

5. 5. 5. 5. 5. WWWWWould personal accounts thrould personal accounts thrould personal accounts thrould personal accounts thrould personal accounts threaten the adequacy of Social Security benefits?eaten the adequacy of Social Security benefits?eaten the adequacy of Social Security benefits?eaten the adequacy of Social Security benefits?eaten the adequacy of Social Security benefits?

Social Security’s defined benefit structure has always attempted to balance “equity”and “adequacy.”

• Equity is the idea that every retiree will receive benefits that are directlylinked to the amount of his or her prior contributions.

• Adequacy is the idea that low-income workers should get a somewhat betterdeal from a public program than high-income workers so that every retireehas an adequate standard of living.

• Both principles appeal to most Americans and should be preserved.

Personal accounts would improve Social Security’s individual equity because thebenefit return would be equal to the market value of prior contributions minus administra-tive costs. However, absent other changes such as matching grants for low-wage workers ora further tilt in the defined benefit formula personally owned accounts would lessen SocialSecurity’s overall progressivity and hence its social adequacy. The Commission’s proposal

19

should address how, or whether, both the adequacy and the equity standards would be hon-ored.

In assessing the adequacy of benefits under a reformed system it must be kept inmind that a person’s retirement income would come from both both both both both sources—a basic level ofguaranteed benefits from a fiscally sustainable defined benefit program and an additionalbenefit financed from the lifetime accumulation of the personally owned account.

Because the current system is substantially unfunded, the proper comparison is be-tween a reformed system with individual accounts and a reformed system without indi-vidual accounts.

6. Should the new system be mandatory?6. Should the new system be mandatory?6. Should the new system be mandatory?6. Should the new system be mandatory?6. Should the new system be mandatory?

Given that Americans like the idea of choice, voluntary participation may be apolitical selling point. While this Commission has been asked to develop a voluntary plan,we believe that mandatory participation is necessary to boost national savings, maintainprogressivity within the system and to ensure that workers build meaningful assets in theirpersonally owned accounts. To date, voluntary savings incentives such as 401(k) plans andIndividual Retirement Accounts (IRAs) have met with mixed results. This experience isevidence that participation in any new system must be mandatory to ensure that personalsavings will actually increase. Assuming voluntary participation, would workers have thefreedom of opting in and out?

In a more fundamental sense, however, mandatory participation is basic to the con-cept of Social Security as a universal system of social insurance. Government has a legiti-mate interest in seeing that people do not under-save during their working lives and becomereliant on safety net programs in old age. Moving toward personal ownership need not andshould not mean “privatizing” Social Security.

7. How much government r7. How much government r7. How much government r7. How much government r7. How much government regulation should theregulation should theregulation should theregulation should theregulation should there be?e be?e be?e be?e be?

No plan can allow contributors complete freedom, including the discretion to liqui-date the account on demand. Very rigid constraints can be adopted to further society’s inter-est in minimizing investment risk and averting insufficient benefits. Less restraint furthersthe individual’s interest in maximizing choice. Here are suggested approaches to some ofthe key issues regarding account regulation:

1. Investment rules

Workers could be required to choose a financial fiduciary and to invest funds withincertain regulatory guidelines designed to eliminate unnecessary risks, minimize administra-tive costs, and ensure the adequacy of retirement income. In addition to rules governing theownership and use of assets, the guidelines should cover:

• certification of fiduciaries.

20

• management fees.• allowable investments, diversification, and asset allocation.

The guidelines could require that a fixed percentage of assets, adjusted for age, beinvested in low-risk debt. They could also set a ceiling on allowable management fees.

A quasi-public “oversight board,” with public and private trustees, could be set upto establish these guidelines, certify fiduciaries, and maintain a “switchboard” to ensurethat all contributions are made in a timely fashion and routed to the right account.

In addition, this oversight board could serve as the default financial manager ofpersonal account funds. Anyone unable or unwilling to deal with a private manager wouldhave his or her account managed by this agency, which would invest all default funds ac-cording to some relatively low-risk formula. The level of risk in default portfolios could beautomatically adjusted to reflect an age-appropriate balance of stocks and bonds. Such port-folio rules would help protect workers nearing retirement from market declines.

2. Deposits and withdrawals

Personal account funds should be subject to strict rules governing ownership anduse. For example:

• Until age 62, no worker should be allowed to withdraw personal account funds forany reason. Enforcing this requirement may prove to be a political challenge, but itis absolutely essential to ensure adequate benefits upon retirement.

• At age 62 and over, all funds withdrawn should be used to purchase an indexedannuity until the annuity, together with the worker’s pay-as-you-go benefit, ensuresthat the worker possesses an income for life equal to some minimum threshold, say150 percent of the poverty line.

• Couples would have to provide for joint income and survivorship of the spouse.Fund balances in excess of those required to purchase the minimum annuity couldbe subject to no use restrictions.

• In the event that a couple divorces, account assets attributable to wages earned dur-ing the marriage should be evenly divided.

• If the account owner dies before annuitizing benefits, the assets should be routedinto the account of the spouse. If the owner is unmarried, they should become partof the owner’s estate.

As an alternative to the annuity rule, workers could be allowed to make annualwithdrawals, with the amount not to exceed the account balance divided by the averageremaining years of life expectancy.

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VIIVIIVIIVIIVII. . . . . Possible Changes in the Possible Changes in the Possible Changes in the Possible Changes in the Possible Changes in the TTTTTraditional Prraditional Prraditional Prraditional Prraditional Programogramogramogramogram

Regardless of whether personal accounts are added to the system, some combinationof cost reductions or increased contributions will be required to make the pay-as-you-goportion of Social Security fiscally sustainable over the long-term. These are often referred toas the “hard choices,” and they are critical to the success of any reform plan.

Personal accounts provide a promising vehicle for prefunding a portion of futurebenefits, particularly for younger workers. But they are no quick fix. It takes many years toaccumulate sufficient assets to serve as a meaningful source of retirement income. And bythemselves, personal accounts cannot close the looming gap between promised benefits anddedicated revenues under the current system.

The Concord Coalition believes that the necessary savings could be achieved usingsome combination of the following options:

A. Raise the “normal rA. Raise the “normal rA. Raise the “normal rA. Raise the “normal rA. Raise the “normal retiretiretiretiretirement age” forement age” forement age” forement age” forement age” for full benefit eligibility full benefit eligibility full benefit eligibility full benefit eligibility full benefit eligibility

One of the most logical options to consider is raising the age for full benefit eligibil-ity. It makes good sense for two reasons:

• Longevity is increasing steadily, and longer life spans mean longer, and more costly,benefit spans.

• In coming decades, the pool of working- age Americans will virtually stop growing,depriving our nation of this engine of economic growth. Raising the full benefit-eligibility age could help augment the labor force by encouraging older people toremain at work for a few more years.

It’s conventional wisdom that our population soon will be growing older becausethe huge baby boom generation is poised to begin retiring and hitting the Social Securityrolls starting in 2008. But that’s only part of the picture. Even if there were no Baby Boom,the rising longevity and fall in birth rates mean an older America and spell serious troubleahead for Social Security (and Medicare as well).

Increasing life spans have already increased benefit spans.

• In 1940, when the first benefits were paid, 65-year-old men could expect to livealmost another 12 years and women another 13.4 years.

• Today, men retiring at 65 can expect, on average, 16 years of benefits and womenmore than 19 years.

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• By the time today’s high-schoolers begin retiring in 2050, 65-year old men are ex-pected to live another 18 years and women another 21 years.

• Or to turn it around, for people today to spend the same number of years collectingbenefits as the typical 65-year-old when the program began, they would have towait until 72, and by 2030 they would have to wait until 74.

But the problem posed by an aging population is not just that benefit spans willlengthen. We also expect to be coping with a labor shortage. The population 65 and up willdouble by 2030, but the working-age population will grow by only about 15 percent duringthe same period. This projection assumes that birth rates hover indefinitely around 1.9 birthsper woman rather than following the downward trend seen in 19 of the 22 other most devel-oped countries.

Instead of increasing our supply of working age people by 2 percent each year as inrecent decades, or even the current 1 percent rate today, between 2010 and 2050, workforcegrowth will slow to a crawl: just 0.3 percent per year. There will be just barely enough newworkers each year to replace those who are leaving.

Growing our economy could help finance benefits for a mushrooming retiree popu-lation. But, boiled down to essentials, economic growth depends on two factors: increasingthe number of workers, and increasing how productive each worker is. Since no one has asure-fire recipe for boosting worker productivity enough to make up for the slowdown inworkforce growth, anything we can do to encourage people to work a few more years andencourage employers to accommodate older workers will help our economy.

B. Index for LongevityB. Index for LongevityB. Index for LongevityB. Index for LongevityB. Index for Longevity

Any reform plan should also index initial benefits to changes in elder life expect-ancy. Without this provision, Social Security will once again drift out of balance; with it, thesystem’s long-term cost will be stabilized relative to worker payroll.

C. C. C. C. C. TTTTTrrrrreat Social Security Benefits Like Private Pensions foreat Social Security Benefits Like Private Pensions foreat Social Security Benefits Like Private Pensions foreat Social Security Benefits Like Private Pensions foreat Social Security Benefits Like Private Pensions for TTTTTax Purposesax Purposesax Purposesax Purposesax Purposes

Making 85 percent of all benefits taxable is fair, and should be on the table as ameans of increasing Social Security’s revenues. The 85 percent taxability rule that nowapplies to beneficiaries with incomes over high thresholds could apply to all beneficiaries.The 15 percent exemption reflects an estimate of the dollar value of most beneficiaries’prior FICA contributions that have already been subject to personal taxation. It would thusbring the tax treatment of Social Security in line with the tax treatment of private pensionbenefits.

Since this provision would affect only those households with enough income to payincome taxes, it would maintain the progressivity of the program. It’s worth noting that

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because current law does not index the thresholds at which benefit taxation applies, a risingshare of total OASDI benefits are now becoming taxable—and eventually 85 percent of allbenefits will be taxable. Full benefit taxation is therefore already due to be instituted in thefuture (and future revenues from it are already included in current projections). What thisoption would do is to move to full benefit taxation right away.

The new revenue from this provision is not large (in today’s dollars, never morethan $25 billion annually), but it is available immediately and thus generates critical near-term budget savings, which may be needed for the transition costs of any reform plan.

D. D. D. D. D. AfAfAfAfAffluence testfluence testfluence testfluence testfluence test

An affluence test for upper income beneficiaries could be designed as an alternativeto full benefit taxation and generate roughly the same aggregate savings in every futureyear, which makes the two provisions substitutable. The appeal of full benefit taxation is itssimple equity: It would merely subject Social Security beneficiaries to the same tax code aseveryone else. The possible drawback is that it reaches deep down into the middle class.The appeal of the affluence test is its greater progressivity. The possible drawback is that itwill be regarded as arbitrary.

E. Change the Cost of Living E. Change the Cost of Living E. Change the Cost of Living E. Change the Cost of Living E. Change the Cost of Living Adjustment (COLAs)Adjustment (COLAs)Adjustment (COLAs)Adjustment (COLAs)Adjustment (COLAs)

Cost-of-Living Adjustments (COLAs) are used in Social Security, the federal in-come tax code, and other programs to ensure that specified dollar amounts are adjustedevery year for inflation, as measured by the Consumer Price Index (CPI).

There has been substantial debate about how accurately the CPI measures the truecost of living. A 1995 commission chaired by Michael Boskin estimated that the CPI over-states it by 1.1 percentage points. There are many sources of bias, some very technical. Forexample, the particular market basket of goods used can rapidly become out of date. Thebasket based on surveys taken between 1982 and 1984 was still in use through 1997. Thismeans, for one, that new products can be ignored completely.

Although the government has made some improvements to the CPI in recent yearssome experts, including Federal Reserve Board Chairman Alan Greenspan, believe thatCPI still overstates inflation and thus over compensates beneficiaries. Additional adjust-ments to the CPI may thus be in order. However, a great deal of caution must be used indeciding whether to make ad hoc COLA reductions. While over-indexing Social Securitysquanders budget resources, setting COLA’s beneath a fair measure of inflation is not theright way to balance the system since it would unfairly penalize the oldest and poorestbeneficiaries.

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FFFFF. Change the formula for. Change the formula for. Change the formula for. Change the formula for. Change the formula for determining initial benefits determining initial benefits determining initial benefits determining initial benefits determining initial benefits

The determination of a retiree’s initial Social Security benefit check is based on thecalculation of Averaged Indexed Monthly Earnings (AIME). The amount of money earnedby an individual each year of work is multiplied by the increase in average wages that hasoccurred up to the year of eligibility for Social Security, and then the average of the highest35 years (fewer for those receiving disability benefits) of indexed wages is taken and di-vided by 12 to get the AIME.

Once the AIME is calculated, the Primary Insurance Amount (PIA) is determinedby applying the “primary insurance amount formula.” This progressive formula is designedto replace a share of annual pre-retirement income based on three “bend points.” (90 per-cent, 32 percent, and 15 percent.) For example, in 2001 the replacement rates are 90 percentof the first $561 of average monthly earnings, 32 percent for earnings up to $3,381, and 15percent of higher earnings up to the taxable maximum.

One way to reduce Social Security’s long-term cost would be to lower the bendpoints across the board. Or if preferred, reduce the replacement rate within each bend pointbracket on a progressive basis that would protect low-income workers. This later approachwould work particularly well with a system of personal accounts, which in the absence ofsome other mechanism such as savings matches paid out of general revenues, would makethe overall system less progressive than it is now.

Another option, which has been used in Great Britain to stabilize its long-term pen-sion outlook, would be to index initial benefits to the growth in prices (CPI) rather than tothe growth in wages. Under this approach, the purchasing power of benefits would be pre-served. Benefits, however, would grow more slowly than wages thus helping to stabi-lize the total cost of Social Security as a share of the economy. Given where federal spend-ing on retirement and health care is headed, it may well be wise policy to break or alter theautomatic link between benefits and wages. According to the General Accounting Office(GAO), spending on Social Security, Medicare, and Medicaid will grow from less than 10percent of GDP in 2001 to over 20 percent of GDP by 2050.

This must result in one of three outcomes: large tax hikes, resurgent and unsustain-able deficits, or the withering away of the rest of government allowing spending on thepoor, on infrastructure, and on defense to steadily decline decade after decade. No onebelieves that the federal government’s sole function should be to transfer income to retireesat the expense of all other government functions. But that is the inevitable consequence ofadhering to two widely held-and entirely contradictory-goals: limiting the size of govern-ment and allowing senior benefits to consume an expanding share of GDP.

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VIII. Looking VIII. Looking VIII. Looking VIII. Looking VIII. Looking AheadAheadAheadAheadAhead

Today’s Social Security system is more than adequate to meet its obligations tothose who are already retired. Indeed, today’s retirees, on average, will get a better dealfrom Social Security than any category of similarly situated retirees will enjoy in the future.And, while the baby boomers can expect less generous benefits relative to their payrollcontributions than their parents now enjoy, fairly modest changes could be enacted to keepthe current system solvent for most boomers.

But what of the so-called Generation X’ers, those born in the post-boom “babybust” years of the late Sixties and Seventies? And, what of today’s children, those who arenow relying on their baby boomer parents and WWII generation grandparents to leave be-hind a growing economy, to say nothing of a secure retirement system?

Too often, it is the young who are overlooked in the Social Security reform debate.And yet, today’s young people are the ones who are expected to pay the higher taxes, acceptthe lower benefits, and bear the burden of debt incurred between now and their “goldenyears” to keep the current pay-as-you-go system going for their elders.

In the end, Social Security reform is about the young. It is about today’s workers andretirees exercising stewardship over the future, and preserving the sacred trust of genera-tional responsibility.

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Documents

social security doc of the concord coalition to the president’s commission to strengthen social security august 2001