Restoring Social Security’s Solvency: Plans That Work

1. Restoring Social Security’s Solvency: Plans That Work John B. Shoven Charles R. Schwab Professor of Economics Stanford University Fathauer Lecture in Political Economy Eller College of Management University of Arizona

2. What’s The Problem? Promised (Legislated) Retirement Benefits Exceed Legislated Funding (i.e. taxes)

4. Reasons for the Projected Cost Increases • Improved Mortality and Life Expectancy • Relatively Low Fertility • Uneven Demographics – Small Birth Cohorts of the 1930s and WWII, followed by Baby Boom, followed by Baby Bust

5. Size of the Problem • The Benefits Reduction Alternative: • Immediately reduce benefits for those under 55 by 25 percent across the board • Wait until 2042, when it would be necessary to decrease benefits by 30%, even for the elderly. • Tax Increase Alternative: • Raise the payroll tax from 15.3% to 17.3% immediately • Wait until 2042 and raise tax 5%

6. Choices for Restoring Solvency • Reduce Promised Benefits • Increase Revenues • Higher payroll tax • Mandatory contributions to individual accounts • Nothing else works!

7. Ways to Reduce Promised Benefits • Increase Normal Retirement Age • Index benefits for future retirees to prices rather than wages • Means-test benefits • Straightforward benefit cut

8. Alternative Ways to Increase Revenues • Increase payroll tax • Increase or eliminate the earnings cutoff for payroll tax (currently $90,000) • Transfer revenues from general funds of federal government • Mandatory contributions to individual accounts

9. Alternative Ways to Restore Solvency President’s Commission to Strengthen Social Security Plan #2 Peter Diamond & Peter Orszag’s plan – the natural Democratic alternative Saving Social Security: A Balanced Approach, Brookings, 2004 Syl Schieber and John Shoven’s Personal Security Accounts 2005 plan The Real Deal: The History and Future of Social Security, Yale University Press, 1999

10. What the Plans Have in Common • Painful Choices – they all either cut traditional benefits, raise taxes or introduce mandatory contributions to individual accounts, or both • No magic bullets, asterisks, or transferring money from the already overcommitted rest of government

11. Presidential Commission Plan 2 • Beginning in 2009, initial benefits indexed to prices rather than wages. Eliminates real benefit increases in current law • Introduces voluntary small individual accounts. Workers could redirect 4% of covered pay into accounts up to $1,000. In return, workers accept lower traditional benefits. • Increases benefits for widows and those with low lifetime earnings

13. Diamond-Orszag Plan • Roughly splits burden of solvency between tax increases and benefit cuts • Taxes and benefits would be indexed to changes in life expectancy • Benefits particularly cut for higher income participants • Maximum earnings base increased • New 3% tax introduced on earnings above the maximum earnings cutoff • Increase in benefits for widows and low income households

16. Personal Security Accounts 2005 • Two Tier Social Security Program • Tier One: flat benefit of $600/month, increases thru time with wages. Two-earner couples would each get $600/month • Tier Two: proceeds from 5% mandatory individual accounts

17. PSA 2005: Continued • 12.4% payroll tax remains unchanged • New, required 2.5% contribution to individual accounts with 1:1 matching by Social Security • Very gradual transition. Everyone over 55 would remain on current plan. Everyone between 25 and 55 would get blend of new and old plan

19. Three Plans That Work • President’s Commission #2 • Cuts benefits and introduces voluntary individual accounts • Diamond – Orszag • Raises taxes and cuts benefits, particularly for middle and upper income participants • Schieber-Shoven PSA 2005 • Introduces large, mandatory individual accounts and new required contributions

20. Current Political Scene • The Choice is between the President’s Plan and doing nothing • Doing nothing is a terrible plan • My position: Support the President’s plan until a better plan is proposed in Congress