January 09, 2005
Sunday

In its campaign to build public support for private accounts in Social Security, the White House has said repeatedly in recent weeks that the program is in financial crisis. Meanwhile, the Administration is defending the so-called "price indexing" proposal to close Social Security's long-term funding shortfall -- a proposal that is likely to be part of the Administration's Social Security plan -- against charges that it would leave retirees worse off. On both of these issues, Administration claims have been incomplete or misleading.

Is Social Security "in crisis"?

The Administration has portrayed the Social Security shortfall as so massive that it threatens to destroy the program and engulf the rest of the budget. Such rhetoric seems designed to further the impression that the program will eventually go completely bankrupt, leaving today's younger workers with no Social Security benefits at all in exchange for their years of contributions.

• Social Security isn't about to disappear. The Congressional Budget Office (CBO) estimates that even if no changes are made to Social Security, it will be able to pay full benefits until 2052 and about 80 percent of promised benefits after that. Using somewhat more pessimistic assumptions, the Social Security Trustees estimate that Social Security will be able to pay full benefits until 2042 and about 70 percent of promised benefits after that.

In 2018 Social Security will start paying out more each year in benefits than it receives each year in tax revenues. But contrary to recent claims by supporters of private accounts, this does not mean the program will begin "collapsing" at that point. In 2018 the Social Security Trust Fund will contain $5.3 trillion in U.S. Treasury bills, and the Trust Fund will grow by another 25 percent over the next decade because of the interest it earns on those Treasury bills.

Some supporters of private accounts argue that the Treasury bills in the Trust Fund are nothing more than paper IOUs that may never be honored. To the contrary, Treasury bills are widely regarded as among the world's safest investments. The U.S. government cannot choose not to repay them -- with interest -- unless it is willing to default on its obligations for the first time in U.S. history.

• The real budgetary crisis. It is certainly true that the federal government will face serious fiscal problems by the 2020s. But those problems will be in the federal budget as a whole, and their two main causes will be: (1) the cost of the Administration's tax cuts, if they are extended permanently, and (2) growing Medicare costs, which are being driven primarily by rising health care costs throughout the economy.

Over the next 75 years, the combined cost of the tax cuts and the Medicare prescription drug benefit -- the President's two principal domestic priorities during his first term -- will be at least five times as large as the Social Security shortfall.

Specifically, the Social Security shortfall over that 75-year period is projected to be 0.4 percent of GDP (according to CBO) or 0.7 percent of GDP (according to the Social Security Trustees). In contrast, the tax cuts will cost 2.0 percent of GDP over that period, based on cost estimates from CBO and the Joint Committee on Taxation. (Experts from the Brookings Institution and other leading organizations have produced a similar estimate.) The Medicare drug benefit will cost 1.4 percent of GDP, according to the Medicare Trustees.

The reality is that the Social Security shortfall, while sizeable, is not gargantuan. It can be closed without undermining the program's basic structure, through a mixture of modest benefit reductions and revenue increases phased in over several decades.

Problems with "Price Indexing" Even Larger than Advertised

Press accounts this week reported that the Administration's Social Security plan is likely to include a fundamental change in the formula used to determine a worker's Social Security benefits. Though this change is usually called "price indexing," its real effect would be to reduce significantly the share of their pre-retirement earnings that workers receive in Social Security benefits.

Moreover, this benefit cut would apply to all beneficiaries, whether or not they elect to forego a portion of their benefits in return for an individual account.

The magnitude of the cuts under price indexing can be seen in this example: under price indexing, an individual who works at average wages throughout his career and retires in 2075 would receive monthly Social Security benefits that replace just 20 percent of his pre-retirement earnings. Under the current benefit structure, his benefits would replace about 36 percent of his pre-retirement earnings. Price indexing, in other words, would cause a 46-percent drop in this worker's Social Security benefits compared to current law.

• Better than nothing? The Administration has defended price indexing by arguing that while benefits under the proposal would be much lower than those promised by current law, they would still exceed the benefits Social Security could afford to pay if nothing were done to close its funding gap.

This claim is contradicted by the Congressional Budget Office's analysis of the so-called "Model 2" reform plan put forth by the President's Social Security Commission, which includes price indexing. CBO found that under price indexing, the combined income from Social Security and individual accounts would be below the benefits that would be paid if policymakers took no action and Social Security benefits were reduced to the levels that the program's revenues could support after its trust fund was exhausted.

CBO estimates, for example, that workers born between 1990 and 2000 who earned median wages and retired at age 65 would receive combined benefits from Social Security and individual accounts that, on average, would be 20 percent - or $3,600 a year in today's dollars - below what would be paid if no action were taken to shore up Social Security's finances (i.e., under a "do nothing" scenario). (1)

• Living in the past. It is true that benefit levels under price indexing would keep pace with changes in prices. But beneficiaries would be excluded from the general increase in the standard of living from one generation to the next. Upon retiring, workers of future generations would essentially be pushed back to today's standard of living, where Social Security benefits would be frozen in perpetuity.

Edward Gramlich, a noted economist who chaired the Advisory Commission on Social Security in the mid-1990s and is now a Federal Reserve governor, made this same point when he noted that "If the system had not been wage indexed, (retirees) would be living today at 1940 living standards," since that was the time Social Security began.

• Effects on people with disabilities, widows, and orphans. Another problem with price indexing is that it poses special risks to recipients of Social Security disability and survivors' benefits. This fact has not been acknowledged by the Administration or noted in initial media reports on this issue.

These people will experience the same cut in Social Security benefits as everyone else, since Social Security uses a common benefit formula for all categories of beneficiaries. Yet they will be much less likely than other recipients to have significant funds in their private accounts that can offset the benefit cut. This is because workers who die or become disabled at a young age will not have had the opportunity to build up much in their individual accounts before they are compelled to leave the work force.

• The price of ruling out new revenues. The reason the Administration appears set on price indexing, despite its serious problems, is that the Administration "needs" the savings from big benefit cuts to close Social Security's long-term funding shortfall. The creation of private accounts would do nothing by itself to close that shortfall, and in fact would worsen it by draining money out of the system that is needed to pay current beneficiaries.

As Peter Wehner, a Bush aide, wrote in a private email to conservative allies that was leaked this week, "If we borrow $1-2 trillion to cover transition costs for personal savings accounts and make no changes to wage indexing, we will have borrowed trillions and will still confront more than $10 trillion in unfunded liabilities."

But closing the Social Security shortfall entirely through benefit cuts is hardly the only option. Instead, the Administration and Congress could adopt a more balanced approach that combined much more modest benefit adjustments with modest revenue increases. They could, for example, retain a smaller estate tax rather than repealing it permanently, or scale back the tax cuts for the highest-income 1 percent of households, and dedicate these revenues to Social Security. They also could made modest changes to the payroll tax, such as raising the level of wages subject to the tax.

Thus far, however, the Administration has rejected using new revenues to help close the Social Security shortfall. This means the entire load of closing the shortfall must come through deep benefit cuts, such as those imposed under price indexing.

Michelle Bazie
Center on Budget and Policy Priorities
Washington, DC - US

 

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