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Future of US social security system

S. Gurumurthi

Financial pressures reflect that the social security in the US is largely financed on a pay-as-you-go basis, implying that the government uses earmarked payroll tax revenues to pay for the current social security benefits. Proposals to preserve the surpl us have the disadvantage of not improving national savings, unless they incorporate some additional tax increases.

THE social security system in the US finances old-age pensions, survivor benefits, and disability benefits. In 1998, the revenues of the Social Security Trust Funds exceeded their spending by almost $100 billions. In fact, the unified surplus of $70 bill ions in 1998 consisted of $29 billions on budget deficit, a $99-billion surplus of the Social Security Trust Funds, and a surplus of less than $500 millions in other off-budget operations. The Congressional Budget Office expects that by 2001 the on-budge t balance will also be positive. The situation, however, is expected to reverse, when more and more baby-boomers leave the workforce and begin to draw benefits.

It has been estimated that the trust funds will be in deficit after 2014, and the trust fund reserves will be depleted in 2034 and after 2034, and the revenues will be sufficient to pay only about 71 per cent of benefits under the current law. Those fina ncial pressures reflect the fact that the social security is largely financed on a pay-as-you-go basis, implying that the government uses earmarked payroll tax revenues to pay for the current social security benefits. For that reason, the expected increa se in the retirees' share of the population will require changes to finance the social security benefits in the long run.

In response to the projected imbalance, a number of US policy-makers and economists have proposed plans that aim at restoring the social security's long-run financial stability. There is the much-debated question as to whether the 1983 Social Security Ac t contributed to higher national savings because it increased payroll taxes and led to positive trust fund balances. If, as some argue, the policy-makers target the overall unified budget balance, raising payroll taxes did not change national savings but simply altered the division between on-budget and off-budget balances. In other words, increasing the payroll tax allowed US Congress to run larger on-budget deficits, diluting the positive effect higher trust fund balances could have had on national sa vings.

Some US policy-makers, most prominently Senators Moynihan and Kerrey, have suggested that social security return to a pure pay-as-you-go system precisely because they believe the surpluses of the Social Security Trust Funds have caused larger on-budget d eficits. In their view, the increase in payroll taxes at least partly financed the income-tax cuts and defence spending of the 1980s. Others believe that the surpluses of the Social Security Trust Funds contributed positively to national savings because policy-makers did not increase on-budget spending by amounts sufficient to completely offset the surpluses in the trust funds.

While numerous proposals for reforming the US social security have been introduced, Jan Walliser, in his paper, Would Saving US Social Security Raise National Saving? examines three typical reform plans that have been

introduced into the US debate: The `carve out', the `add-on', and `preserving the surplus'. In each case, the underlying assumption is that, without the reform, payroll taxes would be adjusted to pay present-law benefits. Regarding the projected unified budget surpluses, the discussion considers two benchmarks: Current law, under which surpluses would reduce the federal debt; and an alternative benchmark, under which the surpluses would be spent by raising government consumption.

The carve-out

A typical carve-out plan takes a portion of the payroll tax and allocates it to new individual savings accounts. In the long run, accumulated account balances replace some portion of the traditional social security benefit. The Personal Security Account (PSA) plan of the 1994-96 Advisory Council on Social Security, as well as the plan put forth by the National Commission of Retirement Policy (NCRP), chaired by US Senators Gregg and Breaux and US Representatives Stenholm and Kolbe, has such a carve-out p rovision. The idea of a carve-out is to convert current payroll tax contributions into private savings by funnelling them into private accounts.

Walliser points out that a carve-out plan could raise national savings compared with the current law through two channels. The first is to at least partly compensate for the shortfall in payroll tax revenue by improving revenues, that is, increasing taxe s or cutting spending. This method is included in the PSA plan, which levies a 1.5 per cent additional tax on wages for 75 years. The second channel is to reduce benefits of current workers at a faster rate than money is accumulated in individual account s. In other words, to cut guaranteed benefits by more than the amounts that are transferred into individual accounts. The NCRP plan includes this channel through an acceleration of retirement ages and a cut of promised benefits.

In times of a unified budget surplus, a carve-out plan without a tax increase or cuts in benefit promises could raise savings compared with a benchmark that spends the surpluses. The monies transferred from the trust funds into individual accounts reduce the unified budget surplus and prevent it from being spent on anything else. Compared with the current law, a carve-out saving response is closely related to the way in which it brings the trust funds to actuarial balance. Since carve-outs reduce the in flow of trust funds, additional transition taxes must be implemented or benefits must be cut sufficiently. While a carve-out could raise national savings compared with a benchmark under which surpluses are spent, it would likely do so without achieving t he goal of long-term balance of the social security system.

The add-on

The typical add-on plan, according to Walliser, has the following two elements. The current system is put on an actuarial sound basis at current payroll tax rates by cutting future benefits. To make up for the reduction in benefits, individual accounts a re created through an additional new tax. The Individual Plan of the 1994-96 Advisory Council on social security is an example. Compared with the current law, add-ons have a positive impact on national savings.

In the short-term, the income and outgo of the trust funds remain unchanged and, in future years, the outlays are smaller than under current law, closing the current financing gap. The individual accounts financed with additional payroll contributions ad d to national savings. How much private savings rise depends on the extent to which households may reduce their other savings. Private savings offset under `an add-on' plan would probably be small because households perceive individual accounts as a subs titute for the cut in future benefits. Walliser notes that in an environment with unified budget surpluses, add-ons may come with a disadvantage, though they do not reduce the unified budget surplus and thus do not `lock-in' the surplus.

Preserving the surplus

Since the emergence of the budget surplus in 1998 in the US, proposals to improve social security's long-run finances have focussed explicitly on using up portions of the projected future budget surplus. Those proposals aim at preserving the surplus for social security by making the surpluses unavailable for other budgetary spending or tax cuts. The two most widely discussed plans are the budgetary proposal by the Clinton administration and a proposal developed by Martin Feldstein. In spite of all their differences, the proposals have two elements in common: They guarantee the current law level of social security benefits and they do so by using general revenues without raising the payroll tax rate.

The US President, Mr. Bill Clinton's plan relies on transfers from general funds into trust funds, a change in accounting rules, and an investment of funds in the stock market. By changing the accounting rules, the Clinton administration's proposal preve nts the transfer from improving the off-budget balance, thus reducing the unified budget surplus and preserving the surplus from being spent on other proposals. The investment of some of the trust fund holdings in equity additionally seeks to improve the return of the trust funds. In addition to transfers from general funds to the trust funds, the President's plan includes several other provisions that use surplus money but do not affect the trust funds.Feldstein's plan transfers money from general reve nues into individual accounts and later adjusts social security benefits according to the balance in individual account. At retirement, their social security benefit is reduced by 75 cents for every dollar withdrawn from individual accounts. If the accou nts are treated as non-budgetary, the tax credit reduces the unified budget surplus by the same amount and preserves the surplus money for future retirement income.

Walliser points out that compared with current law, neither Mr. Clinton's proposal nor Feldstein's plan would raise national savings. Under the President's plan, substantial

amounts of the surplus are not allocated to the trust funds but allocated for other spending. National savings fall simply because overall government savings is lower than otherwise. By allowing individuals to keep some of the money allocated to their in dividual accounts on top of their social security benefits, Feldstein's plan probably encourages people to reduce their other private savings, so that not every dollar transferred from general revenues into individual accounts is saved.

Among the three different types of proposals discussed in his paper -- ``Carve-outs, add-ons, and preserving the surplus'' -- the ranking of the savings response may change depending on the benchmark, observes Walliser. While add-ons provide a clear-cut addition to national savings, compared with current law, they also have the disadvantage of not reducing the unified surplus and, therefore, would not necessarily raise national savings if the surpluses were spent.

Carve-outs and proposals designed to preserve the surplus have the disadvantage of not improving national savings compared with the current law, unless they incorporate some additional tax increases or cuts in guaranteed benefits. At the same time, they may be powerful instruments to lock away money and commit future legislators to not spend the surplus, thus raising national savings compared with a situation in which surpluses are being spent. Walliser concludes that proposals which simply reallocate c urrent-law government resources cannot improve the sustainability of fiscal policy over current law.