Executive Summary
Questions for Evaluating Personal Account Proposals
Additional Materials

Executive Summary

Social Security is often described as the most popular government program, and Americans collectively have come to rely on it for their retirement years. But the long-term viability of Social Security must be addressed in the very near future.

The American Institute of Certified Public Accountants strongly urges that, before taking a position on a possible solution to the funding shortfall, policymakers and the public need to gain a clear understanding of the issues involved in reforming Social Security. The goal of this report is to foster informed discussion by providing unbiased facts and analysis.

The Situation

According to the Social Security Administration's "best guess" (intermediate) assumptions, the Social Security Trust Fund surplus will peak in 2028. Then it will decline steadily until 2042, at which time the Trust Fund will be exhausted. However, inadequate funds do not mean zero benefits. If no changes are made to Social Security, beneficiaries could receive full scheduled benefits through 2042. Thereafter, scheduled benefits would have to be reduced by 27 percent. In 2078, benefits would have to be reduced by 32 percent. This Social Security "deficit" could be funded by an immediate infusion of $3.54 trillion; by increasing the payroll tax rate from its current level of 12.4 percent to 14.3 percent; or by reducing current scheduled benefits 12.6 percent.

Although the intermediate assumptions are reasonable there is still considerable uncertainty about actual results. Under Social Security's high-cost projections, the Trust Fund peaks in 2021 and is entirely depleted by 2031. Under low-cost projections, the Trust Fund would not be depleted and there is no long-term financing problem.

Poverty and Elderly

Social Security is a critical component of the financial security of millions of retirees—especially for future generations of the nation's elderly poor. Social Security provides more than half of the total income for almost 60 percent of beneficiaries. For almost 30 percent, it provides more than 90 percent of income.

Reducing poverty among the elderly is Social Security's major accomplishment to date. The poverty rate among the elderly in 2000 was approximately 10 percent, down from a rate of 35.2 percent in 1959. Without Social Security, the poverty rate among the elderly would be 48 percent.

Fairness—Economic and Otherwise

Social Security was created as a pay-as-you-go system. Most of today's Social Security recipients are receiving – and will continue to receive—more in benefits than their actuarial "fair share" based on their contributions. Even if all promised benefits were paid, future retirees, particularly singles, two-earner couples and those with high incomes, will earn below-market rate returns on their contributions.

The rate of return earned on an individual's Social Security contributions is affected by gender, marital status, and income level. Social policy considerations weaken the direct link between contributions made and benefits received. The Social Security benefit formula includes a declining fraction of income in the calculation. As a result, low income beneficiaries benefit from the formula, high income beneficiaries do not. Married couples benefit from spousal and survivor benefits.

Reform plans to create personal savings accounts within the Social Security system would move the program away from a pay-as-you-go social insurance program and make it more like a defined-contribution pension plan. This will result in less redistribution of income (1) from high- to low-income earners; (2) from single individuals to married couples; and (3) from two-earner couples to one-earner couples.

Impact on Labor and Savings

Although analysts do not believe that Social Security taxes have much impact on the overall labor supply, payroll taxes may affect labor supplied by individuals for whom working is not a necessity. The Social Security benefit rules also appear to affect decisions about early retirement and the amount of work retirees plan to perform during retirement.

Increased national saving is a key to increased capital formation, productivity, and long-term economic growth. The current pay-as-you-go Social Security system may have decreased workers’ overall saving rates. The anticipated shortfall in future benefits may encourage workers to save more, but the magnitude of these affects is subject to debate.

Restoring Fiscal Balance

There are four general methods of improving the financial condition of the Social Security Trust Fund: (1) reducing benefits; (2) increasing revenues; (3) improving the rate of return on Trust Fund assets; and (4) other revenue sources, such as appropriating Treasury general funds.

Benefit reductions can be accomplished through across-the-board cuts, means-testing, raising the retirement age, or changing the inflation-adjustments used to determine benefits. Revenues can be increased by 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 diverting general tax revenues to the Trust Fund.

Investing in Private Securities

If Social Security remains a pay-as-you-go system, the average rates of return on Social Security contributions will eventually decline below rates of return historically available in financial markets. Even if Social Security became a fully funded system, its rate of return could not significantly improve unless the restriction to invest solely in U.S. government securities was lifted.

Investing Trust Fund assets, as a whole, in the stock market could improve Social Security’s financial condition, because—over long periods of time—the stock market generally outperforms the return on U.S. government securities. However, investing in private securities adds risk and increased administrative costs to the financing equation. Further, the potential for large-scale government investment in private equities could result in undue political influence on markets.

Personal Accounts

Under a system of personal accounts, a portion of payroll taxes paid by each worker under age 55 would be redirected from the Trust Fund to that worker’s own personal account. Some restrictions would be imposed on investment and payout options, but the personal account holder could generally expect to earn a higher return on their contributions.

Personal accounts would not entirely eliminate traditional Social Security retirement benefits. However, under most proposals reviewed in this report, traditional benefits would be reduced regardless of whether an individual chose to participate in the voluntary account program.

Benefit Offsets: Workers choosing to contribute to personal accounts would receive benefits from their personal account along with traditional benefits that have been reduced according to the amount redirected to an investment in a personal account. The greater this "benefit offset," the less attractive the personal account option will be, but large benefit offsets make personal account proposals less costly for the Trust Fund.

Risk Shifting: Personal accounts expose account holders to uncertainty about their future benefit levels because of market performance risks. Although some of this risk can be eliminated through diversification; the rest may be transferred to the federal government in the form of minimum benefit guarantees.

Administrative Costs: The costs to administer private accounts have a large impact on the benefits ultimately available to retirees. For an individual with average earnings of $30,000, contributing 2 percent of earnings to an individual account, administrative costs of 0.1 percent of assets could allow an accumulated balance of $125,430 by retirement. However, if administrative costs were 1.0 percent, the accumulated balance would be approximately $98,000—a 22 percent reduction.

Funding Transition Costs

Over the 75-year horizon used to score Social Security reforms, the creation of personal accounts by themselves worsen the financial condition of the Social Security Trust Funds. During the long transition to a personal account system, fewer funds would be available to pay traditional benefits to current retirees and near-retirees, because contributions diverted to the personal accounts of younger workers would result in lower contribution levels into the Trust Fund.

Therefore, extra funds from outside the program or cost savings from inside the program would be needed to fund the transition. All personal account proposals considered in this report include transfers from the Treasury general fund to the Social Security Trust Fund.

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Questions for Evaluating Personal Account Proposals

Among the most important issues to consider under any personal account proposal are the following:

·         To what degree, and over what period, would 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:

o        Participating?

o        Investments?

o        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?

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Additional Materials

Calculation file

Exhibit 1.2

Exhibit 1.3

Exhibit 1.5

Exhibit 1.6

Exhibit 1.8

Exhibit 1.9

Exhibit 2.1

Exhibit 2.3

Exhibit 2.4

Exhibit 2.5

Exhibit 2.6

Exhibit 3.1

Exhibit 4.1

Exhibit 5.1

Exhibits 7.1 to 7.5

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