Social Security Reform:
Alternatives to Personal Retirement
Social Security University
August 28, 2002
Michael Tanner, Director of Health and Welfare
Andrew G. Biggs, Social Security Analyst
The Cato Institute, Washington, D.C.
Opposing accounts isn‟t enough
Many honest people oppose personal accounts.
But the alternative to personal accounts isn‟t doing nothing.
One way or another, Social Security‟s financing problems
will resolve themselves.
If we choose not to implement personal accounts, what are
the other options open to us?
What are the costs and benefits, and the risks and
rewards, of these non-account reform proposals?
How Does Social Security Work?
•Each worker pays 12.4 percent of the first $84,900 of his wages
into Social Security. (Technically, his employer pays half, but
economists agree that employers reduce wages to make up for this,
so the whole burden is on the worker.)
•10.6 percent of the tax pays for Old Age and Survivors Insurance
(OASI); the remaining 1.8 percent pays for Disability Insurance
•At retirement, the SSA calculates a monthly benefit based on the
worker‟s average earnings.
•Low-wage workers get relatively higher benefits, though much of
this is offset because they have shorter life-spans (collect fewer
years of benefits) and are less likely to be married (collect less in
Social Security‟s Pay-as-you-go Financing
•Unlike a conventional pension plan, where each generation provides
for its own retirement by saving and investing its contributions over
time, Social Security is pay-as-you-go.
•Taxes collected today are used to pay today‟s retirees. Your own
retirement will be paid for by workers in the future.
•can begin paying benefits quickly;
•provides big windfalls to early retirees;
•simple to administer
•very sensitive to the ratio of workers paying into the system
to retirees collecting;
•pays very low rate of return to post-windfall generations.
Lower birth rates and increasing life expectancies mean
fewer workers to support each Social Security recipient
1960: 5.1 to 1 Today: 3.4 to 1 2030: 2.1 to 1
The cost of paying benefits has risen…and will rise
much more if the current system is not reformed.
Social Security's Tax History: Higher Rates, Applied to More of Your
Year Tax rate of the first … in wages
1940 2 percent $3,000 ($36,900 in $2002)
1960 6 percent $4,800 ($28,100 in $2002)
1980 10.2 percent $25,900 ($60,700 in $2002)
2002 12.4 percent $84,900
2041 17.8 percent $408,432 ($131,349 in $2002)
2080 20.1 percent $1,959,365 ($196,862 in $2002)
Source: 2002 Trustees Report
With each passing year, Social Security's long-term
deficits grow larger
75-Year Balance (surpluses minus deficits)
Long-term Deficits (if short-term surpluses aren't saved) $25.03
1999 2000 2001 2002
Year of Trustees' projections
But won‟t the Social Security trust
fund help pay benefits?
No – there is no cash in the fund, just government bonds. These bonds
represent a commitment to raise the money needed to pay full benefits, but
to get that money we must raise taxes, cut other spending or borrow. But if
there were no trust fund, we would still have to raise taxes, cut other
spending or borrow – and by the exact same amount. The fund is an IOU to
ourselves, and cannot put off the need for new revenue by a day or a dollar.
The Congressional Budget Office: “Although there is no money in the
Treasury to pay for future obligations, the obligations to people eligible for
Social Security benefits are real. And most important, those obligations are
a direct result of federal law, not a consequence of whatever may or may not
be credited to the Trust Funds. In particular, the size of the balances in the
Social Security Trust Funds – be it $2 trillion, $10 trillion, or zero – does not
affect the obligations that the federal government has to the program‟s
beneficiaries. Nor does it affect the government‟s ability to pay those
benefits.” (CBO Director Dan L. Crippen and Deputy Director Barry B.
Anderson, testimony before the House Ways and Means Committee, Feb. 23,
How Any Kind of Reform Must Work
“Increased funding to raise pension reserves is possible only with
some combination of additional tax revenues, reduced benefits, or
increased investment returns from investing in higher yielding
Henry Aaron, The Brookings Institution
January 19, 1999
A Menu of Choices
•Increasing payroll tax rates.
•Raising or lifting the cap on wages to which payroll taxes are applied.
•Transfer general tax revenues; a de facto income tax increase.
•Force state and local workers, who currently have their own pension plans,
into Social Security.
•Increase the normal and/or early retirement ages.
•Increasing the benefit computation period; instead of basing benefits on the
highest 35 years of earnings, use greater number of years.
•Increase taxation of Social Security benefits; remove exemption for low-
•Reduce annual cost of living adjustments (COLAs).
•Collective investment of trust fund in the stock market.
Cato‟s Criteria for Reform…More Than Just
•Increase future economic growth: In the future, smaller numbers of
workers will need to support larger populations of retirees. Social
Security can help make each worker more productive by raising national
saving, thereby increasing worker productivity and boosting economic
•Increase personal control: Reform should give workers true legal
ownership of their retirement savings, prevent the government from
“raiding” Social Security for other purposes, and give all Americans the
opportunity to build wealth and pass it on.
Increase fairness: The current system can be unfair to African
Americans, who often do not survive to retirement age; to working
women, who often do not receive spousal benefits; and the young, who
must pay high taxes into a system that will be insolvent by the time they
retire. Reform should correct these flaws so all Social Security
participants feel they are treated fairly.
One solution: personal accounts
•Workers could invest part or all of their payroll taxes in
accounts holding diversified stock and bond mutual funds. In
return, they would give up part of their traditional benefits.
•At retirement, workers could purchase an annuity or take
gradual withdrawals of their money.
•If the worker died before the account was exhausted, the
remainder would pass onto his spouse, children or a chosen
•Many plans exist: Congressional proposals, the President‟s
reform commission, think tanks and other interested groups.
Nevertheless, many people reject solutions based on personal
accounts. What would they offer?
The “Do Nothing” Plan
Former Sens. Bob Kerrey (D-NE) and Warren Rudman (R-NH) say
hundreds of Members of Congress already “support” this plan –
because they have not advocated any specific measures to keep Social
“Not acting is itself a choice -- one that has grim consequences for
today's midlife adults and even bigger ones for their children.
Politicians of both parties should get behind specific reform plans or
be held accountable for supporting the consequences of the Do
Doing nothing is easy – but leads to large benefit cuts for younger
Americans: 16 percent for today's 30-year-olds, 29 percent for
today's 20-year-olds and 35 percent for today's newborns.
When the trust fund runs out in 2041, by law benefits must be cut by
25 percent or more. If you are for doing nothing, you are for cutting
Comparisons to Current System Can Be Misleading
Many compare the costs and benefits of various reform plans
to a hypothetical Social Security system that can pay full
benefits forever without raising taxes.
Kerrey and Rudman: “It is certainly fair to criticize reform
plans on policy grounds. But it is fundamentally unfair to judge
them against a standard that assumes the current system can
deliver everything it promises. It can't. Today's Social
Security system promises far more in future benefits than it
can possibly deliver. The relevant comparison for any reform
plan is with what current law can deliver, not what it
Only by comparing personal account-based plans to other
plans that address Social Security‟s financing problems, can
we assess the options on a level playing field.
The Clinton-Gore Plan
•Use Social Security surpluses to repay existing
•Credit the interest savings to the Trust Fund by issuing
•These new bonds would keep Social Security technically
solvent until 2055.
Issues with Clinton-Gore plan
Debt reduction is a good thing but…
•The Clinton-Gore plan uses “Enron accounting”: the trust
fund is already credited for reducing interest costs.
Crediting it twice creates “paper assets.”
•Moreover, the trust fund would be credited with new
bonds even if no government debt were repaid.
•Putting more IOUs in the fund doesn‟t solve the system‟s
What the Experts Say About the Clinton-Gore Proposal
•“It would be tragic indeed if this proposal, through its budgetary accounting complexity, masked the urgency of the
Social Security solvency problem and served to delay much-needed action… “I am very concerned that enhancing the
financial condition of the trust fund alone without any comprehensive and meaningful program reforms may in fact
undermine the case for fundamental program changes. Delay will only serve to make the necessary changes more
painful down the road. The time has come for meaningful Social Security reform.” The administration proposal “does
not represent a Social Security reform plan and does not come close to “saving Social Security.” GAO head David M.
•“Adding to the trust fund balances does nothing to ensure that the necessary economic resources will be there to
support the programs; it simply shifts money from one government pocket to another. In fact, by relieving the most
visible sy mptom of the program‟s fiscal distress, additional transfers from the general fund may lull the nation into
overlooking the funds‟ less obvious problems… Plans that shift funds from one government pocket to another do
nothing to address those programs‟ actual financing problem…and in fact could postpone corrective action.” CBO
Director Dan L. Crippen,
•“The president also has a great deal of „pain‟ in his plan -- a hidden pain in the form of income tax increases that will
be borne by future generations of Americans. I strongly disapprove of a plan that provides a false complacency that
Social Security has been „saved‟ by this nebulous and vague idea of saving the surplus -- while failing to disclose the
real pain that will be imposed on future generations.” Former Senator Bob Kerrey (D-Neb)
•“Its very complexity pretends to have done something for Social Security, and it weakens the demand for reform.”
Eugene Steuerle, senior fellow at the Urban Institute.
•The plan “is not a solution to the question of paying for Social Security benefits. You have no fiscal discipline, you
have no governing device on the program. It just becomes a black hole.” Concord Coalition executive director Robert
•The plan “in no way reduces the rate of growth of benefits. It does not alter the economic burden on the sy stem. It
will have to be paid for, and it will be painful” for future generations. Rudolph G. Penner, Urban Institute; former
director of the Congressional Budget Office
USA Accounts Don‟t Fix Social Security
The Clinton administration and the Gore campaign proposed so-
called Universal Savings Accounts – or USAs.
Workers could make deposits to these supplemental accounts.
Lower-income workers would receive an up to three-to-one
match on their contributions.
USA accounts could be a good idea…but they do nothing to fix
Social Security. Even with USA accounts, Social Security would
still become insolvent.
Moreover, participation by lower-income workers would be low,
even with a generous match. (Personal accounts for Social
Security would let workers invest taxes they already pay, so
participation would be higher.)
Rep. Peter DeFazio‟s Plan (HR 3315)
Tax Increase: Lifts “cap” on payroll taxes, which currently apply
only to first $84,900 in wages. 12.4 percent tax would apply to all of
worker‟s wages, but workers wouldn‟t receive credit for extra taxes.
A worker earning $150,000 would pay an extra $8,100 in taxes each
year, but receive no extra benefits.
Government Investment: Requires the government to invest 40
percent of the trust fund in private stocks and bonds.
Benefit Cuts: Bases benefits on worker‟s 38 highest earning years,
vs. 35 under current system.
Tax exemption: Exempts first $4,000 in wages from payroll taxes.
•Increases benefits 5 percent for retirees over age 85.
•Allows parents three child care years without affecting their
Issues with DeFazio Plan
•Lifting payroll tax cap is biggest tax increase in history ,
•Would raise taxes $1.2 trillion over ten years and increase the top federal
tax rate to almost 55 percent, impacting economic growth and jobs.
•Combination of tax increase and $4,000 exemption breaks link between
contributions and benefits; turning Social Security into a “welfare” program
could hurt public support.
•Child care credits disproportionately benefit the wealthy , who can afford
to leave the workforce to raise kids. Lower-income parents must work.
•Not a permanent solution ; would keep Social Security solvent only until
2075, large deficits beyond that.
•Other countries have tried collective investment; World Bank research shows
most earned lower returns than a bank savings account, in part due to political
consideration. State pension plans like CalPERS (California) have also been
criticized for letting political considerations lead to investment losses (e.g.,
divesting tobacco stocks).
•Al Gore: “The magnitude of the government‟s stock ownership would be such
that it would at least raise the question of whether or not we had begun to
change the fundamental nature of our economy. Upon reflection, it seemed to
me that those problems were quite serious.” (New York Times, May 25, 2000)
•Alan Greenspan: I think it's very dangerous...I don't know of any way that you
can essentially insulate government decisionmakers from having access to what
will amount to very large investments in American private industry...I know
there are those who believe it can be insulated from the political process,
they go a long way to try to do that. I have been around long enough to realize
that that is just not credible and not possible. Somewhere along the line, that
breach will be broken. (Testimony before Senate Banking Committee, July 21,
Henry Aaron and Robert Reischauer Plan
(Brookings Institution/Urban Institute)
•Transfer around $100 billion of general revenues each year for the next 20
•Increase payroll tax ceiling to cover 90 percent of wages (raises ceiling to
•20 percent of the trust fund in the stock market.
•Increase the normal and the early retirement age to 67 and 64 by 2011, then
increase annually for longevity.
•Make 85 percent of Social Security benefits subject to income taxes;
eliminate exemptions of $25k for singles and $32k for couples.
•Reduce the spousal benefit from one-half to one-third of the primary earner‟s
•Increase the benefit computation period from the 35 to 38 highest earning
Some issues with Aaron-Reischauer
•General revenue transfers: personal account opponents
decry the “transition costs” of funding accounts. Yet the
costs of collective investment of the trust fund are the
same. If personal account plans are unaffordable, then so
are collective investment plans like Aaron-Reischauer.
•Increases in both early and normal retirement age:
workers could no longer receive benefits beginning at age
62. Would have to wait until 64 to collect. Could
adversely affect those with shorter life expectancies.
Increases in retirement age very unpopular.
Robert Ball‟s “Maintain Benefits” Plan
(1994-96 Advisory Council on Social Security)
•The maximum wage subject to payroll taxes would immediately be increased
by approximately $10,000. Beginning in 2050, the payroll tax rate would
increase across the board by 1.6 percentage points.
•Reduce annual cost of living increases.
•Increase the benefit computation period from 35 to 38 years, or increase
the current 12.4 percent payroll tax rates by 0.3 percentage points.
•Increase taxation of Social Security benefits; phase out exemptions from
taxation for low-income retirees.
Government investment in the stock market
•Invest 40 percent of the Social Security trust fund in the stock market by
•Force newly hired state and local workers into the system and redirect to
the Social Security trust funds revenues from taxation of Social Security
benefits currently going to the Medicare trust fund.
Increasing benefit computation period
The Ball plan and some others increase the “benefit
At present, benefits are based on highest 35 years
Increasing the benefit computation period by
definition introduces years of lower earnings,
thereby reducing benefits.
Would disproportionately impact women, who have
shorter working lives and would therefore have more
years of zero earnings averaged in.
Robert Matsui-Bob Graham 1990 Plan
•Invest Social Security surpluses in municipal bonds issued by states
•Trust Fund could purchase up to 25% of new municipal bonds issued,
•Since municipal bonds earn lower interest rates than the trust
fund‟s bonds, the investment would hurt Social Security‟s financing.
•General revenues would be transferred to make up the difference,
meaning tax increases/spending cuts.
•A new board would rate the municipal bonds‟ value, giving
Washington more power over state/local govts.
•Bonds would be for financing roads, bridges, schools, mass
transportation systems, ports and water-treatment facilities. But
many economists find these projects are less productive than market
National Committee To Preserve Social
Security And Medicare
•Repeal tax cuts and use general revenues to
supplement payroll taxes.
•Raise payroll tax cap to cover 90 percent of wages.
•Require all newly hired state and local workers to join
Social Security system.
•Government invest of the Social Security trust fund in
stocks should be “seriously considered.”
Issue with repealing tax cut
Some plans advocate repealing the recent tax cuts in
order to fund Social Security reform.
But we would still need to do something with the extra
money. Simply crediting it to the trust fund would not
We could invest it centrally in the stock market, but
that has political risks. We could use it to retire debt,
but that‟s not a long-term solution.
Tax cut repeal must be coupled with an investment
strategy and with other steps to maintain solvency. By
itself, it‟s not a permanent solution.
•Increase payroll tax by .8%, divided equally
between employer and employee.
•Increase the benefit computation period from 35
to 38 years, reducing benefits for all retirees.
•Require all newly hired state and local workers to
join Social Security system
•Fully incorporate recent changes in CPI formula
into Trust Fund projections.
•Note: this plan would not make Social Security
Inclusion of state/local workers
Many state/local government employees exempt from
Social Security. Pay into their own pension plans, which
generally provide superior benefits.
Forcing new state/local workers into Social Security
would provide temporary increase in revenues, but
eventually these workers would be eligible for benefits.
Very small long-term financing gains.
State/local workers, and the politicians who represent
them, would fight inclusion. Could be a deal-killer for
(Center for Economic and Policy Research)
•Index payroll tax rates to increases in life expectancy or
alternately transfer general revenues to Social Security
•General revenue transfers can be supported by repealing
tax cuts, increasing capital gains tax from 18 to 28%,
and/or imposing a .25 percent transaction tax on all stock
•Repeal payroll tax cap for employer‟s portion of payroll
•Fully incorporate recent changes in CPI formula into Trust
National Coalition Of Women‟s Organizations
•Increase payroll tax in future by 1.8 percentage
points, to 14.2 percent of wages.
•Repeal payroll tax cap, so taxes are applied to all
of a worker‟s wages (rather than just the first
•Government investment of 40 percent of Social
Security Trust Fund in the stock market.
Issues with raising payroll tax rates
Some plans advocate raising payroll tax rates, as we have
done many times in the past.
But payroll tax rates are already high, and payroll taxes are
the biggest tax for about three-quarters of American
Increased rates would translate into lower wages, making it
harder for businesses to attract workers. Could increase
Unless payroll tax increases today were effectively saved
for tomorrow, would not really address the problem. 1983
payroll tax increases created large trust fund “balance,” but
the fund will not truly help pay benefits after 2017.
•Raise payroll tax cap to cover 90 percent of
•Transfer general revenues to Social Security
• Consider allowing the federal government to
invest a portion of Social security Trust Fund
Note: such a plan would not keep Social Security
solvent unless large and ongoing general revenue
transfers are made.
Divide and Conquer
Matched head-to-head, the alternatives to personal accounts
often do not fare well.
Knowing this, account opponents seek to avoid a direct
comparison; many refuse to put forward their own plans until
personal accounts are taken off the table.
Instead, they follow a two step plan;
First, they will try to defeat personal accounts politically by
comparing them to a current system that faces no problems.
This is misleading, but could be effective.
If personal accounts are defeated, they will then introduce
their own proposals.
This strategy makes it all the more important that honest
head-to-head comparisons are made now.