Class Discussion of Social Security Reform

October 18, 2006

Outline

Finish discussion of economic effects of Social Security

Effect on national savingsRole of the Trust Funds

Class discussion of reformSome reform optionsTen myths

National SavingsNational saving =

individual saving + gov’t savingWe care about national savings because it provides the “fuel” for investment, and thus long-term economic growthUnderstanding effect of government policy is often difficult

Ex: Do 401(k) plans increase national savings?

• Individual saving rate clearly rises• But government revenues decline• Which is larger? (For 401(k)s, most believe there

is net increase)

SS and National Saving

Individuals have 12.4% of their income go to pay Social Security payroll taxesIn return, they receive retirement benefits in the futureIndividuals save less because they know they will have some SS income in retirementBut there is no corresponding increase in government saving because of “pay-as-you-go” nature of the program

How Big is the “Crowd-Out”?There is a substantial body of economic research examining this question using

Changes in savings over timeDifferences across individualsDifferences across countries

Each $1 of “Social Security Wealth” (i.e., the present value of future Social Security benefits) crowds out private saving by 30-40 cents.

Keep in mind that this is a huge program!U.S. capital stock may be trillions smaller than it would otherwise be …

What difference does it make?Lower national saving rate less capital available for investmentLess investment lower rate of economic growthLower economic growth the “size of the economic pie” is smaller in the futureOne key issue to consider when discussing potential Social Security reforms is what effect it will have on national (public + private) saving

What about the Trust Fund?

Any surpluses from Social Security are credited to OASDI trust fundsTrust fund creates a legal liability for the U.S. Treasury

When SSA redeems the bonds, Treasury must find the money to pay for themThe bonds are an asset to SSA, but a liability for the U.S. Treasury

The Trust Fund and Savings

At end of 2004, the trust fund held nearly $1.86 trillion in government bondsDoes this mean that the government “saved” $1.86 trillion over the past two decades?If we hold constant all non-SS spending and taxes, then running a $1 surplus in Social Security increases national saving by $1But should we hold other spending constant?

TF and Budget AccountingSocial Security is “Off Budget”But the “unified budget” includes Social SecurityOne view is that the presence of large SS surpluses made it easier for Congress to spend more money in rest of the budget

Use the SS surpluses to hide deficits elsewhere“Raiding the trust fund”

• Did not happen from accounting perspective• Might have happened from economic perspective

The “Lock Box”

Featured prominently in 2000 election (and on Saturday Night Live!)Idea was to “lock the surpluses away” so that they would be saved, not spentBut the lock box was soon broken

Large deficit spending Is there a better lock box?

Four Groups

White House

Senator Harry Reid

AARP

Americans for Tax Reform

In your groups …What is your position on the severity of the problem facing Social Security?If you believe there is a problem, what specific proposals do you support to fix it?

Benefit cuts?Tax increases?

What is your view about personal accounts?“Carve-out” vs. “Add-on”Part of Social Security vs. outside of Social Security

Prepare to Report to Class …

Choose one person as a spokesperson

Be prepared to provide 2-3 minute summary of your group’s position to the class

Entire group should be prepared to answer questions from class

Now Form Teams Across “Groups”

Make sure each team has at least one member from each of the four groups

WH, Reid, AARP, ATR

Each individual should continue to hold their group position – can you agree on any steps toward reform?

What policies might satisfy all parties?What are the major stumbling blocks?

The 2005 SS Debate

State of the Union (minutes 12-22)

http://www.pbs.org/newshour/bb/white_house/sotu2005/

Democratic Response (minutes 5-7:20) http://www.pbs.org/newshour/bb/white_house/sotu2005/dems_text_2005.html

AARP responsehttp://aarp.typepad.com/socialsecurity/2005/03/aarps_social_se.html

How debate evolved over summer 2005

Top Ten Myths of Social Security Reform

Ten Myths of Social Security Reform

1. Social Security is financially sound for “decades to come”

2. Economic growth will eliminate the existing problem

3. Social Security is in “crisis” and will not be there when today’s younger workers retire

Ten Myths of Social Security Reform

4. Personal accounts can save Social Security without benefit cuts or tax increases

5. Allowing individuals to redirect their contributions from the trust fund to personal accounts will provided a higher rate of return

6. Personal accounts will worsen Social Security’s financial problem

Ten Myths of Social Security Reform

7. Personal accounts will cause benefit cuts

8. Personal accounts are risky and the current system is safe

9. Transitioning to personal accounts is too costly

10.Social Security reform is bad for the poor / women / minorities

Methods to Reduce Shortfall

See SSAB Handout …Changes to benefit formula

• AIME calculation - # years, indexing, etc.• PIA calculation – change bend point factors• Increase retirement age

Changes to tax base• Raise taxable maximum

Changes in coverage • State and local workers

Many others

Pros of Personal AccountsPerhaps a better way to “save” SS surpluses than the trust funds (and thus increase national savings)Possibly improve labor supply incentives because contributions no longer viewed as a pure taxPotential to extend asset ownership to 50% of households that lack itOffers opportunity to pursue higher expected returns

Cons of Personal Accounts

Exposes individuals to increased financial market risk

VoluntaryBut might government bail-out “losers”?

Need to finance the transition from pay-as-you-go system to funded systemPossibly erode long-term support for social insurance aspects of the system