The rhetoric in Washington has grown in intensity ever since the President's Inaugural Address firmly established Social Security reform as the "top domestic priority" for his administration. Playbooks have emerged on both sides of the aisle, full-page ads for and against reform have appeared in newspapers, and every think-tank in Washington has held a program to debate the issue.
While there are many aspects of reform, there are two main areas of debate: 1. how to finance the unfunded liability (the difference between the promised benefits over time and the expected revenues), and 2. carving out a portion of Social Security taxes and benefits for new Personal Savings Accounts. While these are separable issues, the two are often interwoven in the debate.
According to the Social Security Administration, starting in 2018 projected benefits paid to retirees will exceed projected payroll tax revenues, and the forecast says that shortfalls will continue to grow thereafter. The Social Security trust fund can cover the difference by gradually liquidating its portfolio of Treasury bonds, which have accumulated through past years when revenues exceeded payouts. In 2042, the trust fund will run out of Treasury securities. The excess of promised benefits over revenue after 2042 is the unfunded liability--a $3.7 trillion gap over 75 years. The current system and any reform plan must address this liability.
While the exact years when these events will occur can be disputed, their existence cannot. With life spans rising and birthrates declining, the ratio of workers who pay Social Security taxes to retirees who receive benefits keeps on declining. (See Chart 1.) It seems inevitable that sometime around 2018 workers will pay into the system less than beneficiaries draw out, and the trust fund will eventually run out of money--unless something is done about it.
Funding the unfunded liability must come from some combination of additional borrowing, raising taxes, reducing other government spending, and reducing Social Security benefits. Under current law, when the Social Security trust fund runs dry, benefits will automatically be reduced to a level equal to incoming revenue. The benefit reduction is projected to start at 27% in 2042 and continue to rise.
Personal Savings Accounts
President Bush has promoted the concept of Personal Savings Accounts (PSAs), which would allow individuals to invest a portion of their contributions to Social Security in stock and/or bonds. PSAs are tied to the President's "commitment to an Ownership Society" and represent a fundamental change in government's role in providing for retirement benefits.
The most common approach under discussion is to "carve out" a portion of what is paid in Social Security payroll taxes to be placed in a "401(k)-like" retirement vehicle directed by the individual. …