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Updated January 14, 2005
SOCIAL SECURITY DEBATE OFF TO A MISLEADING START
In its campaign to build public support for private
accounts in Social Security, the White House has said repeatedly in recent weeks
that the program is in financial crisis. Meanwhile, the Administration is
defending the so-called “price indexing” proposal to close Social Security’s
long-term funding shortfall — a proposal that may well be part of the
Administration’s Social Security plan — against charges that it would leave
retirees worse off. On both of these issues, Administration claims have been
incomplete or misleading.
Is Social Security “in crisis”?
The Administration has portrayed the Social Security shortfall as so massive
that it threatens to destroy the program and engulf the rest of the budget.
Such rhetoric seems designed to further the impression that the program will
eventually go completely bankrupt, leaving today’s younger workers with no
Social Security benefits at all in exchange for their years of contributions.
- Social Security isn’t about to disappear. The
Congressional Budget Office (CBO) estimates that even if no changes are
made to Social Security, it will be able to pay full benefits until 2052 and
about 80 percent of promised benefits after that. Using a different set
of assumptions, the Social Security Trustees — a group that includes Treasury
Secretary Snow and other Cabinet officials — estimate that Social Security
will be able to pay full benefits until 2042 and about 70 percent of promised
benefits after that.
In 2018 Social Security will
start paying out more each year in benefits than it receives each year in tax
revenues. But contrary to recent claims by supporters of private accounts, this
does not mean the program will begin “collapsing” at that point. In 2018 the
Social Security Trust Fund will contain $5.3 trillion in U.S. Treasury bonds,
and the Trust Fund will grow by another $1 trillion over the next decade — to
$6.6 trillion by 2028 — because of the interest it earns on those Treasury
bonds.
Some supporters of private
accounts argue that the Treasury bonds in the Trust Fund are nothing more than
paper IOUs that may never be honored. To the contrary, Treasury bonds are
widely regarded as among the world’s safest investments. The U.S. government
cannot choose not to repay them — with interest — unless it is willing to
default on its obligations for the first time in U.S. history, a move that
likely would trigger an international financial crisis.
Those who have argued that
Social Security faces a crisis when its benefit costs exceed its non-interest
income should note that creating individual accounts would accelerate
that “crisis” by diverting payroll taxes from Social Security into private
accounts. According to the Social Security actuaries, the major individual
account plan proposed by the President’s Social Security Commission (which is
reported to be the principal plan the President is considering) would advance
the date at which Social Security’s benefit costs exceed its non-interest income
from 2018 to 2006. In other words, under that plan, Social Security would have
to rely on interest the Trust Fund earns on its bonds to pay benefits starting
next year.
- The real budgetary crisis. It is certainly true
that the federal government will face serious fiscal problems by the 2020s. But
those problems will be in the federal budget as a whole, and their two main
causes will be: (1) the cost of the Administration’s tax cuts, if they are
extended permanently, and (2) growing Medicare costs, which are being driven
primarily by rising health care costs throughout the economy.
Over the next 75 years, the
combined cost of the tax cuts and the Medicare prescription drug benefit — the
President’s two principal domestic priorities during his first term —— will be
at least five times as large as the Social Security shortfall.
Specifically, the Social Security shortfall over that 75-year period is
projected to be 0.4 percent of GDP (according to CBO) or 0.7 percent of GDP
(according to the Social Security Trustees). In contrast, the tax cuts will
cost 2.0 percent of GDP over that period, based on cost estimates from CBO and
the Joint Committee on Taxation. (Experts from the Brookings Institution and
other leading organizations have produced a similar estimate.) The Medicare
drug benefit will cost 1.4 percent of GDP, according to the Medicare Trustees.
The reality is that the Social Security shortfall, while sizeable, is not
gargantuan. It can be closed without undermining the program’s basic structure,
through a mixture of modest benefit reductions and revenue increases phased in
over several decades.
Problems with “Price Indexing” Even Larger than
Advertised
Recent press accounts have suggested that the Administration’s Social
Security plan is likely to include a fundamental change in the formula used to
determine a worker’s Social Security benefits. Though this change is
usually called “price indexing,” its real effect would be to reduce
significantly the share of their pre-retirement earnings that workers receive in
Social Security benefits.
Moreover, this benefit cut would apply to all
beneficiaries, whether or not they elect to forego a portion of their benefits
in return for an individual account.
The magnitude of the cuts under price indexing can be seen
in this example: under price indexing, an individual who works at average wages
throughout his career and retires in 2075 would receive monthly Social Security
benefits that replace just 20 percent of his pre-retirement earnings. Under the
current benefit structure, his benefits would replace about 36 percent of his
pre-retirement earnings. Price indexing, in other words, would cause a
46-percent drop in this worker’s Social Security benefits compared to current
law.
- Better than nothing? The Administration has defended price
indexing by arguing that while benefits under the proposal would be much lower
than those promised by current law, they would still exceed the benefits Social
Security could afford to pay if nothing were done to close its funding gap.
This claim is contradicted by
the Congressional Budget Office’s analysis of the so-called “Model 2” reform
plan put forth by the President’s Social Security Commission, which includes
price indexing. CBO found that under price indexing, the combined income from
Social Security and individual accounts would be below the benefits that
would be paid if policymakers took no action and Social Security benefits were
reduced to the levels that the program’s revenues could support after its trust
fund was exhausted.
CBO estimates, for example, that workers born between 1990 and 2000 who earned
median wages and retired at age 65 would receive combined benefits from Social
Security and individual accounts that, on average, would be 20 percent — or
$3,600 a year in today’s dollars — below what would be paid if no action were
taken to shore up Social Security’s finances (i.e., under a “do nothing”
scenario).
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- Living in the past. It is true that benefit levels under
price indexing would keep pace with changes in prices. But beneficiaries would
be excluded from the general increase in the standard of living from one
generation to the next. Upon retiring, workers of future generations would
essentially be pushed back to today’s standard of living, where Social Security
benefits would be frozen in perpetuity.
Edward Gramlich, a noted
economist who chaired the Advisory Commission on Social Security in the
mid-1990s and is now a Federal Reserve governor, made this same point when he
noted that “If the system had not been wage indexed, [retirees] would be living
today at 1940 living standards,” since that was the time Social Security began.
- Effects on people with disabilities, widows, and orphans.
Another problem with price indexing is that it poses special risks to
recipients of Social Security disability and survivors’ benefits. This
fact has not been acknowledged by the Administration or noted in initial media
reports on this issue.
These people will experience the
same cut in Social Security benefits as everyone else, since Social Security
uses a common benefit formula for all categories of beneficiaries. Yet they
will be much less likely than other recipients to have significant funds in
their private accounts that can offset the benefit cut. This is because workers
who die or become disabled at a young age will not have had the opportunity to
build up much in their individual accounts before they are compelled to leave
the work force.
- The price of ruling out new revenues. The reason the
Administration is considering price indexing, despite its serious problems, is
that the Administration “needs” the savings from big benefit cuts to close
Social Security’s long-term funding shortfall. The creation of private
accounts would do nothing by itself to close that shortfall, and in fact
would worsen it by draining money out of the system.
As Peter Wehner, the President’s
director of strategic initiatives, wrote in a private email to conservative
allies that was leaked last week, “If we borrow $1-2 trillion to cover
transition costs for personal savings accounts and make no changes to wage
indexing, we will have borrowed trillions and will still confront more than $10
trillion in unfunded liabilities.”
But closing the Social Security
shortfall entirely through benefit cuts is hardly the only option.
Instead, the Administration and Congress could adopt a more balanced approach
that combined much more modest benefit adjustments with modest revenue
increases. They could, for example, retain a smaller estate tax rather than
repealing it permanently, or scale back the tax cuts for the highest-income 1
percent of households, and dedicate these revenues to Social Security. They
also could make modest changes to the payroll tax, such as raising the level of
wages subject to the tax.
Thus far, however, the
Administration has rejected using new revenues to help close the Social Security
shortfall. This means the entire load of closing the shortfall must come
through deep benefit cuts, such as those imposed under price indexing.
The Administration’s contrary claim — that benefits under price indexing
would be higher than under a “do nothing scenario” — does not reflect
the fact that investing in equities results in greater risk for
individuals. The Administration’s claim assumes both that individual
accounts will be invested in high-risk, high-return equities and that the
returns will be, in effect, certain to materialize. In contrast, CBO
follows a practice that is broadly accepted among professional economists by
assuming that individuals get a higher return from investing in equities but
pay an additional cost, which lowers the return, to reflect the greater risk
they face.
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