Analysis of Conservative Social Security Proposals Presented Before Senate Finance Committee

Components of the plan

• Workers may initially divert up to 4 percentage point of their payroll tax, up to $1,000 – adjusted annually for wage growth – to private accounts.
• Upon retirement, workers can convert the principal and interest in their accounts into an annuity to supplement Social Security benefits.
• Upon retirement, the traditional guaranteed Social Security benefit would be reduced by the annuitized value of the diverted payroll taxes accrued at an interest rate 2 percent above inflation ("clawback").
• The computation of Social Security's guaranteed benefits would change from wage indexing to price indexing starting in 2009, which would effectively end increases in benefits in line with living standards.

Impact of the plan

• Benefits: By 2105, scheduled OASDI benefits would be one-fourth the level scheduled under current law.
• Revenue generation: Social Security revenues would drop from about 5 percent of GDP to 4.2 percent of GDP in 2007 as payroll taxes are diverted into private accounts. To keep the trust fund balance above zero will require general fund transfers between 2036 and 2050, of an amount peaking at 1.0 percent of GDP. The source of funding for these general revenue transfers is unspecified.
• Solvency: Social Security trust funds will be depleted by 2036.

Evaluation

• Social Security's trust funds would be depleted six to16 years earlier than is currently expected.
• The plan would require borrowing an estimated $2.2 trillion in net present value (2002) to transition to private accounts with cuts to the disability program. Preserving disability benefits would require transferring $2.8 trillion today to cover, together with interest, all shortfalls over the next 75 years, resulting from the establishment of private accounts.
• Disability benefits would have to be reduced in 2050 by 33 percent to make the numbers in the proposal add up.
• Retirees would be expected to make up the difference with the incomes from their annuitized personal accounts. Benefits from both OASDI and private accounts will be less than what would be received if full promised benefits were paid under the current system.

Components of the plan

• Pozen's progressive price indexing plan would keep benefits tied to wage growth for low income earners (less than $25,000 per year) and tied solely to price growth for high income earners (more than $113,000). For those in between, benefits would be calculated with a mix of price and wage indexing.
• Workers can divert up to 2 percentage points of their payroll taxes into private accounts.

Impact of the plan

• Benefits: Benefits would be cut by 28 percent for a worker earning average earnings throughout her lifetime and who retires in 2075 (currently, the average worker earns $33,000 per year). Ultimately, progressive price indexing would lead to most workers receiving the same Social Security benefit level, regardless of how much they had paid in payroll taxes.
• Revenue generation: The plan would require transfers from the Treasury's general fund from 2031 to 2074, peaking at 3.7 percent of taxable payroll in 2032. The plan does not specify the source of revenue for these transfers.
• Solvency: Progressive price indexing would reduce the shortfall in Social Security's finances over the next 75 years by three quarters. At the same time, the diversion of 2 percentage points of payroll to individual accounts would worsen Social Security's solvency. In sum, the projected Social Security shortfall would be halved over the next 75 years.

Evaluation

• The plan will require $1.9 trillion (2004 net present value) in transfers from general fund revenues over 75 years. The source of this revenue is unspecified.
• Progressive price indexing is particularly hard on the middle class who rely substantially on income from Social Security.
• The benefit cuts hitting the middle class would grow over time from six percent for an average wage who retires in 2025, to 28 percent for an average-wage earner who retires in 2075.

Components of plan

• Starting January 1, 2005, workers under 55 years of age and their employers would each pay 5 percent of wages, instead of the current Social Security payroll tax of 6.2 percent for each, into private investment accounts.
• Participation is voluntary, but there are large incentives to participate in the private accounts option.
• Guarantee that those who maintain the default portfolio allocation in their private accounts (65 percent in a broad index of equities and 35 percent in a broad corporate bond index) would receive no less in retirement than they would under traditional Social Security benefits.
• Personal account distributions upon retirement are tax free.
• Upon retirement, the retiree would be required to purchase an annuity equal to the amount of benefit he or she would have received under current Social Security law.
• Those who divert money into private accounts would receive recognition bonds from the federal government that would pay them a proportion of future Social Security benefits equal to the proportion of lifetime taxes they had already paid.
• Ability of the Social Security trust fund to pay benefits would be maintained through general revenue transfers that would be specified in law.

Impact of the plan on closing Social Security's 75-year shortfall:

• Benefits: Guaranteed Social Security benefits would only be cut for those who choose voluntary accounts and do not maintain the default portfolio allocation. Those who never participate in the personal account option would be provided present-law scheduled benefits.
• Revenue Generation: The plan relies on very large transfers from the general fund of the Treasury to meet benefit obligations. The sources for the general revenue transfer are not specified.
• Solvency: The plan almost doubles Social Security's 75 year shortfall due to unspecified general revenue transfers.

Evaluation

• The plan will undoubtedly result in large increases in government borrowing.
• Ferrara's plan relies on general revenue transfers equal to $6.9 trillion in net present value, nearly twice the entire Social Security shortfall, to fund benefits over the next 75 years. It assumes highly improbable reductions in federal spending by 1 percent per year for eight years, to fund the vast majority of these transfers.

Components of the plan

• Individuals would be allowed to divert their half (6.2 percentage points) of the payroll tax to individually owned, privately invested accounts. Those who chose to do so would agree to forgo all future accrual of retirement benefits under the traditional Social Security system.
• The remaining 6.2 percentage points of payroll taxes would be used to pay transition costs and to fund disability and survivors' benefits.
• Workers who chose the individual account option would receive a "recognition bond" based on the accrued value of their lifetime to- date benefits. Those bonds, redeemable at the worker's retirement, would be fully tradable in the bond market.
• Those who wish to remain in the traditional Social Security system would be free to do so, accepting a level of benefits payable with the remaining revenue.

Impact of the plan on closing Social Security's 75-year shortfall:

• Benefits: By diverting half of payroll taxes to private accounts without any increases in revenues, the plan would severely cut the amount of money available to fund Social Security's benefits for those who do not participate in the accounts.
• Revenue Generation: The plan does not raise any extra revenue to fund benefit payments.
• Solvency: Solvency would be achieved through draconian benefit cuts.

Evaluation

• Benefit cuts would be extreme.