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An Analysis of the President's Budgetary Proposals for Fiscal Year 2006 March 2005 |
In February, the Administration proposed introducing voluntary individual accounts into the Social Security system.(1) Under that proposal, workers would be able to redirect part of their payroll taxes into an account, and their retirement benefits would be reduced proportionally. The Administration suggested that the proposal would be part of a more comprehensive Social Security plan, but it has not yet identified other specific changes. Thus, the budgetary and economic impact of the overall plan cannot be estimated. In isolation, the provision for individual accounts could increase federal outlays by a total of almost $1 trillion from 2009 through 2015 if all workers chose to participate, but actual outlays would depend on the extent of participation.
Overview of the Account ProposalBeginning in 2009, workers born in 1950 or later would be allowed to redirect 4 percentage points of the overall 12.4 percent Social Security payroll tax to an individual account, up to a maximum dollar limit.(2) That contribution limit would be $1,000 in 2009 and then increase by $100 per year plus the growth in average annual wages. Investment options and program management for the accounts would be similar to those used in the federal employees' Thrift Savings Plan, which offers a limited number of broad stock and bond index funds. Investments in the accounts would be recorded in the federal budget as outlays, because the receipts from the designated payroll taxes would be paid into people's investment accounts instead of remaining in the Treasury. If everyone eligible for an account took part in the program, those additional outlays would total $969 billion (not including any administrative costs) over the 2009-2015 period, the Congressional Budget Office (CBO) estimates. If two-thirds of eligible workers participated, the impact over that period would fall to $646 billion (see Table B-1).(3) Should only one-third of eligible workers choose to participate, the impact would fall to $323 billion.
The Budgetary Impact of Individual Social Security Accounts (Billions of dollars)
Factors Affecting ParticipationThe actual level of participation in an individual-account program would depend on the provisions of the complete proposal, including details about implementation of the accounts, the resulting value that workers would place on the accounts, and any changes to the traditional Social Security system. Workers would base their decisions on a comparison of the benefits of having or not having an individual account. Under the Administration's proposal, the benefits from participating in the account program would be uncertain. Participants would forgo part of their traditional retirement benefits, so total benefits would be dependent on the returns earned by their account. Thus, participation would be affected by the size of the reduction (or "offset") in traditional benefits. The larger that offset, the less likely workers would be to take part. The offset envisioned in the President's proposal is based on a real (after-inflation) return of 3 percent. If account holders realized a higher rate of return, their total retirement benefits would be larger; if they realized a lower return, their total benefits would generally be smaller. A central issue is the role of investment returns in such accounts. On the basis of historical patterns and likely future economic conditions, CBO assumes that the real return on Treasury securities will average 3.3 percent in the future, whereas the comparable return on stocks will average 6.8 percent. But stocks also carry higher risk. When choosing investments, investors evaluate the opportunities for low returns (and low risk) versus higher returns (and higher risk) and select a balance of stocks and bonds that suits their individual tolerance for risk. Investors who have a very high tolerance for risk purchase mostly stocks; others are willing to accept a lower expected return in exchange for the relative safety of bonds. In the process, investors' purchases reveal their current valuation of potential future returns and risks. The market prices of stocks and bonds indicate how those securities are valued by investors, including individuals and pension funds. The fact that the market value of $100 worth of bonds and $100 worth of stocks is identical means that investors value the net effect of the higher risk and return of stocks as equal to the lower risk and return of bonds. For that reason, one can use the expected return on government bonds as a guide to the current value of an account that would influence a typical worker's decision about participation. Many other factors, however, would also affect participation decisions:
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