The Basics: Social Security Reform (Revised for 2005)
The Century Foundation, 2/1/2005
By Paul Krugman
From the introduction to The Basics: Social Security Reform:
http://www.socsec.org/publications.asp?pubid=509
[Paul Krugman does some elementary math too, with the numbers being thrown out
by the administration. Read him at: Paul Krugman (2005) "Confusions about
Social Security ", The Economists' Voice: Vol. 2: No. 1, Article 1.
http://www.bepress.com/ev/vol2/iss1/art1 ]
President George W. Bush repeatedly has emphasized
that one of his foremost second-term priorities is a
fundamental transformation of the Social Security
program into a system that includes personal
investment accounts. Enacted in 1935 and amended many
times since, most recently in 1983, Social Security
provides benefits to workers and their family members
upon retirement, disability, or death. Since the
program�s inception, the size of those benefits always
has depended on the earnings of workers over the
course of their careers. President Bush wants to
change the system so that in the future the amount
that each worker collects from Social Security upon
retirement would depend on the performance of
investments in his or her own personal account.
Much is at stake in this debate. More than 96 percent
of workers pay Social Security taxes and are thereby
entitled to collect benefits from the program. More
than 47 million Americans today receive checks from
the Social Security system. Although the average
monthly payment to those individuals is a modest $895,
Social Security constitutes more than half of the
incomes of almost two-thirds of retired Americans. For
one in six, it is their only income.
Transforming the system to create new personal
accounts for younger workers while continuing to
provide payments owed to today�s beneficiaries
requires a huge infusion of additional money. Although
the president had not proposed a detailed plan as of
the date this pamphlet was written, most analysts
expected the creation of private accounts to require
new federal borrowing amounting to trillions of
dollars. That additional debt could constrain
significantly the nation�s overall economic
performance and the scope of federal activities years
into the future.
President Bush and others who support his approach
argue that such dramatic changes are necessary because
Social Security faces a financing shortfall. According
to the Social Security Trustees� latest estimates,
based on intermediate economic and demographic
assumptions they deem to be neither optimistic nor
pessimistic, Social Security will continue to be able
to pay benefits in full until its Trust Funds are
exhausted in the year 2042. After that, funding would
be sufficient to provide about 73 percent of currently
promised benefits. For perspective, it is worth noting
that in 1997, the Trustees predicted that the Trust
Funds would run out in 2029. So without any changes to
the program, the nation�s improved economic
performance added thirteen years to the estimate of
when the system would face a genuine crisis.
The reason why Social Security faces a long-term
financing challenge, as most people know, is that the
huge baby-boom generation born between 1946 and 1964
will be eligible to begin retiring in about 2008. They
will place a strain on Social Security because a
smaller share of the U.S. population will be working
and contributing taxes to the system relative to the
number who will be collecting benefits.
The retirement of the baby boomers was already on the
radar in 1981 when President Ronald Reagan created a
commission headed by Alan Greenspan, now chairman of
the Federal Reserve, to strengthen Social Security. At
that time, the Social Security Trust Funds were nearly
depleted, and the Greenspan Commission recommended
that those funds be substantially bolstered to avert
another such crisis as the boomer generation retired.
Those reforms, enacted in 1983, are projected to keep
the Social Security program solvent through 2042.
Right now, Social Security has reserves in excess of
$1.5 trillion, and those reserves are projected to
rise to more than $6 trillion over the next
twenty-five years to absorb the impact of the baby
boomers� retirement. It should be noted that by 2042,
the majority of the baby-boom generation will no
longer be alive.
Whether one favors or opposes the creation of private
accounts, the plain fact is that they would make the
challenges facing Social Security more immediate and
severe. The problem is that financing the accounts
while sustaining payments to today�s beneficiaries
requires drawing down the Trust Funds� reserves much
more rapidly, resulting in their depletion about
twenty years sooner than they otherwise would be.
It is no exaggeration to say that Social Security has
never been more likely to be subject to fundamental
restructuring than it is today. That is why, aside
from matters of war, the debate over the program�s
future is more important to the country and its
citizens than any other issue before Congress. In the
end, the right decision will depend on an informed
public. This pamphlet, the fifth updated edition,
presents the best available facts, figures, and
arguments about what is right with Social Security,
what is wrong with it, and the strengths and
weaknesses of proposals to convert it into a system
reliant on private investment accounts.
The Basics: Social Security Reform has been revised
for 2005. Featuring statistics, graphs, and accessible
descriptions of how Social Security works, who it
affects, and the debate about its future, this
pamphlet has long been a popular resource for
straightforward information about the program. This
edition features a new final chapter on how the
current drive to privatize the program would
jeopardize Social Security's financial health and
endanger the prospects for a secure retirement for
millions of working Americans.
Download the complete Basics pamphlet in PDF format,
or email [EMAIL PROTECTED] with your address to receive a
copy by mail.
Media inquiries should be directed to Christy Hicks at
[EMAIL PROTECTED] or 212-452-7723.
And a more detailed one, from the same website:
Ten Myths about Social Security
Greg Anrig Jr., The Century Foundation, 1/26/2005
The current debate over privatizing Social Security
has been marred by numerous myths perpetuated by both
privatization's advocates and the media. The Century
Foundation looks at 10 commonly accepted assertions
and points out why each has little to do with reality.
Read it below or download the PDF.
Myth #1: Social Security is in crisis and facing
bankruptcy.
Even if Congress were to leave Social Security
untouched, the program would be able to pay currently
guaranteed benefits in full until 2042, according to
the program's trustees. Thereafter, about 70 percent
of promised benefits could be financed. The
nonpartisan Congressional Budget Office is even more
optimistic: it projects that, without changes, Social
Security will be able to meet its obligations in full
until 2053, after which about 80 percent of benefits
still could be paid for. Even under those worst-case
scenarios, decades from now the system would be far
from "bankrupt," "flat-out bust," or "broke," which
imply that no resources would be available to pay any
benefits. At that time, workers and their employers
still will be contributing payroll taxes to finance
benefits for retirees.
So Social Security is facing a long-term financing
problem, but it is far from a "crisis" by any
definition of that word. And the problem is much less
immediate and threatening now than in the recent past,
even though no changes have been made to the program.
In 1997, Social Security's trustees had projected that
the program's trust funds would last only another
thirty-two years and would be depleted in 2029. Those
forecasts have improved steadily-largely because of
stronger than expected economic growth-so that the
trust funds now are expected to remain sufficient for
thirty-seven more years.
Like a doctor who recommends "watchful waiting" while
a patient becomes healthier, Congress should think
twice before performing radical surgery on an
enormously successful program that appears to be
getting better with age.
Myth #2: Social Security is unsustainable.
Over the course of the next seventy-five years, the
gap between promised Social Security benefits and
resources available to pay those benefits�the
shortfall projected to arise beginning in 2042�is
predicted to be about 0.7 percent of gross domestic
product (GDP), or $3.7 trillion, according to Social
Security's trustees. Without question, that's nothing
to sneeze at. But by way of perspective, the tax cuts
enacted in 2001 and 2003, if made permanent, would
cost nearly three times as much: $11.6 trillion, or
2.0 percent of GDP, according to the Center on Budget
and Policy Priorities. Furthermore, the new
prescription drug benefit enacted last year will cost
more than twice as much as eliminating the Social
Security shortfall.
So saying that Social Security isn't "sustainable" or
"affordable" is simply wrong. The program's entire
seventy-five-year shortfall could be paid for simply
by rescinding just a third of the planned tax cuts,
which primarily benefit the highest earners�people who
would still be paying substantially less to the
government than they did in the prosperous 1990s. A
myriad other trade-offs are possible as well. But the
long-term challenge confronting Social Security is by
no means insurmountable.
Myth #3: Social Security's trust funds are filled with
worthless IOUs.
When investors become worried about the economy and
the stock market, they "flee to safety" by selling
their other securities in exchange for U.S. Treasury
bonds and bills. Backed by the full faith and credit
of the United States government, U.S. Treasury
securities are considered to be the safest, most
reliable investment worldwide. Because the federal
government is legally obligated to pay back interest
and principal on those securities, it would take an
almost unimaginable calamity for a default to occur.
Social Security's trust funds, which now amount to
$1.5 trillion and are expected to grow to $5.3
trillion by 2018, hold nothing but U.S. Treasury
securities.
Alan Greenspan, now the Federal Reserve chairman, led
a bipartisan commission in 1983 that recommended
changes to Social Security explicitly to produce the
large trust funds that the system will draw on to pay
for the baby boom generation's retirement from roughly
2008 to 2030. Those reforms, signed into law by
President Ronald Reagan, were widely hailed at the
time by both parties as a model of effective
government. If anything, those reforms have turned out
to be even more successful than originally imagined,
as the improved forecasts in recent years for the
program demonstrate. The central reason for that
success was the Greenspan Commission's idea of
building up trust funds invested in safe U.S. Treasury
securities.
Myth #4: The real date to worry about is 2018.
President Bush and others have argued that Social
Security's problem begins not in 2042, when the trust
funds would be depleted, but 2018, when Social
Security's trustees project that payroll taxes will no
longer exceed that year's benefit obligations. But the
whole reason why President Reagan and Alan Greenspan
created the trust funds was to guarantee that benefits
could continue to be paid in full when payroll taxes
did not fully cover the system's expenses. Remember
that the trust funds will amount to about $5.3
trillion at that time. Just the interest on the trust
fund's Treasury securities will be more than
sufficient to finance payments fully for another ten
years. Indeed, the trust funds still will grow another
25 percent from 2018 to 2028, reaching about $6.6
trillion because of the interest earned on those
securities.
>From the standpoint of the federal budget, after 2018,
some general revenues will be needed to pay for the
difference between each year's payroll taxes and
guaranteed benefits as part of the interest owed on
the trust fund's Treasury securities. But in each of
those years, the expected cost will be relatively
modest. The Center on Budget and Policy Priorities
calculates that in 2025, for example, the difference
between Social Security's benefit costs and its
non-interest revenues will be less than 10 percent of
the projected federal deficit. By comparison, the Bush
administration's tax cuts, if made permanent, and the
new prescription drug benefit for Medicare will cost
five times as much in that year.
Myth #5: Social Security is a bad deal.
The vast majority of today's retired Americans will
receive Social Security benefits that far exceed what
they contributed in taxes during their working years.
While that so-called "rate-of-return" is projected to
decline somewhat for future retirees, the program
still offers a far better deal than any other private
alternative could conceivably provide. Here's why:
Focusing on retirement benefits alone, most workers
with moderate and low incomes will receive an annual
rate of return slightly in excess of the 2 percent
that government bonds typically provide above
inflation. For example, a couple with one worker who
earned an average income and retires in 2029 would
receive an average real rate of return of 3.97
percent. Those with high earnings would receive a
lower, but still positive rate of return. Unlike
Individual Retirement Accounts and 401(k)s, Social
Security's retirement benefits are not subject to
investment market fluctuations and provide benefits
that increase with inflation. So the program's
baseline retirement benefits in their own right
constitute a good deal.
Retirement benefits are not all that Social Security
offers. In addition, it provides insurance to workers
and their families in the event of disability or
death. More than a third of Social Security
beneficiaries are survivors of deceased workers,
spouses and children of retired or disabled workers,
or disabled. For an average wage earner with a spouse
and two children, in 2000 the disability coverage
provided by Social Security was equivalent to a
$353,000 disability policy in the private sector;
Social Security's survivorship insurance was
equivalent to a $403,000 life insurance policy.
Moreover, Social Security's insurance payments are
adjusted annually to protect against erosion caused by
inflation; private insurance rarely, if ever, protects
against inflation. Rate-of-return calculations do not
take into account the significant value of that
insurance protection.
>From the standpoint of taxpayers, Social Security is
enormously efficient. Its administrative costs are
less than 1 percent of benefits. In contrast, the fees
in privately managed investment accounts are likely to
reduce the ultimate retirement value of the accounts
by 20 percent, according to a study by University of
Chicago economist Austan Goolsbee.
Myth #6: Social Security is overly generous.
While Social Security continues to be a terrific deal
from the perspective of what taxpayers receive
relative to their lifetime contributions, it is by no
means extravagantly generous. The average monthly
payment is $895, or $10,740 a year. By comparison, the
poverty level in 2003 was $8,980. The Social Security
benefits of an average-wage worker with a spouse who
retires at age sixty-five in 2004 were about 63
percent of his or her average earnings. For low-wage
workers, it replaces 85 percent of past earnings; for
high-wage workers, the replacement level is 45
percent.
Without Social Security, about 40 percent of the
nation's elderly would be in poverty, rather than just
10 percent. Before 1960, the poverty rate among the
elderly was over 35 percent. The dramatic decline
since then is largely attributable to Social Security.
In 2003, 34 percent of the elderly relied on Social
Security for at least 90 percent of their total
income. For 65 percent of the elderly, Social Security
constitutes more than half their income. So while the
program's guaranteed benefits are far from excessive,
they are essential to enabling the nation's retirees,
and assuring today's workers, that they will be able
to live out their golden years in decency.
Myth #7: "Privatization" will strengthen Social
Security.
Although President Bush has not yet put forward a
specific proposal, the President's Commission to
Strengthen Social Security in 2001 laid out three
alternative approaches for diverting payroll taxes
into individual retirement accounts. The second of
those proposals is widely considered to be close to
the model that the president will endorse. Its two
main features are (1) a cut in promised benefits by
switching from a wage-indexing to a price-indexing
formula, thereby reducing the wage-replacement rate
each year for new retirees; and (2) the creation of
personal retirement accounts using up to four
percentage points of each worker's taxable payroll
income. Here is why the proposal would weaken, rather
than strengthen Social Security. (see the issue brief
Twelve Reasons Why Privatizing Social Security is a
Bad Idea for an extended discussion)
� It would dramatically reduce guaranteed benefits-far
beyond the amount needed to close the program's
long-term financing gap. The graph below shows the
extent to which promised benefits would be reduced
relative to the current "worst-case scenarios"
projected by Social Security's trustees and the
Congressional Budget Office. The benefit reductions
under the commission's plan would begin to kick in
relatively gradually, but would reduce payments
steadily so that today's young workers would be far
worse off than if no changes were implemented.
Source: "Do Nothing" from Social Security Trustees
2004 report Table IV.B1 and from CBO "Long Term
Analysis of Plan 2 of the President's Commission to
Strengthen Social Security," Table 1B; "Price
Indexation" from SS Chief Actuary, as reported in the
Washington Post. (Some intermediate numbers
interpolated.)
If retirees have private accounts, these also would
contribute to their income. But the contribution of
private accounts can be ignored. That is because while
"price indexation" would apply to all Social Security
recipients, whether or not they opted for private
accounts, those who chose to invest would face
additional, even greater reductions in guaranteed
benefits. Moreover, according to the Congressional
Budget Office, the risk-corrected value of private
accounts barely would exceed the guaranteed benefits
they replace. Private accounts have essentially no
effect on the situation.
� Diverting payroll taxes into private accounts would
cause a much more immediate and severe "crisis" to
arise. Under the commission's plan, Social Security
would have to rely on interest from the trust funds to
pay benefits starting next year, rather than in 2018.
The trust funds would be exhausted well before 2020 if
everyone elected to contribute the maximum 4 percent
of their income to the accounts-more than thirty years
earlier than would otherwise be the case.
� To finance the accounts while continuing to pay
benefits to current retirees will require huge new
federal borrowing - again, far beyond what would be
needed to cover the Social Security's long-term
shortfall. The 2004 Economic Report of the President
included an analysis of the fiscal impact over time of
the most commonly discussed privatization proposal by
the president's commission. It found that the federal
budget deficit would be more than 1 percent of GDP
higher every year for roughly two decades, with the
highest increase being 1.6 percent of GDP in 2022. The
national debt levels would be increased by an amount
equal to 23.6 percent of GDP in 2036. That means that,
thirty-two years from now, the debt burden for every
man, woman, and child would be $32,000 higher because
of privatization.
� Social Security's disability and survivor's
insurance would be decimated under privatization. In
the principal proposal put forward by the president's
commission, the reduction in disability benefits was
severe, with cuts ranging from 19 percent to 47.5
percent after the year 2030. The commission itself
somewhat disavowed this aspect of its proposals,
suggesting that a subsequent commission or other body
that specializes in disability policy might revise how
its plans apply to the disabled. Economists Peter A.
Diamond (MIT) and Peter R. Orszag (The Brookings
Institution) have noted that the personal accounts
would do little to offset these benefit reductions for
the disabled. One reason is that their individual
accounts often would be meager, since those who become
disabled before retirement age may have relatively few
years of work during which they could make
contributions to their accounts. Second, under the
commission proposals, disabled beneficiaries (like all
other beneficiaries) would not be allowed access to
their individual accounts until they reached
retirement age.
Myth #8: Today's young workers will benefit the most
under privatization.
Social Security privatization is often sold to young
adults as a much better deal for them than the current
system. But younger generations will be the ones who
bear the bulk of the costs of transforming the
program. That is attributable to the additional new
debt burden they will face as well as the long-term
impact of no longer keeping guaranteed benefit levels
connected to improvements in living standards.
According to the Congressional Budget Office, "to
raise the rate of return for future generations by
moving to a funded system, some generations must
receive rates of return even lower than they would
have gotten under the pay-as-you-go system." A July
2004 Congressional Budget Office analysis of the
commission proposal found that nearly all age groups
at all income levels born from the 1940s through the
first decade of the twenty-first century on average do
worse under the proposed system of private accounts.
Only individuals with the lowest incomes from the
1950s and the 1990s do slightly better, on average.
Myth #9: Privatization will enable retirees to leave
the assets in their accounts to their heirs.
Although this claim continues to be made widely, most
workers would not be able to bequeath their Social
Security investment accounts upon their death. The
proposals put forward by the president's commission
would allow retirees to collect some or all of their
lump sums, provided that both spouses agree and that
the withdrawals are of sufficient size to keep the
worker and spouse out of poverty. (Turning over the
entire "nest egg" to retirees would run the risk that
individuals would squander it, either leaving them
impoverished or the government on the hook for
providing subsistence benefits.) The commission did
not provide details about how the government would
determine whether retirees would be at risk of
poverty, but given that nearly half of today's
retirees would be in poverty without Social Security,
it's safe to say that a large portion of future
workers would not be allowed to access their accounts
in the form of a lump sum. To a large extent, it would
be only the wealthiest elderly�those who already have
sufficient assets to pass along to their heirs�who
would gain access to their investment accounts.
Most other retirees would be required to convert their
lump sums into financial vehicles called annuities,
which would provide each retiree monthly payments that
would continue until the retiree and his or her spouse
died. The value of the annuities' monthly payments is
based on the life expectancy of each beneficiary upon
retirement. If annuity payments were to continue to
children and other heirs after the death of the
beneficiary, the investment companies providing the
annuities would go out of business. Annuities also are
rarely indexed for inflation, as today's Social
Security benefits are, for the same reason: private
companies would not be able to earn a reliable profit.
Myth #10: Reforms that retain Social Security's
existing protections will not work.
Social Security's projected shortfall beginning after
the year 2042 could be surmounted by choosing from a
menu of modest benefit cuts and revenue increases,
without increasing federal deficits. Among the
alternatives that would help strengthen the system:
including all state and local workers in the program
(most of whom are now exempted) to increase revenues;
including earlier, lower-salary years of workers in
calculating their retirement benefits; changing the
benefit formula so that workers with high income have
a smaller share of their pre-retirement earnings
replaced by Social Security; raising the cap on
earnings subject to the payroll tax; modestly reducing
early retirement benefits; and so on. Any combination
of such changes would strengthen the system's
long-term finances while preserving the features that
have made it so successful.
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