FROM THE OFFICE OF PUBLIC AFFAIRS

March 11, 2005
js-2307

The Honorable Mark Warshawsky
Prepared Remarks
The National Newspaper Association
“The Urgency for Social Security Reform in the United States”
March 11, 2005
Washington, DC

Thank you for the kind introduction.  In his State of the Union address the President said, "One of America's most important institutions – a symbol of the trust between generations – is also in need of wise and effective reform." 

He was of course referring to Social Security.  As you are aware, President Bush has made Social Security reform a major priority of his second term.  Accordingly, we in the Administration want to formulate a reform plan that modernizes the program, is fair and puts Social Security on a sound and sustainable financial footing. 

Today I'll explain why it is so important that responsible Social Security reform occur now, and why one element of a successful reform plan must be personal retirement accounts that give individuals more control over their financial futures.  There is a great new web site that all Americans can use to learn more about what I will be talking about today:  StrengtheningSocialSecurity.gov.

I have been in the economics field for 25 years researching retirement security policies and if you had told me at any point that the solvency and reform of Social Security would be discussed around the kitchen table, the water cooler, or in the news everyday, I never would have believed you.  Now the fact that Social Security cash flows will start going into the red in 2018 and the trust fund will be exhausted by 2042 is on the minds of Americans.  And they want a solution.  The debate has come much further than anyone could have imagined.  Now we need ideas, more rather than less, to produce real results.

It is imperative that Social Security be reformed now well in advance of the exhaustion of the trust fund.  Why?  As I'll explain in this speech, delaying reform only reduces the options for fairly distributing the benefits of Social Security across generations.  As reform is delayed fewer generations are able to participate in a reformed entitlement system that will close Social Security's funding gap, and, therefore, the more severe those reforms will need to be. 

It is also imperative that PRAs be part of the Social Security solution.  Why?  PRAs provide individual control, ownership, and offer individuals the opportunity to build a nest-egg that the government cannot take away. They allow individuals to partake in the benefits of investing in the financial markets.  Individual control and ownership means that people would be free to pass any unused portion of accounts to their heirs.  But most importantly, PRAs allow effective pre-funding of Social Security benefits.  I like to characterize PRAs as individual "lockboxes" for Social Security surpluses.  PRAs are effective because the government can never take that money away.

According to the Social Security actuary's current projections, Social Security cash surpluses (payroll and benefit taxes less benefit payments) that last year amounted to 1.6 percent of taxable payroll will get ever smaller after the extraordinarily large baby boom generation begins to retire in 2008, and will ultimately turn to deficits beginning in 2018.  Starting at that time, benefits payments will have to be at least partially financed from general revenues that initially correspond to interest payments earned by the Trust Fund and later by redemptions of Trust Fund balances.  Under current projections, the drawdown of trust fund securities will be complete in 2042, at which time only about three-quarters of benefits will be payable.

Of course, full benefits could continue to be paid after 2042 if the payroll tax rate, now 12.4 percent, were to be increased.  If, for example, the system were to operate on a pay-as-you-go basis in every year beginning in 2042, current projections indicate that the payroll tax rate would have to rise gradually, but steadily, to more than 19% at the end of the current 75-year projection period.

Alternatively, Social Security which has a $3.7 trillion deficit calculated over 75 years could be made solvent over the next 75 years if the payroll tax rate were immediately increased by 1.9 percentage points (to 14.3 percent), or if all current and future benefits were reduced by 13 percent.  In either case, a large Trust Fund would accumulate that would be exactly dissipated at the end of the 75 year projection period.  This type of reform would therefore not make the system permanently solvent.  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. 

This last observation - that reforms that make the system appear solvent when calculated over 75 years do not make the system permanently solvent - shows that a 75 year horizon does not fully capture the financial status of the Social Security program.  In fact, no finite period will completely embody the financial status of the program because people pay taxes in advance of receiving benefits; at any arbitrary cutoff date, people will have accrued benefits that have not yet been paid.  For example, the current 75 year projections include nearly all of the 2010 birth cohort's taxes but virtually none of their benefits.   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 2004 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 $10.4 trillion.  This is the financing gap that program reforms must ultimately close.  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, there would be massive near-term Trust Fund accumulations. 

These results make 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 2042 when the trust fund is depleted, the requisite tax increase would be 6.5 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. 

Fortunately, this untenable situation 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 taxes 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 accounts will provide Americans who choose to participate with an opportunity to share in the benefits of economic growth by participating in markets through sound investments.  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 to be permanently sustainable.

Perhaps most importantly, the retirement security of our current young and future workers depends on PRAs.  They 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 prefunding 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.

As proposed by the President, PRAs are designed to hold down administrative costs, encourage careful and cautious investing, and provide a reliable income for the full length of retirement.

Centralized administration and a trim menu of investment choices will hold down administrative costs.  The PRA administration and investment options will be modeled on the federal Thrift Savings Plan (TSP), the voluntary retirement savings plan offered to members of Congress and other federal employees.  TSP offers benefits and features comparable to those available to private sector employees in 401(k) retirement plans.  The Social Security Administration's actuaries project that the ongoing administrative costs for a TSP-style personal account structure would be roughly 0.3 percentage points – that is $3 for every $1,000 invested.

PRA investors will have access to low-risk, low-cost broad index funds like those currently available to TSP participants.  Workers will also be able to choose a "life cycle" fund.  The asset composition of a life-cycle funds changes automatically to adjust investment risk downward as the fund's owner ages.  To protect near-retirees from sudden market swings on the eve of retirement, the President's plan specifies that a life-cycle fund be the default fund for workers age 47 and older.  The worker can opt out of this default if the worker and his or her spouse sign a waiver form stating they are aware of the risks involved. 

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 four 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.

LINKS

• Strengthening Social Security