Social Security Forum, February 24, 2005

Presenter: Dr. R. Steven Daniels

Department of Public Policy and Administration

Characteristics of Social Security

Eligibility40 quarters (10 years) of covered work at least $920 per quarter (2005).

Spouse or dependent of covered worker.

Disabled

Characteristics of Social Security

RevenuesPayroll tax rates: 6.2% employer and 6.2% employee.Maximum taxable income is $90,000 in 2005.

BenefitsBenefits based on Average Indexed Monthly Earnings (Monthly average of best 35 years indexed to wages).The Principal Insurance Amount, with first eligibility in 2005, equals the sum of the following:

A. 90 percent of the first $627 of the AIME, plusB. 32 percent of the amount above $627 up through $3,779, plusC. 15 percent of any amount in excess of $3,779.

Characteristics of Social Security

At the end of 2003, 47 million people were receiving benefits: 33 million retired persons and their dependents, 7 million survivors of deceased workers, 8 million disabled workers and their dependents.

In 2003, 154 million people had earnings covered by Social Security.

Social Security Shortfall

Social Security Trustees 2004 estimate.Surplus increases until 2018.Outlays exceed income in 2018.OASDI trust fund reaches zero in 2042.In 2043, revenue covers 73% of benefit.

Congressional Budget Office 2004 estimate.Surplus increases until 2019.Outlays exceed income in 2019.OASDI trust fund reaches zero in 2052.

Differences due to different estimates in real earnings growth, real interest rate, inflation, and unemployment.

Social Security Shortfall

Measures necessary to maintain solvency until 2078 (Social Security Trustees).

Increase tax rate from 12.4% to 14.29%.

Or, all current and future benefits could be reduced by 13%.

Or, raise maximum wage cap to $200,000.

Or, move money from general revenues or use combination of approaches.

Does not guarantee solvency after 2078.

Social Security Shortfall

Caveat about Projections

Bush Social Security Plan

Caveats:No formal plan submitted yet.

Submitted components are incomplete.

Other components are based on trial balloons and high placed administration sources.

Bush Social Security Plan

No changes for Americans 55 and older = Current social security plan.Gradual changes.Reforms on the table:

Limiting benefits to wealthy retirees.Indexing benefits to prices rather than wages.Increasing the retirement age.Discouraging early collection of retirement benefits.Changing the way benefits are calculated.

Bush Social Security Plan

Negotiable reforms (?): Maximum taxable income.

Nonnegotiable: Increases in tax rate.

Centerpiece: Personal Retirement Accounts

Personal Retirement Accounts

Yearly contribution limits raised over time, eventually permitting workers to set aside 4 percentage points of their payroll taxes in their accounts.

Starts at $1,000 per year going up $100 per year to 4 percentage points (maximum 32% of total FICA taxes).

Benefits reduced by one dollar for every dollar contributed plus yearly percentage increase in wages (usually 3 percent).

Proposed Benefits of Private Retirement Accounts

Centralized administrative structure.

Personal retirement accounts build “nest egg”.

Ownership and control.

Inheritability.

Better for younger workers.

Retirement accounts voluntary.

Proposed Benefits of Private Retirement Accounts

Available accounts similar to Thrift Savings Plan of federal retirees.

U.S. Treasury securities - 3.67% real interest.An index fund comprising investment grade bonds – 4.58% real interest.Small and mid-cap stock index fund – 8.62% real interest.Large cap stock index fund – 7.33% real interest.International stock index fund – 1.95% real interest.Life-cycle portfolios at age 47.

Invested in a mix of conservative bonds and stock funds.

Proposed Benefits of Private Retirement Accounts

Not eaten up by Wall Street fees.

Not accessible prior to retirement.

Accounts paid out over time rather than all at once.

Accounts phased in.

Transition financing equal to $754 billion over 10 years.

Personal retirement account caveats.

Accounts do not make Social Security solvent.

Transition costs could be as high as $2 trillion over 10 years.

Plan shifts resources from current beneficiaries to future recipients. Program needs to account for shortfall ($2.6 trillion over 75 years).

Personal retirement account caveats.

System does not allow as much individual flexibility as advertised.

Program requires annuities, which limits the inheritability.

Program places heavy burden on health of stock market.

Plan assumes poor economic performance to produce crisis

Plan assumes good economic performance to ensure adequate payoff for private accounts.

Components to Balance Plan

Phase I - Renege on treasury notes in Social Security Trust Fund (covers tax cuts). Low probability.

Phase II – Recalculate initial benefit formula, shifting from wage increases in the 35-year average to price increases. (See next table).

Components to Balance Plan

Conclusion

Private accounts with limited control for up to 32% of payroll taxes (although contributions are voluntary).

Probable shift in benefit calculation.

Additional one-time, transition costs ($750 million to $2 billion).

Borrowing costs to cover lost revenue to be paid to current beneficiaries.