FROM THE OFFICE OF PUBLIC AFFAIRS
May 18, 2005
js-2451
Assistant Secretary of the Office of Economic Policy
Mark J. Warshawsky
The Urgent Need for Social Security Reform
National Press Foundation
Washington, D.C.
Thank you for the kind introduction. I am honored to be here today.
I want to thank the organizers of this conference at the National Press Foundation. This is a great opportunity to discuss topical issues, like social security, in an open forum.
President Bush said in his
SOCIAL SECURITY REFORM
President Bush has made Social Security reform a major priority of his second term. Today I'll explain why it is so important that responsible Social Security reform occur now, why one element of a successful reform plan must be personal retirement accounts that give individuals more control over their financial futures, and why progressive indexing is a good approach to improving the solvency of the system.
The Size of Social Security's Financial Shortfall
How big is Social Security's current funding gap? The most widely cited measure of that gap is the 75-year actuarial imbalance, which is now estimated at $4.3 trillion or 1.92 percent of taxable payroll. This measure suggests that immediately raising the payroll tax rate by 1.92 percentage points, to 14.32 percent, would permanently fix Social Security. But as many of you are aware, that is not true. With each passing year, the Trustees would report an ever larger financial imbalance as the 75-year scoring window is moved forward to include years with ever larger gaps between expected system costs and income.
As this example makes clear, estimates made over a 75 year horizon do not fully capture the financial status of the Social Security program. In fact, no finite forecast period completely embodies the financial status of the program because people pay taxes in advance of receiving benefits; at any finite cutoff date, people will have accrued benefits that have not yet been paid.
In order to get a complete picture of Social Security's permanent financial problem, the time horizon for calculating income and costs must be extended to the indefinite future. Such a calculation is provided in the 2005 Trustees Report; it is estimated there that for the entire past and future of the program, the present value of scheduled benefits exceeds the present value of scheduled tax income by $11.1 trillion. To put this in perspective, eliminating the permanent deficit could be accomplished with an immediate and permanent 3.5 percentage point increase in the payroll tax rate (to 15.9 percent), or with a 22 percent reduction in all current and future benefits. In both cases, it would be worth noting, there would be massive near-term Trust Fund accumulations.
Intergenerational Equity: Why Social Security Must be Reformed Now
It is clear that the Social Security system is not financially viable and must be fixed. How to close the permanent financing gap raises difficult questions over how the net benefits of Social Security should be shared across generations. In this context, it is important to recognize that the large unfunded obligations in the system are primarily the consequence of the past system generosity to generations that are now either dead or retired. Of course, those early generations are beyond reform's reach, so the entitlement reforms needed to close the financing gap must fall entirely on later generations.
Viewing Social Security from the perspective of how it affects generations and individuals explains why it is imperative that Social Security be reformed now. Delaying reform only reduces the options for fairly distributing the benefits of Social Security across generations. Most people agree that it would not be fair to alter Social Security's promises to retirees and near retirees. The longer reform is delayed, the fewer generations that are left to participate in a reformed entitlement system so as to close Social Security's funding gap, and the more severe those reforms will be.
To make this point more concretely, consider a policy of closing Social Security's permanent financing gap by immediately increasing the payroll tax rate by 3.5 percentage points. If the tax increase were instead delayed until 2041 when the trust fund is depleted, the requisite tax increase would be 6.3 percentage points. Clearly, I do not advocate any of these policies. My point is that there is no doubt that fairness to future generations requires that action be taken now.
I would also point out that purely pay-as-you go financing of Social Security would be grossly unfair to future generations. For example, one way to make Social Security solvent would be to leave benefits unchanged and to raise payroll taxes year by year beginning when the Trust Fund is exhausted. According to current projections, the payroll tax rate under that policy would steadily rise beginning in 2041 and reach 19 percent at the end of the 75-year projection period and would continue to rise thereafter. No reasonable person would view that as a fair policy. I conclude that any reform that is fair across generations would avoid pay-as-you go financing and therefore would at least partially pre-fund Social Security benefits.
Fixing the System
Fortunately, the current untenable situation of Social Security is fixable. President Bush has said that "Social Security is one of the greatest achievements of the American government, and one of the deepest commitments to the American people." The President supports social security reform that increases the power of the individual, does not increase the tax burden, and provides economic opportunity for more Americans. The President has issued guiding principles for reforming Social Security.
One very important principle is that the benefits of seniors at or near retirement should be protected, and that payroll tax rates should not be increased.
Another principle is that personal retirement accounts (PRAs) should be made available for younger workers to build a nest egg for retirement that they own and control, and which they can pass on to their children and grandchildren.
Additionally, we must pursue the goal of a permanently sustainable system, eschewing halfway measures that would necessitate further reforms in the future.
Personal Retirement Accounts
I would like to focus on the advantages of PRAs. PRAs provide individual control, ownership, and offer individuals the opportunity to partake in the benefits of investing in private-sector markets. Individual control and ownership means that people would be free to pass the value of accounts to their heirs (bequests).
Personal retirement accounts will be voluntary. At any time a worker can "opt in" by making a one-time election to put a portion of his or her payroll taxes into a personal retirement account. A worker who chooses not to opt in will receive traditional Social Security benefits, reformed so as to make the system permanently solvent.
Perhaps most importantly, the retirement security of our current young and future workers depends on PRAs. PRAs allow individuals to save now to help fund their retirement incomes. In principle, that could be done with reforms that save tax revenues in the Social Security Trust Fund. But such "saving" would almost certainly be undone by political pressures to increase government spending and hence produce larger deficits outside of Social Security. The only way to truly save for our retirement and give our children and grandchildren a fair deal is with personal accounts. Personal accounts serve as private and therefore effective "lock boxes". When pre-funding is done using a personal account, there is no pressure to increase government spending, because this pre-funding belongs to individuals and does not appear on the government balance sheet as budget surpluses.
Progressive Indexing
Recently, in a primetime news conference, President Bush outlined his proposals to permanently strengthen Social Security. The President believes that future generations should receive benefits equal to or greater than today's seniors - and that the safety net should be strengthened for those who need it most. Middle- and low-income Americans are among those with the most to gain from these reforms.
Common sense dictates that the highest earning seniors in the future do not need benefits dramatically higher than the highest earners receive today -- especially when the cost of paying such benefits would mean crippling tax increases. To protect the neediest Americans, President Bush is proposing a progressive indexing approach which would offer greater benefits for most Americans than the current system can afford to pay. For middle- and low-income seniors, benefits would continue to grow faster than inflation. For the highest-earning seniors, however, benefits would grow no faster than the rate of inflation.
Progressive indexing would mean real income security for millions of middle class Americans who would otherwise face certain benefit cuts. Under the President's proposal, all future seniors would receive benefits at least as high as today's seniors, even after adjusting for inflation and some – those most in need – will do much better. Today's middle-income 20-year-old would get $17,300 per year in benefits, which is $1,800 more than the current system can pay and $2,500 more than today's middle-income retiree receives. Expected benefits for those workers who invest in personal accounts would be even higher.
A responsible, reasonable and sustainable rate of benefit growth for wealthier seniors would also eliminate poverty among future seniors. Today, roughly two million retirees who paid into Social Security their whole lives are collecting benefits that leave them below the poverty line. By 2041, this number would double. A sliding-scale benefit formula would eventually be able to ensure that no American who works a full lifetime need retire in distress.
President Bush is proposing a reformed system that can afford to keep the promises it makes. Progressive indexing would create benefits which middle class Americans can rely on, rather than the empty promises of the current system. The Administration wants to see Social Security strengthened for those Americans who need it most and President Bush is leading the way towards a permanent solution.
CONCLUSION
To conclude, let me say that I am encouraged that Social Security reform is finally being earnestly debated, and that all parties are motivated to make Social Security fair and permanently solvent. Today, my small contribution to this debate consists of five major points:
- Social Security as currently designed cannot be sustained. We know with absolute certainty that Social Security will ultimately be reformed. The only question is when and how.
- Social Security reform is urgent. The longer reform is delayed, the more unfair reform will be to future generations, and the more difficult it will be for individuals to plan their financial futures.
- Social Security reform must make Social Security permanently solvent. Half measures ensure that further reforms will be necessary, and amount to a delay of reform that would be unfair to future generations.
- Making Social Security permanently solvent requires that retirement incomes be pre-funded in PRAs rather than the Social Security Trust Fund. Any attempt to pre-fund retirement incomes in the Trust Fund would be undone by excessive government spending outside of Social Security.
- Progressive indexing would solve most but not all of Social Security's financing shortfalls. The President is committed to working with Congress to find the best way to resolve the remaining shortfall.