A
fair agreement makes all parties to it grumble
equally, people say—so get ready to grumble. Proposals on
how best to modify Social Security to ensure its long-term
viability but not betray soon-to-retire baby boomers or
overburden the young, proportionately smaller workforce are
now front and center, thanks to President George W. Bush’s
push for a reform plan. The good news is the funding
shortfall finally is being discussed seriously. The bad news
lies in the considerable uncertainty about the best way to
solve it. Some ideas to strengthen Social Security have been
working their way through Congress, and there are several
alternatives to consider in the public debate.
Progress
In 2000 the poverty rate for elderly
Americans was 10%, down from 35.2% in 1959.
Source: Understanding Social
Security Reform: The Issues and Alternatives
, AICPA,
www.aicpa.org/members/socsec.htm , 2005.
| To convey information
about the reform ideas in progress, the New York State
Society of CPAs (NYSSCPA) held a March 2005 press briefing.
Its panel consisted of Louis Grumet, NYSSCPA executive
director; Laurence Keiser, CPA, JD, a tax and estate
planning specialist; and David Lifson, CPA, a past chairman
of the AICPA tax executive committee. The centerpiece of the
session was Understanding Social Security Reform: The
Issues and Alternatives, a newly updated AICPA report
prepared by the Tax Division and the Social Security Reform
Task Force (see
www.aicpa.org/members/socsec.htm ). Grumet, who
praised the AICPA for doing an outstanding job of
synthesizing important information, says, “The dialogue
about Social Security reform is a great opportunity for CPAs
to increase the public’s confidence in the profession.” This
article gives practitioners of all types a thumbnail
comparison of the plans and issues covered in
Understanding Social Security Reform.
SOCIAL SECURITY SNAPSHOT
Social insurance. Reducing poverty
among the elderly has been Social Security’s major
accomplishment and remains critical to future plans. Without
Social Security almost half (48%) of elderly Americans would
live in poverty. Although the demographics of those who
contribute to the program and receive its benefits have
changed since the system was created, all Americans expect,
and many rely upon, the benefits promised in return for
their contributions into the system.
Projected deficit. A problem with
deciding how to strengthen Social Security is that its
looming shortfall can only be estimated. Projections over
75-year periods start and end at different points and use
varying assumptions, making comparison difficult. Under the
Social Security Administration’s “best guess” scenario the
trust fund surplus will peak in 2028, decline thereafter,
and finally be exhausted in 2042. If nothing changes,
beneficiaries could receive full benefits through 2042,
after which benefits would have to be reduced by 27%. In
2078 benefits would have to be reduced by 32%. An immediate
infusion of $3.54 trillion, increasing the payroll tax rate
from its current level of 12.4% to 14.3% or reducing current
scheduled benefits by 12.6% could prevent the projected
deficit. While those assumptions are “reasonable,”
many others are as well. Under some projections the trust
fund will peak in 2021 and be entirely depleted by 2031.
Under other assumptions the trust fund would not be depleted
in the immediate future and there is no long-term financing
problem.
Potential fixes. Whatever the actual
extent of the shortfall, three general ways to improve the
financial condition of the Social Security Trust Fund are to
Reduce benefits. Across-the-board
cuts, means-testing, raising the retirement age and/or
changing the inflation adjustments to benefits are methods
to lower them.
Increase revenues or turn to other revenue
sources. Raising the payroll tax rate, raising the
cap on taxable income, extending the payroll tax to all
government workers, raising income taxes on Social Security
benefits and/or diverting general tax revenues to the trust
fund would increase revenues. Several plans suggest using
Treasury general funds to shore up the Social Security Trust
Fund.
Improve the rate of return on trust fund
assets. Social Security’s trust fund rate of
return—even fully funded—can improve significantly only if
the restriction to invest exclusively in U.S. government
securities is lifted. But investing in private securities
adds risk and administrative costs, and large-scale
government investment in private equities could distort
markets. AICPA RESOURCE
| Understanding Social Security
Reform: The Issues and Alternatives, a newly
updated AICPA report prepared by the Tax Division
and the Social Security Reform Task Force,
www.aicpa.org/members/socsec.htm .
|
PERSONAL SAVINGS ACCOUNTS?
Creating personal savings accounts or private accounts
within the Social Security system would change it from a
pay-as-you-go social insurance program to a hybrid with a
defined-contribution pension plan component. Proposals
suggest putting part of each under-55 worker’s payroll taxes
into a voluntary personal account, with investment and
payout restrictions. Personal accounts wouldn’t eliminate
all traditional Social Security retirement benefits, but
less money would be redistributed from high- to low-income
earners. In a best-case scenario, workers could earn
a higher return than under the traditional benefits plan. In
a worst-case scenario, workers could lose some amount of
their retirement nest egg. Under most proposals reviewed for
the report, traditional benefits would go down regardless of
whether an individual participated in the voluntary account
program. All personal account proposals in the report
require an infusion of money such as transfers from the
Treasury general fund to the Social Security Trust Fund.
Benefit offsets. Workers choosing to
contribute to personal accounts would receive benefits from
their private accounts plus traditional benefits, offset in
proportion to the amount redirected to personal accounts.
Large benefit offsets would make personal accounts less
costly for the trust fund but riskier for the worker.
Transition costs. Over the 75-year
horizon used to estimate Social Security reforms, the
creation of personal accounts will worsen the financial
condition of the trust fund. During the long transition to a
personal account system, contributions diverted to personal
accounts would shrink trust fund levels, leaving less money
to pay benefits to retirees. To remain solvent the program
would need funds from outside or significant savings from
inside.
Personal account issues. Important
issues to consider under any personal account proposal are
To what degree, and over what period, will
benefits under the existing system remain in place?
Will there be a safety net for low-income
beneficiaries?
How much choice will individuals have about
Participating?
Investments?
Distributions?
Will benefit payments be subject to tax? If so,
at what rate?
What will the plan “cost” beneficiaries in lost
traditional benefits as a trade-off for a personal account?
PLANS NOW IN CONGRESS
Presently there are many proposals for reform in
Congress. The AICPA study compares the basic types of plans
by looking at seven proposals: Ferrara-Ryan, Reform
Commission Plan 2, Diamond-Orszag, DeMint, Graham,
Kolbe-Boyd and Smith. All but one involve personal accounts.
The exhibit on page 42 compares them. For more detail
readers are urged to consult Understanding Social
Security Reform: The Issues and Alternatives.
Ferrara-Ryan: Peter Ferrara, an
Institute for Policy Innovation senior fellow, wrote a paper
entitled A Progressive Proposal for Social Security
Personal Accounts. Rep. Paul Ryan (R-Wis.) introduced
the Social Security Personal Savings and Prosperity Act of
2004 (HR 4851), an almost identical plan to Ferrara’s. Under
it, all workers at least 55 in the year following enactment
would receive benefits under the current system. Workers
under 55 could elect to have some payroll taxes redirected
to personal accounts. Funds deposited in those accounts
would be automatically invested in a three-tier investment
process. If market performance fell short, the federal
government would make up the difference. Diverting funds to
the new accounts would have a significant impact on the
Social Security Trust Fund, which would become insolvent in
2015 instead of 2042.
Reform Commission Plan 2 (Model 2): In
2001 President Bush charged a commission to come up with a
plan to restore Social Security to a sound footing while
making personal savings accounts available to younger
workers who want them. In its report, the commission
presented three alternative models. Model 2, which attracted
the most interest, includes voluntary personal accounts, but
on a smaller scale than Ferrara-Ryan. It includes major
changes (mostly reductions) in traditional benefits even for
those not opting for personal accounts. It proposes smaller
personal accounts and reduces conventional benefits—and
therefore needs less outside funding than Ferrara-Ryan.
Diamond-Orszag: Peter Diamond, an
economics professor at the Massachusetts Institute of
Technology, and Peter Orszag, an economist and Brookings
Institution senior fellow (and former special assistant to
President Clinton), described their plan in Saving
Social Security: a Balanced Approach (Brookings:
2004). It does not include personal accounts and does not
require outside funds to remain solvent. Instead of
financing a transition to personal accounts, the plan would
finance approximately two-thirds of the current Social
Security unfunded liability through payroll tax increases
and the remaining one-third through benefit reductions
targeted at higher-income workers. Over the 75-year horizon
the payroll tax rate would gradually increase from the
current 12.4% to 15.4%. Payments to beneficiaries would
gradually increase by 16.5%, less than under current law.
DeMint: Rep. Jim DeMint (R-S.C.)
introduced the Social Security Savings Act of 2003 (HR
3177). Similar to Ferrara-Ryan, it uses large personal
accounts and requires large transfers from the Treasury
general fund. It does not cut traditional Social Security
benefits other than redirecting payments to personal
accounts. Under DeMint, no one over age 55 when the plan is
implemented would be affected. All other workers would
automatically be enrolled but permitted to withdraw. On
average 5.1% of earnings would be redirected to personal
accounts.
Graham: Sen. Lindsey Graham (R-S.C.)
introduced the Social Security Solvency and Modernization
Act of 2003 (S. 1878), which would reduce scheduled
benefits, largely by changing from wage indexing to price
indexing. Under this plan, current retirees, workers 55 and
older and persons with disabilities would remain in today’s
system with no changes. Workers 54 and younger would have
the option of putting 4% of wages into personal accounts, up
to $1,300 annually. The government would guarantee currently
scheduled benefits to workers not electing personal accounts
in return for their paying an additional 2% tax on
their wages into Social Security. The additional tax would
increase over time.
Kolbe-Boyd: Reps. Jim Kolbe (R-Ariz.)
and Allen Boyd (D-Fla.) introduced the Bipartisan Retirement
Security Act of 2004 (HR 3821). This plan reduces Social
Security benefits by changing the method of adjusting for
inflation, gradually increasing the normal retirement age
and increasing the income cap on Social Security payroll
taxes. In 2006, workers under age 55 could redirect 3% of
their first $10,000 of earnings and 2% of their remaining
earnings below the wage cap (currently $90,000, but it is
indexed for inflation) to individual accounts. Contributions
would be invested, under each worker’s direction, in
federally administered individual security accounts, similar
to the Federal Employees’ Thrift Savings Plan.
Smith: Rep. Nick Smith (R-Mich.)
introduced the Social Security Solvency Act of 2003 (HR
3055), which would permit workers to elect to redirect 2.5%
of their pay to personal accounts in each year until 2025,
and 2.75% from 2026 to 2038. The contribution rate would
increase from 2.75% in 2038 to 8% in 2068. Workers could
choose options with stock-to-bond ratios of 40/60 or 80/20,
or the money would otherwise go into a default portfolio of
60% common stock and 40% corporate bonds. Once an account
balance reached $2,500, the worker could invest in a range
of mutual funds that replicated several broad-based indices
of securities and did not involve high investor risks.
Certain low-income earners could receive a subsidy credit of
up to $300 to their personal accounts. Summary Outline
Comparison of Seven Social Security Reform Bills
to Current Law.* |
| Current law (2003 assumptions)
| Ferrara-Ryan (w/o payroll tax cut)
| Reform Commission Plan 2
| Diamond- Orszag |
DeMint | Graham |
Kolbe-Boyd | Smith |
General features:
| Change in
structure of traditional benefits |
— | No | Yes |
Yes | No | Yes |
Yes | Yes |
Payroll tax increase | — |
No | No | Yes |
No | No | Yes |
No | Personal
accounts | No | Yes |
Yes | No | Yes |
Yes | Yes | Yes
|
Features of personal accounts:
| Annual
contributions (percentage of payroll)
| — | (Large) 10% of
1st $10,000 5% of other (6.4% average)
| (Small) 4%, up to $1,000
| — | (Large) Sliding scale
from 8% to 3% (5.1% average) |
(Small) 4%, up to $1,300 |
(Medium) 3% of 1st $10,000; 2% of
other | (Medium) 2.5% through
2025; 2.75% for 2025–2038 |
Investment—individual accounts,
centrally administered? | — |
Yes | — | — |
Yes | Yes | Yes |
Yes | Minimum
distribution | — | Current
law benefits | — | None
specified | Poverty level** |
120% of the poverty level |
None specified | Poverty level
|
Cost: |
Funds required from outside Social
Security (in present value, billions of
dollars) | $3,544 (about
$3.5 trillion) | $5,557 |
$2,267 | –$449 (i.e.
none) | $4,627 | $1,708
| $1,029 | $596
| | *For
details see Understanding Social Security
Reform: The Issues and Alternatives, pages
73, 78, 83, 85, 87, 88, 89–96,
www.aicpa.org/members/socsec.htm .
**Guarantee of current benefits if standard
portfolio allocation. Source: Social
Security Administration memoranda evaluating these
proposals can be found at
www.ssa.gov/OACT/solvency .
|
IT'S TIME TO GET INVOLVED
President Bush has presented a rigorous case for
Social Security reform, and Republicans have introduced
reform plans featuring personal accounts. Grumet admonishes
more Democrats to join the public discourse about this
issue. “Being in a fetal position isn’t what leadership is
all about,” he notes. A May 3, 2005, New York
Times editorial proposed adjustments to Social
Security based on Americans’ longer life expectancy and
income levels. Raising the payroll tax by three-tenths of a
percent in 10 years and in increments over 20 years
thereafter and raising the cap on wages subject to Social
Security tax to about $150,000 from the current $90,000 are
less expensive ways to obtain the necessary funding. “Social
Security can be strengthened without cuts as blunt and
inflexible as the ones Mr. Bush proposes,” it said.
Americans are trying to tell President Bush “there are
better ways to go. He obviously can’t hear them, but we hope
Congress can.” Concerned citizens should write to Congress
and make it clear they want a solution that works, “not
window dressing,” Grumet says. The preface to
Understanding Social Security Reform urges
policymakers and the public to gain a clear understanding of
the issues involved before modifying a program as important
as Social Security. It cautions: “Although care and
deliberation are called for…we must move toward a solution
in the near future. The longer we delay, the more difficult
and painful reaching a solution will become.” Practitioners
are in a great position to help the public understand the
plans before us and perhaps help shape even better ones.
—Michael Hayes Michael Hayes is a senior
editor on the JofA . Ms. Hayes is an employee of
the AICPA and her views, as expressed in this article, do
not necessarily reflect the views of the Institute. Official
positions are determined through certain specific committee
procedures, due process and deliberation. |