Social Security Reform: A Comparison of Alternative Proposals

The issue of Social Security reform is under consideration by the Administration as well as in the U.S. Congress, and for good reason. According to a recent U.S. General Accounting Office study,1 the Social Security system faces a revenue shortfall of approximately $3 trillion over the next 75 years. While program revenues should continue to exceed expenditures until 2013, the substantial size of the anticipated shortfall highlights the need for reform in the near future. In the absence of such reform, the program will be unable to meet its obligations by 2032. Experts agree that this would have a grave impact on both workers and beneficiaries, as well as society as a whole.

The Social Security program is the cornerstone of America’s retirement system. For nearly 60 years Social Security has provided benefits to retired workers and their families. For 15 percent of this population, Social Security is the only source of cash income. The program also provides benefits for many disabled Americans. Social Security was originally designed as a pay-as-you-go system in which the payroll taxes of current workers are used to pay the benefits of current beneficiaries. Under this system, any excess revenues are credited to a Social Security Trust Fund to serve as a reserve for future benefits. Currently these reserves are invested in interest-bearing government securities, providing additional revenues for the program.

This financing system made sense during the program’s early years, when benefits were low and the number of workers per beneficiary was high. However, as the program matured, more beneficiaries were added at higher average benefit levels.2 Thus, over the years a number of legislative actions have been taken to maintain the long-term solvency of the Social Security system. For example, the Social Security payroll tax was increased 20 times between 1937 and 1990, when it reached its current combined rate of 12.4 percent of covered earnings.

Congressional Proposals for Social Security Restructuring

Traditional approaches to resolving Social Security’s long-term financing problems include increasing program revenues, decreasing program expenditures, or both, while maintaining the program’s pay-as-you-go structure. Program revenues are typically increased by raising the payroll tax, increasing the tax base, or increasing the taxation of benefits. Expenditures have been decreased by cutting benefits and increasing the retirement age.

However, given the current political climate, it is unlikely that Congress will be willing to raise taxes or cut benefits. This has led members of Congress to consider new ways of reforming Social Security. Some recent proposals seek to maintain the current structure but increase revenues by allowing the government to invest the Trust Fund in higher-earning assets, such as corporate stocks and bonds. Other proposals suggest moving to a fully funded system by privatizing Social Security, at least to some degree. This would be accomplished by establishing personal retirement accounts for all covered workers. The various proposals differ as to the size of the accounts and degree of individual control, but all would allow some private market investment. Many of the recent proposals include provisions to raise the retirement age. The major congressional proposals to reform the Social Security system, introduced in the 105th Congress, are compared in Appendix A.

Other Proposals for Enhancing Retirement Security

  • The 1994-1996 Advisory Council PlanThe Report of the 1994-1996 Advisory Council on Social Security outlined three options for Social Security reform.3 The first option seeks to maintain the current system’s basic benefit structure by increasing revenues and reducing outlays. Specifically, the plan seeks to increase program revenues by extending coverage to state and local government employees hired after 1997, extending and increasing the taxation of benefits to all recipients, and increasing the payroll tax by a combined 1.6 percent. The plan also calls for an extension of the benefit computation period from 35 to 38 years by 1999, thereby reducing benefits by an average of 3 percent. Since these revenue and expenditure measures do not completely solve the long-term solvency problem, the panel members recommended that Congress consider investing up to 40 percent of the Trust Fund in the stock market.The second option seeks to restore program solvency mainly through reductions in outlays. Such reductions would be achieved by accelerating the increase in the retirement age to 67 by 2011 and to 70 by 2083, reducing the growth of basic benefits, and extending the benefit computation period.4 This option would also establish a system of mandatory individual accounts to be funded by employee contributions. Specifically, workers would be required to contribute an additional 1.6 percent of covered earnings into a personal saving account.5 Individuals would have limited choices on how these accounts would be invested.The third option would replace the current Social Security system with a new two-tiered system. The first tier would provide a flat-rate benefit based on a worker’s length of service. Workers with 35 or more years of covered employment would receive a monthly benefit equal to $410 (or 65 percent of the current poverty level).6 The second tier would supplement this basic benefit by creating a system of Personal Saving Accounts (PSAs), funded by 5 percentage points of the current 6.2 percent payroll tax on employees. These accounts would be individually owned and managed. Workers would be able to invest in a wide range of investment options.7
  • The Ball PlanSince the release of the Advisory Council’s report, former Social Security Commissioner Robert Ball has made a number of proposals that attempt to maintain the program’s current structure. His most recent proposal would supplement Social Security with a system of voluntary personal savings accounts. These accounts, which would be similar to Individual Retirement Accounts (IRAs), would be funded by additional payroll deductions of up to 2 percent of covered wages. In addition to the creation of personal accounts, Mr. Ball proposes to restore long-term solvency to the Social Security program by investing up to 50 percent of the Trust Fund in stocks, extending coverage to newly hired state and local government employees, and increasing the maximum amount of a worker’s earnings subject to Social Security taxation.
  • The Feldstein PlanAnother proposal, which has received considerable attention recently, was developed by Professor Martin Feldstein of Harvard University. Under the Feldstein plan, workers would be required to deposit an additional 2 percent of covered earnings into a personal retirement account. Income taxes would be reduced dollar-for-dollar for contributions made to personal accounts. The reduction in the income tax would be financed by federal budget surpluses. At retirement, for every dollar withdrawn from a personal account, the retiree’s Social Security benefits would be reduced by $0.75.
  • The Kotlikoff PlanProfessor Laurence Kotlikoff of Boston University has proposed a plan to replace the retirement portion of the current system with a mandatory system of Personal Social Security Accounts. Under the Kotlikoff plan, 8 percentage points of the current 12.4 percent combined payroll tax would be diverted to a personal account to be invested in a single market-weighted global index fund composed of stocks, bonds, and real estate. Contributions to personal accounts would be tax deferred.A similar plan, authored by David Altig and Jagadeesh Gokhale of the Federal Reserve Bank of Cleveland, would create a voluntary system of personal accounts. Under the Altig/Gokhale plan, workers under the age of 32 would be allowed to divert 46 percent of their payroll tax into personal savings accounts, similar to IRAs. The remaining 54 percent of the payroll tax would be used to pay benefits under the current system. Workers joining the new system would not receive any benefits under the current system.

Conclusion

The ACCF Center for Policy Research hopes this Special Report will further the debate as policymakers, the American public, and the media confront the prospect of significant changes in the structure of Social Security and the challenge of saving for retirement.

Notes

  1. United States General Accounting Office. July 1998. Social Security: Different Approaches for Addressing Program Solvency (GAO/HEHS-98-33). Washington, D.C.: U.S. General Accounting Office.
  2. America had approximately 17 workers per beneficiary in 1950. Today there are about 3.4 workers per beneficiary, and that ratio is expected to fall to around 2 workers per beneficiary by 2030.
  3. Report of the 1994-1996 Advisory Council on Social Security. Volume I: Findings and Recommendations. 7 January 1997.
  4. The plan would also increase program revenues in a manner similar to the first option.
  5. A similar plan, proposed by the Committee on Economic Development, an independent research and educational organization in Washington, D.C., would require workers and employers to contribute a combined 3 percent (1.5 percent each) of covered earnings to a system of personal savings accounts. This plan also calls for an increase in the benefit computation period from 35 to 40 years.
  6. Workers would be eligible for half of the monthly benefit after 10 years of covered employment, with a 2 percent increase for each additional year of work up to 25 years.
  7. The plan also includes a number of revenue and expenditure provisions similar to those contained in the first two options, as well as a gradual increase in the retirement age.

 

Appendix A: Social Security Reform Proposals (105th Congress)
Title Current Law: The Old-Age, Survivors and Disability Insurance (OASDI) Program Social Security Solvency Act of 1998 (Sens. Moynihan, D-NY and Kerrey, D-NE) 21st Century Retirement Act of 19981 (Sens. Gregg, R-NH & Breaux, D-LA and Reps. Kolbe, R-AZ & Stenholm, D-TX)
Bill Number S. 1792 S. 2313, H.R. 4256
Description OASDI consists of two separate parts paying monthly benefits: (1) Old-Age and Survivors Insurance (OASI) paid to retired workers and their families and survivors of deceased workers; and (2) Disability Insurance (DI) paid to disabled workers and their families. The bill would amend the Social Security Act to allow the periodic adjustment of payroll taxes so that annual revenues would closely match annual outlays. The tax rate would initially be lowered from the current 12.4% to 10.4%. The bill would amend the Social Security Act by establishing Individual Security Accounts (ISAs) funded by a portion of the payroll tax. It also would establish a guaranteed minimum benefit at 100% of the poverty level for individuals who work a minimum of 40 years.2

TAX PROVISIONS

Tax rate Workers and employers each pay 6.2% of the workers’ qualifying pay, for a combined rate of 12.4%. The proposed rate schedule is: 2001-2024: 10.4% 2025-2029: 11.4% 2030-2044: 12.4% 2045-2054: 12.7% 2055-2059: 13.0% 2060 and thereafter: 13.4% No change.
Tax base Taxes paid on earnings up to $68,400 ($72,600 in 1999). The amount of earnings subject to the payroll tax would be increased to $97,500 by 2003 and would be indexed to increases in the average wage. No change.

INVESTMENT PLAN

Private market investment No. Yes. Yes.
Individual accounts No Yes. Workers could open voluntary Personal Savings Accounts financed with the proceeds of the initial 2% reduction in the payroll tax. Alternatively, a worker could simply take the employee share of the tax cut (1%) as an increase in take-home pay. Yes. Two percentage points of the payroll tax would be diverted into an ISA. In addition to the mandatory component, individuals would be allowed to contribute a maximum of $2,000 more per year.
Who decides where to invest The Board of Trustees invests in interest-bearing government securities. Contributors could choose between a selection of stocks and government securities. The accounts would be overseen by the Voluntary Investment Fund Board. Individual may choose between three investment options: (1) a common stock fund; (2) a government securities fund; and (3) a blended fund. The government would solicit bids from the private sector to manage the stock funds.

OTHER PROVISIONS

Retirement age Under current law, the retirement age will gradually rise from 65 to 67, beginning with individuals who attain the age of 62 in 2000. The early retirement age is 62. The retirement age would be raised to 70 by 2073 and indexed thereafter to the average life expectancy at retirement. Individual may choose between three investment options: (1) a common stock fund; (2) a government securities fund; and (3) a blended fund. The government would solicit bids from the private sector to manage the stock funds.
Taxation of benefits Beneficiaries whose “adjusted gross income” exceeds certain threshold amounts must pay income tax on up to 85 percent of their annual OASDI benefits. Social Security benefits would be taxed to the same extent as private pensions, that is, to the extent that the worker’s benefits exceed his or her contributions to the system. No change for regular Social Security benefits. Voluntary contributions to ISAs would receive the same treatment as nondeductible IRA contributions. The earnings test would be eliminated for retirees.
Title Personal Retirement Accounts Act of 1998 (Sen. Roth, R-DE) Personal Security and Wealth in Retirement Act of 1998 (Sen. Grams, R-MN) Senator Phil Gramm (R-TX)’s Proposal
Bill Number S. 2369 S. 2552 No bill as of yet.
Description The bill would not alter the current Social Security system, but would establish a program of personal retirement accounts as a potential solution to the long-term problem of social security. The bill would amend the Social Security Act to allow the periodic adjustment of payroll taxes so that annual revenues would closely match annual outlays. The tax rate would initially be lowered from the current 12.4% to 10.4%. The plan would not alter the current system, but would allow workers to choose to enroll in an investment-based system or to remain in the current program.3

TAX PROVISIONS

 Tax rate  No change.  No change.  No change.
Tax base No change. No change. No change.

INVESTMENT PLAN

Private market investment Yes. Yes. Yes.
Individual accounts Yes. Eligible workers would receive a minimum deposit of $250 per year and an additional amount based on how much they paid in payroll taxes. The plan would be funded using the federal budget surplus. Yes. Workers who opted out of the current system would establish individually held personal retirement accounts (PRAs).4 Workers and their employers would each contribute 5 percentage points of the current 6.2% payroll tax into a PRA (for a combined rate of 10%). The remaining 2.4 percentage points (combined) would be paid into the Social Security Trust Fund to finance the benefits of current recipients.5Workers may make additional contributions of up to 20% of after-tax income, within the income cap. Yes. Workers who chose the investment-based system would invest 3% of their wages into a Social Security Individual Investment Account (this amount would be phased up to 8.5% over a 30-year period). The remaining 9.4 percentage points of the current payroll tax would go to pay benefits under the current system.
Who decides where to invest Individual account holders may choose between three investment options: (1) a stock index fund; (2) a corporate bond fund; and (3) a treasury bond fund. The stock fund would be managed by private-sector investment managers. Personal accounts would be managed by government-approved private investment companies and financial institutions. Individuals would choose among stock and bond funds approved by a new Social Security Investment Board.

OTHER PROVISIONS

Retirement age No change. Workers may retire at any age, as long as the minimum retirement benefit is fully funded for their entire retired lifetime. No change.
Taxation of benefits No change. Workers may withdraw the portion of their PRA in excess of the minimum retirement benefit tax free. No change.
Title Personal Retirement Accounts Act of 1997 (Rep. Sanford, R-SC) Individual Social Security Retirement Accounts Act of 1997 (Rep. Porter, R-IL) Social Security Solvency Act of 1997 (Rep. N. Smith, R-MI)
Bill Number H.R. 2768 H.R. 2929 H.R. 3082
Description The bill would phase out the current Social Security system and replace it with a system of Personal Retirement Accounts (PRAs), starting in 2000. Retirees would continue to receive their full Social Security benefits. Individuals already in the work force could choose between the new system and the old system, but new workers would be required to open a PRA. The bill amends the Social Security Act to allow eligible workers to choose to establish an Individual Social Security Retirement Account (ISSRA) or remain in the current program. Individuals electing the ISSRA would be subject to a reduced tax rate. The bill would replace Social Security’s current pay-as-you-go system with a new system based on worker-controlled investment accounts. Workers could choose to remain under the current system or contribute a portion of their payroll taxes to a Personal Retirement Savings Account (PRSA).6

TAX PROVISIONS

 Tax rate  No change for workers electing to remain under the old system. The combined payroll tax would be reduced to 12% under the new system.  No change for workers electing to remain under the old system. The combined payroll tax would be reduced to 10% after 10 years for individuals electing the ISSRA.  No change.
Tax base No change. No change. No change.

INVESTMENT PLAN

Private market investment Yes. Yes. Yes.
Individual accounts Yes. An amount equal to 6% of income would be automatically deducted from each paycheck and matched by the employer. Of that, 8 percentage points would go into the individual’s PRA. The remaining 4 percentage points would be used to pay benefits under the current system. Individuals may contribute any additional amounts they choose. Yes. If the worker elected to participate, 5% of his or her wages would be diverted to an ISSRA. The worker’s employer must match this contribution.7Workers may make additional contributions of up to 20% of their gross income. Yes. Beginning in 1999, workers could elect to contribute 2.5 percentage points of the current 12.4% payroll tax into a PRSA. Over time, the annual contribution would rise to 10.4 percentage points of the payroll tax.
Who decides where to invest PRAs would be overseen by certified financial institutions. PRA funds must be invested in a mutual fund portfolio until enough is accumulated to pay an annuity that would provide $8,500 in annual income. Thereafter, amounts could be invested in any type of assets. Individuals would own and manage their accounts by choosing among a broad range of investment options, similar to those available to workers who have an IRA or 401(k) account. Individuals would own and manage their accounts by choosing among a broad range of investment options.

OTHER PROVISIONS

Retirement age The bill would raise the retirement age to 70 by 2029. The retirement age would rise to 70 by 2028 and the early retirement age to 62 for workers who remain in the current system. Workers who elected the new system could begin withdrawing funds at age 59. The retirement age would rise to 69 by 2018 and the early retirement age to 65 by 2011. The bill would allow workers to withdraw funds from their personal accounts starting at age 59.
Taxation of benefits No change for workers under the current system. Contributions to PRAs would be tax deductible. Distributions from PRAs would be included in gross income for tax purposes. No change for workers who elected to remain under the current system. Employer contributions to ISSRAs would be deductible as a business expense. Employee contributions would not decrease their taxable income. Inside build-up would be tax deferred. The portion of retirement benefits due to employee contributions would be taxed, while the portion due to employer contributions would be tax-free. No change.
Title Personal Retirement Savings Account Act of 1998 (Rep. Kasich, R-OH) Savings Account for Every American Act of 1998 (Rep. Sessions, R-TX) Retirement Security Act of 1998 (Rep. Petri, R-WI) Representative Earl Pomeroy (D-ND)’s Proposal
Bill Number H.R. 3456 H.R. 3683 H.R. 4076 No bill as of yet.
Description The bill would not alter the current system, but would establish the Social Security Plus Fund with a Social Security Plus Account for every person with a Social Security number. Each fiscal year, 80% of the federal budget surplus (if any) and the total net earnings from Fund investments would be distributed evenly among the eligible workers. The bill would amend the Social Security Act to allow eligible workers to choose to participate in the Savings Account for Every American (S.A.F.E.) Program or remain in the current program.8 The bill would supplement the Social Security program by establishing the Individual Retirement Investment Program under which a Personal Social Security Investment Account (PSSIA) would be created for every person with a social security number. Each account would be opened with a balance of $1,000 to be funded by the federal budget surplus. The plan would not alter the current system, but would allow for collective investment in stocks and voluntary contributions to individual accounts.

TAX PROVISIONS

Tax rate  No change.  No change.  No change.  No change.
Tax base No change. No change. No change. Likely to contain a modest increase in the wage base and would index the base to increases in the average wage.

INVESTMENT PLAN

Private market investment Yes. Yes. Yes. Yes.
Individual accounts Yes. All workers employed in a job earning at least $2,800 and paying into the Social Security Trust Fund during the current fiscal year would be eligible to receive contributions to their “Plus” account. Yes. If the worker elected to participate, his or her employer would deposit the 6.2% employee contribution in a tax-exempt S.A.F.E. account. Once a worker had maintained the account for 15 years, the employer’s 6.2% contribution would be added to the account as well. Yes. Workers could contribute up to a maximum of $7,000 annually into their PSSIA, of which the first $2,000 may be deducted from gross income for tax purposes. Yes. Workers could invest up to 2% of the wage base in a voluntary supplemental account to be invested in one of several investment options. This 2% is over and above the current 12.4% combined payroll tax.
Who decides where to invest Individuals could choose between three investment options: (1) a stock fund that invests in the S&P 500 index; (2) a bond fund; and (3) a government securities fund. The stock and bond funds would be managed by a private investment company. Individuals may choose to invest their S.A.F.E. account in any IRA-qualified investment option, including stocks, bonds, mutual funds, money market accounts, etc. Individuals could choose between three investment options: (1) a common stock fund; (2) a fixed-income investment fund; and (3) a government securities fund. The stock fund would be administered by the Federal Retirement Thrift Investment Board, established under the bill. An Investment Board set up under the proposal would oversee the investment of the trust fund. Individuals would determine where to invest their personal accounts.

OTHER PROVISIONS

Retirement age No change. No change. No change. No change.
Taxation of benefits No change for regular Social Security benefits. All “Plus” account contributions and earnings would be tax deferred. Withdrawals would be subject to the normal income tax. No change. No change for regular Social Security benefits. Contributions to PSSIAs in excess of $2,000 would be tax deductible. Disbursements from PSSIAs would be taxed as income.9 No change.

 

Notes on Table 

  1. Developed by the bipartisan National Commission on Retirement Policy.
  2. The minimum benefit begins at 60 percent of the poverty line for individuals who worked for 20 years and increases 2 percentage points for each additional year worked.
  3. The program would remain unchanged for those who choose to remain in the current system. Benefits from the investment-based system would be guaranteed to equal or exceed those promised under the current system.
  4. Recognition bonds would be issued for contributions already made under the current system. These bonds would be redeemable, with interest, at retirement.
  5. This 2.4 percent contribution would be phased out in 20 years.
  6. Workers who choose to contribute to PRSAs would have their Social Security benefits reduced by the actuarial value of these contributions.
  7. The remaining 1.2 percent tax on both workers and employers would be paid into the Social Security Trust Fund for 10 years. After this period, this 1.2 percent tax would eliminated.
  8. Workers who elected the S.A.F.E. program would become ineligible for OASDI benefits.
  9. Individuals would be prohibited from drawing regular Social Security benefits until all funds in their personal account had been depleted.