MOAA: Track to the Future

This is the third in a series of articles about Social Security that MOAA has published recently. The purpose of this series is to focus on the issues raised in the ongoing national debate concerning the future of Social Security and to provide as much objective information about the competing points of view so MOAA members can make up their minds about what should be done.

The first article, “Balancing Act” (December 2003), framed the basic issues under discussion. The second, “Should workers be able to invest their Social Security funds in personal retirement accounts?” (July 2004), highlighted the opinions of well-known advocates debating the pros and cons of creating private accounts within Social Security. This article seeks to focus on the Social Security solvency issue by summarizing specific recommendations put forth under different concepts to restore long-term Social Security solvency.

Social Security is one of the most successful government programs in our nation’s history. One of its purposes is to function as a basic insurance plan that replaces a portion of a worker’s income in retirement. It also provides a publicly funded safety net designed to provide extra benefit support to lower-wage workers, disabled workers, and the families of workers who die before retirement. It’s so successful that it long has been considered sacrosanct. The traditional view among legislators has been that Social Security is the “third rail” of politics: If you touch it, you die.

No more. In recent months, executive and legislative branch leaders have appeared increasingly willing not just to touch it but to grab on with both hands.

To date, most of the discussion in the White House and on Capitol Hill has revolved around whether the Social Security system should be modified to provide private accounts. Legislators of both parties, however, acknowledge that instituting private accounts alone will not address the long-term funding and solvency issues at the core of the Social Security reform debate.

Today’s Social Security tax revenues are more than sufficient to meet today’s Social Security benefit requirements. But executive and legislative branch leaders have recognized for years that demographic changes in the American population (specifically, the retirement of the baby boomers) will affect Social Security. That’s why they passed legislation in the early 1980s that has bolstered the current surplus in the Social Security trust fund. Those reserves are estimated at $1.7 trillion today, with $155 billion to be added in 2005. These reserves are in the form of U.S. Treasury bonds, and the interest due on them is paid in more Treasury bonds. This is because for years the government has borrowed funds from the Social Security trust fund to use elsewhere.

There are various estimates of when Social Security will begin to have funding problems, but most experts agree that by 2018, Social Security will begin paying out more in benefits than it takes in taxes. The Social Security Administration then will have to ask the Treasury Department to begin redeeming bonds to pay the interest due in cash. In 2028, the Treasury Department will have to start redeeming bonds on the principal borrowed from Social Security. According to the latest assessment by Social Security actuaries, the trust fund will be depleted by 2042. If that happens, benefits will have to be paid directly from payroll tax receipts, which will cover about 70 percent of expected Social Security benefits.
Such a scenario assumes no further action by Congress, which is extremely unlikely. But it does underscore the reality that legislative action will be needed at some point to avoid forcing a 30 percent benefit cut.

Legislators and executive branch officials are debating whether the fix should be implemented in the form of a benefit cut, a payroll tax increase, use of alternate methods to generate better returns than the Social Security trust fund has realized in the past, or some combination of those measures. But the debate is only starting to get serious. And just as there are various options for private accounts, there are many competing plans for ensuring the long-term solvency of Social Security.

Many more plans to ensure long-term solvency of Social Security are likely to surface in coming months. Additional ideas already offered include:

In the end, there’s no free lunch — and no pain-free way of restoring Social Security solvency for the long term. It comes down to a matter of eventually having to reconcile the amount of taxes deposited into the system with the amount of benefits that must be paid out.

The solution probably will end up entailing some combination of tax increases and benefit reductions. But to achieve that goal in the most reasonable way, legislative and executive branch leaders will need to assure the public that the numbers make sense and that no generation is being asked to accept a disproportional financial sacrifice in the process.

MOAA members have parents, children, and grandchildren who will be affected directly by whatever Social Security measures eventually are adopted. MOAA’s approach to the issue is guided by the resolution approved by members last year:

“Resolved, that MOAA considers it essential that any restructuring of Medicare and Social Security to restore those programs’ long-term financial viability must fairly balance the legitimate interests of both current and future beneficiaries and current and future taxpayers, and be it further

Resolved, that MOAA supports efforts to ensure that no group is forced to bear disproportionate sacrifice in any required restructuring.”

Social Security Plans

Below are four alternative approaches to tackle the Social Security reform debate. MOAA doesn’t mean to imply that these are the only significant options or necessarily the most popular ones. They merely represent a cross section of ideas from individuals or groups that have some expertise concerning these complicated issues.

1. Social Security Commission “Plan 2”

This is one of several options included in the 2001 report of the Social Security Commission convened by President George W. Bush, all of which entailed establishing private accounts. The commission’s Plan 2 would:

Establish private accounts. Four percentage points of workers’ payroll taxes, up to $1,000 each year, would be diverted into private investment accounts.
Index benefits to prices. Recognizing that diverting general payroll taxes to private individual accounts would reduce funds available to pay traditional Social Security benefits, the plan would recalculate future Social Security benefits using a consumer price growth index instead of a wage growth index. Because wages historically have grown faster than prices, the commission envisions this would slow future benefits growth a cumulative 30 percent or more by 2052.
Make adjustments to guaranteed benefits. Guaranteed benefits would be further reduced by the amount contributed to private accounts. Workers with lower-income work histories would be guaranteed a minimum benefit equal to 120 percent of the poverty level.

2. Diamond/Orszag “Balanced Plan”

Economists Peter A. Diamond and Peter R. Orszag have proposed restoring Social Security solvency using a combination of tax increases and benefit cuts. They would:

Raise the taxable wage cap. Currently workers don’t pay Social Security payroll taxes on earned income in excess of $90,000 a year (this amount increases slightly each year). Diamond and Orszag’s plan would raise that cap to $105,000.
Increase payroll tax rate. Payroll taxes would be raised to 12.7 percent of taxable income by 2025 and to 13.2 percent by 2035. Currently, the tax rate is 12.4 percent, of which half is paid by the employee and half by the employer.
Impose a high-income surtax. Payroll taxes would be imposed on earned income amounts that exceed the Social Security taxable wage cap but at a reduced 3-percent rate.
Reduce benefits. Gradual benefit reductions would be phased in over a long period, with a 0.6-percent reduction by 2022, 3.7 percent by 2032, and 12 percent by 2052. The reductions would apply to more affluent retirees.

3. Ball “Social Security Plus” Plan

Robert M. Ball served as commissioner of Social Security under presidents Kennedy, Lyndon B. Johnson, and Nixon. He has long asserted that Social Security solvency can be restored without resorting to dramatic or draconian benefit changes. His plan would:

Make CPI modifications. Annual COLAs would be constrained modestly through minor changes to the CPI recommended by the Bureau of Labor Statistics.
Restore 90-percent earnings base. The taxable wage cap would be raised to $145,000, which represents the 90th percentile of earnings. This would restore the earnings level covered in 1983. The current earnings ceiling represents about the 85th percentile.
Include all workers. About 30 percent of state and local government employees currently don’t participate in Social Security. Ball’s plan would include all new workers hired after 2009 to increase the payroll tax base.
Divert inheritance tax money. Inheritance taxes from estates valued at $3.5 million or more would be dedicated to meet projected Social Security funding needs.
Use supplemental savings accounts. Workers would be allowed to deposit an extra 2 percent of their earnings, over and above their Social Security payroll taxes, in individual supplemental savings accounts maintained by Social Security. Accounts would be managed under IRA rules with individually selected investment options.

4. AARP “Modified Investment” Plan

AARP has been a vocal opponent of diverting payroll taxes into personal accounts but has endorsed a plan that would provide alternate options for stock market investment by both the Social Security trust fund and individual workers. The AARP plan would:

Restore 90-percent earnings base. Like Ball’s plan, AARP’s plan would restore the historic payroll tax base by raising the taxable wage cap to $145,000.
Diversify trust fund investments. AARP proposes investing 15 percent of the Social Security trust fund in a broad stock market index fund to increase the Social Security trust fund’s return above what it has achieved historically. This limited central investment plan is aimed at protecting individual annuitants against market ups and downs. Under the current law, 100 percent of the fund is invested in U.S. government bonds.
Include all workers. All newly hired state and local government workers would be covered under Social Security. Unlike the Ball plan, the AARP plan would do this immediately.
Use supplemental retirement accounts. Workers would deposit money in IRAs, but these deposits would be over and above their normal Social Security payroll taxes, and the individual account amounts would be payable in addition to normal Social Security benefits.

What’s in a Trust Fund?

There is, in fact, a Social Security trust fund, and the money individuals and employers pay in Social Security payroll taxes is invested in the fund in the form of government bonds.

A government bond is an IOU from the most reliable borrower in the world — the U.S. government. The U.S. government has never defaulted on a bond in its history, and there is little reason to think it ever will.

But a bond still is an IOU, and that means the government has borrowed the trust fund money to meet other immediate government expenses.

Is it real money? It’s as real as any government bond you’ve ever bought for yourself, a child, or a grandchild. It’s certainly real enough to let all those millions of Social Security annuitants cash their checks every month.

A government bond is a government debt. The person or institution that holds the bond — whether it’s an individual or the Social Security trust fund — will be paid when the debt comes due. But the government (and that means the taxpayers) still has to figure out a way to come up with the money to pay that debt on time. That’s the hard part.