The Future of Social Security

by George McClure

Reforming Social Security is one of the top four priorities for the Bush administration, along with national security, tax reform and tort reform. While the payroll tax for Social Security is bringing in more money than is being paid out now, by 2018 that situation is expected to reverse as fewer workers contribute and more retirees draw benefits.

The Problem

By 2042 or 2052 — depending on whose estimate is used — the system will have depleted all reserves and will be able to pay out only about 75 percent of benefits due, unless something is changed. Actuaries for Social Security calculate that benefits will outpace projected tax revenues by $3.7 trillion (in current dollars) over 75 years. An immediate 15 percent increase in the payroll tax — from 12.4 percent to 13.9 percent — would cover the shortfall, when added to interest on Social Security bonds and the income tax on 85 percent of benefits paid by the highest income beneficiaries.

One Solution

President Bush says the way to correct this problem is to act now, by permitting Personal Savings Accounts to be funded by a portion of the payroll tax now going to the Social Security funds. The PSA account would be optional. A worker who does this will have his basic benefit reduced in proportion to the reduction in his payroll tax used for basic Social Security, with the balance drawn from his PSA account. Although no proposal has gone to the Congress yet for consideration, reports are that the PSA account could be funded by 4 percentage points of the 6.2 percent employee contribution, up to $1,000 per year. The employee contribution is matched by a 6.2 percent employer contribution, making the total contribution 12.4 percent now, on income capped at $90,000 this year. The PSA accounts, which could be elected by workers younger than age 55, would be invested in conservative stocks and bonds, with very low management fees, but over time would increase in value at a higher rate than the one-to-two percent return for the basic Social Security fund. The PSA funds would belong to the worker. If a worker died before drawing Social Security, the amount in the PSA account would pass to his or her heirs.

According to the president, this approach would stabilize the Social Security system for 75 years. No increase in payroll tax or reduction in benefits would be required, he said initially. Later pronouncements have indicated he is firm about not raising taxes, but is open to negotiating with Congress on other changes. President Bush has rejected an AARP proposal to raise the cap on payroll tax to $140,000 — a move that could reduce the shortfall by nearly half. When questioned about his flexibility in advance of any congressional proposals, President Bush remarked that he would “not negotiate with myself in public.” [www.onlinejournal.com]

Some Opposition

The PSA proposal has elicited a firestorm of opposition, ranging from the AARP [www.aarp.org]  and the Older Women’s League [www.owl-national.org], to the National Committee to Preserve Social Security and Medicare [www.ncpssm.org], and to Democrats who see the PSA accounts as a great way to increase savings for retirement, but think that they should be outside the Social Security system. The chair of the House Ways and Means Committee, Bill Thomas (R-Calif.), suggests that the debate on Social Security reform should be broader than just personal accounts. For example, he notes, females live longer than males, yet the benefit is gender neutral. Since the life expectancy of some non-white males is shorter than whites, perhaps their benefit should be larger. White-collar workers may physically be able to work longer than blue-collar workers. When a worker dies and is survived by a non-working spouse, the spousal benefit steps up to equal what the worker was drawing. According to critics and skeptics, all of these issues, and not just PSAs, should be on the table [www.washingtonpost.com].

Others have pointed out that the estimated benefit of PSAs is calculated using the wage index, but that if the price index were used instead, the benefit would be 40 percent smaller — a reduction in benefits. David Walker, comptroller general for the Government Accountability Office, describes the difference as preserving today’s standard of living for future benefits with the price index, and preserving a future standard of living with the wage index.

Other Social Security Benefits Must Be Considered

The overall Social Security program includes a retirement benefit, a disability benefit (worth about $350,000), and a survivor benefit for young families of deceased workers (equivalent to a $400,000 life insurance policy). The retirement benefit is tilted so that lower-income workers receive a relatively larger monthly stipend, in proportion to their payroll taxes collected, than do higher-income workers, but all receive cost-of-living adjustments (COLA). Since the retiree never stops receiving the Social Security retirement benefit, it can be thought of as a lifetime annuity, with COLA. Few privately available annuities have COLA provisions.

An Alternative to the PSA Carve-out

Rep. Clay Shaw (R-Fla.) of the House Ways and Means Committee has introduced a bill to reform Social Security by adding new money for individual savings accounts from the general fund to build up by 2038 when it could be tapped for augmenting Social Security reserves. He calls it the Social Security Guarantee Plus Plan (H.R. 750). A tax credit would be given for up to 4 percent of earnings put in the accounts. There would be no upper-age limit on eligibility to participate. Under Shaw’s plan, the retiree would still get what is promised as the current benefit even if the individual account performs poorly. If the individual account performs well, the retiree would get a higher benefit. At retirement, a lump sum benefit of 5 percent of the personal account value would be paid [http://shaw.house.gov]. He points out that when Social Security started, there was a one percent payroll tax to fund it, there were 42 workers per retiree, and life expectancy at birth was 62 years. Now we have three workers per retiree and that will trend downward to two workers. The crisis is looming. The higher return on a personal account would reduce the expected shortfall. If nothing is done, Shaw said, in 75 years Social Security will have a deficit of $26 trillion. He pointed out that federal employees (including the military) already have a Thrift Savings Plan, with five managed investment options, that can include securities, and that his own account has done very well. The C fund, a common stock index fund, has achieved an average annual return of 12.1 percent over the 17 years since inception in 1987. However, four of those years saw a negative return [www.msnbc.msn.com].

Anyone who funds a Roth IRA can approximate the performance of Shaw accounts (except for the tax credit on contributions and the 5 percent federal bonus) using his own money. Where traditional IRAs cannot receive contributions past age 70-1/2, Roth IRAs have no such limitation, and amounts withdrawn in retirement are tax free.

The Loyal Opposition to PSAs

Rep. Xavier Becerra (D-Calif.), also on the Ways and Means Committee, will lead the opposition to personal accounts. He says he prefers not to look at his own recent statements for the Thrift Savings Plan (three of the down years were 2000-2002; the other was 1990). He worries about those who may retire in a year in which the PSA (which he calls the USA — Universal Savings Account — a term coined during the Clinton years) was down. He says that we innovated first with the working lunch, then the working vacation, and now may be on the threshold of the working retirement, if the Social Security benefit is cut. Social Security will take in $160 billion more than it pays out this year, and by 2018 will have over $5 trillion in the account, but in that year outgo will begin to exceed income.

Rep. Becerra is concerned about transition costs to begin the personal accounts, which he says could be $1.5 to $2 trillion. This could, he says, take all the funds planned for education, veterans, the environment and seniors. He says a better plan would be to take back a third of the recently passed tax cuts to fund Social Security, or take all the tax cut that went to the top 1 percent of taxpayers and apply that to Social Security [http://becerra.house.gov and http://becerra.house.gov].

Looking at PSA Transition Costs

Joshua Bolten, the president’s budget director, points out that not all of the transition costs for personal accounts would be incurred at once, and that it is a wash, anyway, in terms of “national savings” [www.signonsandiego.com]. For the first year, the transition would require $700 billion to pay recipients, replacing the four percentage points diverted to the personal savings account. Unknown is what fraction of workers would opt for the personal accounts.

Other Options

Other means of offsetting the shortfalls in out years are being debated. One of these is removing (or at least raising) the cap on salaries subject to the Social Security payroll tax. There is no cap on the payroll tax to fund Medicare. Another is raising the benefit eligibility age very gradually past age 67. Putting in a means test, where the wealthier retirees would draw less or no Social Security benefit, is another option. A 13 percent immediate reduction in benefits paid would stabilize the system for 75 years, just as the 15 percent increase in the payroll tax, mentioned above, would.

Some cynics point out that, even though the funds for Social Security are invested in government bonds, those are really only IOUs for money the government has already spent, and to access the $5 trillion owed to Social Security in 2018, the taxpayers will have to cough up the money.

What our Members Have to Say About It

Today’s Engineer ran a Reader Poll on IEEE members’ attitudes toward private savings accounts. Here are some of the comments:

• I would support personal savings accounts only if the money could be funneled into my 401k plan.

• Remove the cap on earnings taxed, and index the benefits to an average of the CPI (Consumer Price Index) and wage growth rates. We need to fix the deficit (I favor raising taxes). The bigger problem is Medicare funding.

• Adding a personal savings account on top of Social Security would be all right, but to replace part of the basic benefit – no. Implement means testing so those who don’t need the benefit don’t get it.

• The PSA goes too far. A poor investment strategy could hurt the lowest income retiree. This could shift more elderly into the poverty category. This is not what I want.

• I am against the PSA. People who want to gamble their retirement savings in the stock market can already do it with an IRA. If the PSA reduces the safety-net level of income that Social Security was meant to provide, the system would be essentially destroyed. That may be what is intended.

How the Public Sees It

A poll on general public views [www.cnn.com], sponsored by Gallup/CNN/USA Today, elicited the following views:

• More than two-thirds wanted a means test to limit the benefit, and to tax all the benefit for the wealthy (now 85 percent is taxed)

• 64 percent agreed that the system is in trouble

• 55 percent said PSAs are a bad idea

• 40 percent said good ideas included reducing early retirement benefits, and PSAs

• 37 percent thought increasing the payroll tax would be okay (a Bush no-no)

• 37 percent thought most Americans would get lower benefits with PSAs

• 35 percent support raising the age for full benefits

• 30 percent said PSAs would increase benefits

• 29 percent said reducing benefits for people under 55 is acceptable

• 27 percent said they personally would do worse with PSAs

• 4 percent said there is no problem with Social Security

To dig deeper:

David Wessel, the Wall Street Journal’s deputy Washington Bureau chief, has dealt extensively with Social Security options in his weekly "Capital" column, December 2004 to February, and published reader responses as well as an interview with Edward M. Grimlich, a Federal Reserve governor who served on previous panels on Social Security. Grimlich is author of Is It Time to Reform Social Security? (University of Michigan Press, 2001).

Social Security now is a pay-as-you-go system, but PSAs are a way to partially pre-fund benefits. Some implications are discussed at www.sfgate.com.

George McClure is chair IEEE-USA's Communications Committee, a member of the IEEE-USA Career & Workforce Policy Committee, and technology policy editor for IEEE-USA Today’s Engineer. Comments may be submitted to todaysengineer@ieee.org. Opinions expressed are the author's.