December 23, 2004
EMERGING ISSUES IN THE SOCIAL SECURITY DEBATE
At this
week's "economic summit," President Bush repeated his call to create a system of
private accounts in Social Security. While the President still has not endorsed
a specific plan, it apparently will include large-scale borrowing. It also may
include substantial cuts over time in the percentage of a worker's
pre-retirement earnings that Social Security benefits replace.
Paying for Individual Accounts by Borrowing:
A $2 Trillion Solution to a $10 Trillion Problem?
Social Security uses the payroll taxes it collects each year to pay current
beneficiaries; any payroll taxes that are diverted to private accounts will have
to be replaced with other funds in order to continue payments to current
beneficiaries. Under a plan the Administration is considering (the principal
plan proposed by the President's Social Security Commission, known as "Model
2"), replacing these lost funds would cost $2 trillion.
The Administration has ruled out covering this cost by raising payroll taxes
or cutting benefits for current retirees. Instead, it appears to favor
borrowing the full amount needed.
Administration officials have defended the proposed borrowing by claiming
that borrowing $2 trillion to set up personal accounts will solve Social
Security's $10 trillion shortfall. That claim is misleading:
- First, it should be noted that the $10
trillion figure is the estimate of the Social Security shortfall not over 75
years, or even over several centuries, but from now into eternity. The
American Academy of Actuaries, the nation's leading professional organization
of actuaries, has stated that such "infinite horizon" projections are
misleading. Over the next 75 years, the time period traditionally used to
examine the system's finances, the shortfall is less than 1 percent of GDP —
and much less than the cost over this period of making the 2001 and 2003 tax
cuts permanent (see table).
- Most importantly, the money borrowed to
fund individual accounts does nothing by itself to reduce Social
Security's long-term deficit. Individual account plans that eliminate the
long-term deficit in Social Security, such as "Model 2," do so entirely by
reducing future Social Security benefits, not because of borrowing.
Social
Security Shortfall Is a Fraction of the Cost of the Tax Cuts |
|
Cost over
75 years* |
Cost over
"infinite horizon" |
Social Security shortfall |
0.7% of GDP
(according to Social Security actuaries)
0.4% of GDP
(according to Congressional Budget Office) |
$10 trillion |
Tax cuts of 2001 & 2003** |
2% of GDP |
$18 trillion |
* 75 years is the standard
period used for examining Social Security's long-term finances.
**Assumes tax cuts are made permanent and are not eroded by the Alternative
Minimum Tax. |
Should the Borrowing Be Left Out of the Budget?
To mask the effect of this borrowing — which would occur at a time when the
deficit already is projected to be several hundred billion dollars each year —
the Administration and some Congressional leaders are reportedly considering
omitting the new borrowing from the budget so it would not show up as an
increase in the deficit.
Such an effort to make trillions of dollars in costs simply disappear would
not be fiscally responsible. It would not reduce the actual damage that
borrowing on that scale would do to the nation's fiscal situation.
Some argue that the borrowing can legitimately be omitted from the budget
because its cost will be more than offset by large cuts in Social Security
benefits once the accounts are established. But the debt created by this
borrowing will create a real, added burden on the government, which will have to
repay the borrowed funds with interest. In contrast, the supposed gains from
future benefit cuts may never materialize if public opposition to the cuts
becomes too strong and the cuts are scaled back or reversed before they are
implemented.
The "Price Indexing" Proposal
One of the principal ideas the Administration is considering for future
benefit reductions under a private account plan is sometimes known as "price
indexing." It would change the formula used to determine a worker's Social
Security benefit levels in such a way that workers ultimately would receive much
lower benefits than they would receive under the current formula.
Under this proposal, the gap between workers' pre-retirement earnings and
their Social Security benefits would grow over time. In other words, Social
Security benefits would replace a much smaller share of the pre-retirement
earnings of workers who retire farther into the future than of workers who
retire sooner.
To get a sense of the magnitude of the cuts: under the current benefit
formula, a steady average wage-earner who retires in future decades at age 65
will receive Social Security benefits that replace 36 percent of his or her
pre-retirement earnings. Under the "price indexing" proposal, Social Security
would replace 27 percent of the earnings of an equivalent worker who retires in
2042, and just 20 percent of the earnings of a worker who retires in 2075.
This benefit cut would apply to all Social Security beneficiaries, not
just those who elected to forego a portion of their Social Security benefits in
return for an individual account.
The benefit cut also would apply to people with serious disabilities who
receive Social Security disability benefits and to orphans, widows, and anyone
else who receives Social Security survivors' benefits. Nor could these people
necessarily rely on significant funds from their private accounts to supplement
their reduced Social Security benefits, since workers who become disabled or die
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 due to
disability or death.
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