Social Security – A Former President Bush Type Proposal: Costs and Benefits

From: Erika Solanki, Policy Analyst, University of California, Los Angeles

Re.: Social Security – A Former President Bush Type Proposal: Costs and Benefits

Background & Problem Definition:

The Old-Age, Survivors, and Disability Insurance (OASDI) program, commonly referred to as Social Security, is a federally sponsored program that provides income to retired persons in the United States. The working population pays the Social Security tax on income, which deducts 7% of each citizen’s income up to $90,000 and places it in the Social Security Trust Fund, which is used to pay Social Security income to those that qualify. The federal government being able to meet its financial commitment to those who qualify for benefits is solely dependent upon the financial contributions of the current working population. Two major issues that indicate and contribute to the threatening Social Security crisis include the decreasing size of the working population and the increase in average American life expectancy.

·     Currently, the Social Security Trust Fund balance reflects the excess of total Social Security tax revenues over the total benefit payouts—excess that is a function of the baby boomer generation comprising the majority of the working population. In 2008, the total benefits paid were $615 billion, and the total income from social security tax was $805 billion.[i] As the baby bust generation emerges into the working population and the baby boomer generation starts to draw Social Security benefits, the Social Security tax revenues will be insufficient and the fund will go bankrupt.

·     United States life expectancy is currently 77.6 years and increases consistently each year.[ii] This consistent increase in life expectancy means that more beneficiaries will receive Social Security benefits for more years than before. African Americans typically have shorter life expectancy than other groups, thus receive less benefit payments.[iii]

According to a report released by the OASDI, the annual cost of Social Security will begin to exceed tax income in 2016. Due to depleted funds, the government will be unable to pay benefits in full on a timely basis in 2037.[iv] It’s critical that Congress adopt sound policies that will improve the solvency of the current system without burdening future generations with lower future benefits, higher taxes, or increased government borrowing.

Proposed Solution - A Former President Bush Type Proposal:

President Bush and several other Members of Congress are proposing the creation of individually controlled, voluntary personal retirement accounts, in which individuals are allowed to divert part of their social security contributions. Individuals are required to pay the same amount of Social Security income taxes, however, instead of paying only a tax that is placed in the Trust Fund, individuals can deposit a portion of their contributions to their individual retirement accounts. Individuals will use these accounts to invest in private stocks and mutual funds, with full control over investment decisions. Workers that choose to participate in an IA, in exchange for the reduction in contributions to the Social Security Trust Fund, would accept a future Social Security benefit reduction.[v]

Implementation:

A central administration would collect and maintain records of individual account contributions. Private investment managers would be chosen to manage the pooled account contributions through a competitive process. Individuals have the option of investing in various government-approved investment funds differing in degrees of risk and return.[vi]

Modifications to Proposed IA Proposal:

If Congress approves Individual Accounts, participation should be made mandatory because the lack of mandatory participation carries vulnerabilities for the nation’s Social Security system.

• Universal and mandatory participation involves new money rather than a mere diversion of Social Security taxes, thus mandatory participation would more likely increase national savings, maintain consistency within the system, and ensure that workers build meaningful assets.
• Although the proposal’s intent is to phase in IAs and gradually reduce benefits, the timeline is not definitive, and public apprehension can further delay the widespread use of IAs.
• The larger the number of individuals who participate in the accounts, the greater the dollar amount diverted away from the current social security system, and the greater the up-front negative impact on Social Security solvency. However, the greater the number of individuals who choose to participate in the IA system, the greater the eventual reduction in benefits promised to these individuals under the current social security system and the greater the potential long-term enhancement to Social Security solvency. The more immediate and widespread IA accounts are adopted, the faster Americans will experience the long-run positive benefits of Individual Accounts.

Benefits of Proposed Individual Accounts:

• Voluntary nature: people have the option of contributing to individual retirement accounts, thus the reform has a good political selling point, as Americans like the idea of choice.
• IAs earn higher rates of return than the Trust Fund and the assets accrued over time will build wealth that can be passed onto next of kin.
  
  • IAs can benefit low-income wage earners because usually low-income wage earners don’t have money left over to set aside for retirement after paying the Social Security tax, thus strongly depend on Social Security upon retirement. Social Security benefits are not enough to protect workers from poverty, thus the ability to accrue assets through IAs could be more profitable and workers could accumulate substantial savings.[vii]
  • African Americans are disproportionately dependent on Social Security benefits, as one-third of all older African Americans rely solely on Social Security benefits.[viii]
• Proposal is modeled after the thrift savings plan of federal employees, which give individuals the choice to invest in a list of privately run pension funds. The list provided by the federal government includes funds that are sound, safe, and regulated by the government. Federal law mandates that pension fund managers diversify their investments in order to minimize the risk of large losses.[ix]
  
  • Future generations of African Americans will have higher incomes due to inherited wealth.
• The positive economic impact of more capital in the market through the investments accumulated through IAs is multi-faceted. IAs would constitute the largest tax cut for the lower-income brackets in American history since IAs are tax free accounts, thus giving lower income individuals the opportunity to invest in the market and receive a higher rate of return. Ultimately, with more capital flow, businesses will expand, creating more employment opportunities, and resulting in higher tax revenues.
• In the long run, IAs will help reduce social security benefits and increase the solvency of the system, thus offsetting any initial administrative costs and decreases in Trust Fund tax revenue.

Costs of Proposed Individual Accounts:

• Voluntary nature: voluntary participation makes the administrative costs associated with the system seem unnecessary, as a large portion of Americans may not participate.
• Problems with implementation: administrative costs, objectively chosen investment managers and accountability, the risks associated with losing assets, and lack of participation by beneficiaries.
• The worker bears all of the investment risk: the assets accrued over time depend on the rate of return for individual accounts based on the individual’s decisions.
  
  • Whether the worker does better under the IA proposal depends on whether he or she is able to obtain a higher annual rate of return. Younger workers and those with higher lifetime earnings would benefit the most from IAs, whereas low-income groups and older workers will have less income to contribute to the funds.
• Voluntary IAs undermine the social ideals behind social security and the progressive benefit structure.
  
  • Existing system is a progressive system in which lower-income workers receive higher rates of return than higher-income workers. The IAs create strong incentives for higher-income and younger workers to opt out of the Social Security system to the maximum extent allowed, leaving behind the more vulnerable segments of the population. This would also leave behind a pool of disproportionately lower-income workers contributing to the Trust Fund that are highly dependent on Social Security benefits upon retirement.
• Short-run exacerbation of solvency: the solvency will worsen within the next 75 years because the reduction in future benefits for IA participants take place upon a worker’s retirement, whereas the contributions to the IAs begin almost immediately and continue up to the worker’s retirement. Thus the savings from less benefit payouts offsets the loss of revenue to the Trust Fund many years later.
• Policy advocates want to avoid funding administrative costs by benefit reductions or tax increases, thus the Individual Accounts proposal will likely increase publicly held debt and budget deficit.

Benefits Outweigh the Costs, Consider African Americans:

Studies have shown that African Americans currently receive the least benefits from the current Social Security system as a result of having shorter life expectancy. An individual benefits more from social security if they live longer. African Americans pay the same percentage of their income into the Social Security Trust Fund as all other Americans (besides those whose incomes are in excess of $90,000), but African Americans generally have lower life expectancies than other groups. When a black male reaches age 65, he is expected to live only another 13.9 years, almost 2 years less than a white male, amounting to 24 social security payments.[x] According to a study conducted by the RAND Corporation, a nonpartisan think tank, the rate-of-return for African Americans on Social Security taxes was approximately one percent lower than that for whites (approximately a net wealth of $10,000 per person).[xi]  In addition, African Americans tend to comprise larger portions of lower-income groups, and lower-income groups struggle in setting aside additional savings for retirement after making Social Security payments. Thus, African Americans are more dependent on Social Security benefits upon retirement, even though benefits do not to prevent poverty. The poverty rate among older African American women is 29%, almost twice as high as the rate for all women.[xii] Implementing the Individual Accounts proposal for African Americans would prove beneficial in the long-term, regardless of the initial short-term stress on the Social Security Trust Fund and administrative complications.

• All workers would be able to accumulate substantial savings, or at least more than the savings workers are able to accumulate with the current-law system.
• African Americans would own their savings in the IAs, thus if an individual died early, the accumulated savings could benefit family members. Ultimately future generations of African Americans will have higher incomes due to increased inherited wealth.
• Overall increase in savings caused by moving to a partially pre-funded retirement system would stimulate the economy and lead to increased investment sources. Business expansion will lead to increased opportunities for employment, thus providing more opportunities to African Americans to further decrease the income gap.[xiii]

Ultimately, while substantial costs are associated with the Individual Accounts proposal, the long-term benefits will ultimately offset the heavy short-term costs. The public and especially African Americas would readily accept the system after studying the long-term benefits. The system will especially help historically disadvantaged groups accumulate assets and savings to reduce vulnerability to poverty. Franklin D. Roosevelt originally implemented Social Security in 1935 in an effort to provide citizens with exactly that—security. Thus, considering the looming Social Security crisis and lack of alternatives, instituting the Individual Accounts proposal would be a reasonable program for Congress to approve, as long as modifications are thoroughly considered and implementation strategy is efficiently instituted.

[i]  Social Security, OASDI. (2009, May 12). 2009 OASDI Trustees Report.
Retrieved from http://www.ssa.gov/OACT/TR/2009/II_highlights.html.

[ii] Ehrenberg, N. (2005, Dec. 80. U.S. life expectancy rate rises. CBS News.
Retrieved from http://www.cbsnews.com/stories/2005/12/08/health/main1109413.shtml.

[iii] Tanner, M. (2001, Feb. 5). CATO Institute: The African American Stake in Social Security Reform.

Retrieved from http://www.cato.org/pub_display.php?pub_id=4381.

[iv] Social Security, OASDI. (2009, May 12). 2009 OASDI Trustees Report.
Retrieved from http://www.ssa.gov/OACT/TR/2009/II_highlights.html.

[v] Haltzel, L. (2007, Jul. 25). Domestic Social Policy Division, CRS Report for Congress: Social Security.

Retrieved from http://waxman.house.gov/UploadedFiles/Social_Security_Transition_Costs.pdf.

[vi] Haltzel, L. (2005, Apr. 25). CRS Report for Congress: Social Security Reform: Bush’s Individual Account Proposal.

Retrieved from http://benefitslink.com/articles/RL32879.pdf.

[vii] CATO Institute: Project on Social Security Choice.

Retrieved from http://www.socialsecurity.org/reformandyou/you.html.

[viii] Tanner, M. (2001, Feb. 5). CATO Institute: The African American Stake in Social Security Reform.

Retrieved from http://www.cato.org/pub_display.php?pub_id=4381.

[ix] Dubay, C. and Scott Hodge. (2005, Feb. 2). Stock Market Investing: Good Enough for Public Employee and Union Pension Funds. Retrieved from http://www.taxfoundation.org/research/printer/111.html.

[x] CATO Institute: Project on Social Security Choice.

Retrieved from http://www.socialsecurity.org/reformandyou/you.html.

[xi] Tanner, M. (2001, Feb. 5). CATO Institute: The African American Stake in Social Security Reform.

Retrieved from http://www.cato.org/pub_display.php?pub_id=4381.

[xii] CATO Institute: Project on Social Security Choice.

Retrieved from http://www.socialsecurity.org/reformandyou/you.html.

[xiii] Tanner, M. (2001, Feb. 5). CATO Institute: The African American Stake in Social Security Reform.

Retrieved from http://www.cato.org/pub_display.php?pub_id=4381.