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New Legislation for Real Social Security Reform

No tax hikes or benefit cuts, PLUS strict spending curbs

Last week, Rep. Paul Ryan (R-Wisc.) and Sen. John Sununu (R-N.H.) introduced a dramatic and sweeping Social Security reform proposal. The legislation would allow workers the option of having personal retirement accounts, rather than relying on a Social Security system that is financially unsustainable. Currently, the Social Security payroll tax takes 12.4%–split between the employer and employee–of workers’ incomes. Under the Ryan-Sununu bill, workers would be able to devote, on average, 6.4 percentage points, just over half the total tax, to their personal accounts. Thus the legislation would create the largest accounts ever proposed in Congress; and it is turning out to be the most popular Social Security reform bill on Capitol Hill. Of course, there would be no change in Social Security of any sort for today’s retirees. Indeed, there are no benefit cuts in the bill of any sort for anyone at any point. The proposal has already been scored by the chief actuary of Social Security as achieving permanent solvency for the program, without cutting benefits or raising taxes. In addition, because of the much higher returns paid on market investments, the accounts would provide higher benefits than Social Security. If Social Security were to pay all currently promised benefits by raising taxes, the tax rate of 12.4% would have to be increased to over 20%. But under the reform plan as scored by Social Security’s chief actuary, the payroll tax rate could eventually be reduced to less than below 4%–an amount large enough to pay all remaining disability and survivors benefits under the current Social Security framework. A broad coalition of grassroots activist groups, taxpayer organizations and free market leaders support this reform. Leading the way is the Alliance for Retirement Prosperity, with national co-chairs Jack Kemp of Empower America, Dick Armey of Citizens for a Sound Economy, and former Social Security Commissioner Dorcas Hardy. The National Policy Chairman is Steve Moore, president of the Club for Growth, with Empower America chief economist Larry Hunter serving as executive director. Other founders of the coalition are Charlie Jarvis, president of the United Seniors Association, Grover Norquist, president of Americans for Tax Reform and Tom Giovanetti, president of the Institute for Policy Innovation. These leaders and their organizations are also joined by Bill Shipman, co-chairman of the Cato Institute Project on Social Security Reform, David Keene and the American Conservative Union, Star Parker and the Coalition for Urban Renewal, commentator Larry Kudlow, Lew Uhler and the National Tax Limitation Committee, former Reagan White House policy aide Robert Carleson, Richard Rahn of the Discovery Institute, Curt Winsor, Jim Martin of 60Plus, and others. The bill is fully consistent with the principles for Social Security reform and personal accounts endorsed by President Bush, although the amount people can direct into their personal accounts is significantly larger than the President’s commission proposed. The bill follows closely the reform proposal first developed by Peter Ferrara, director of the Club for Growth Project on Social Security, and a senior fellow at the Institute for Policy Innovation, which published the proposal last summer (a copy of the study can be found at www.ipi.org). Last week, I interviewed Mr. Ferrara about the proposal. Matthews: How is this bill different from other reform plans that have been introduced? Ferrara: The bill basically provides for the biggest, most liberating reduction in the size and burden of government ever. It ultimately would produce the largest tax reduction, the largest reduction in effective government debt and the largest reduction in government spending in world history. At the same time, it provides an enormous increase in the private, personal prosperity of working people. Each worker would personally and directly own the account, just like their own bank accounts, IRAs and 401ks. The chief actuary of Social Security projects that just 15 years after adoption of the reform, working people would have accumulated over $7 trillion in today’s dollars in the accounts. Every worker would consequently become a major owner in America’s business and industry. That also means, by the way, the end of the left’s case for socialism and big government. There would no longer be a dichotomy between labor and capital for the Left to exploit. Every individual would be both a worker and a capitalist under this reform. Matthews: Al Gore called this kind of approach a “risky scheme.” Are workers really capable of investing their Social Security money on their own? Ferrara: The bill provides for a safe framework that is easy for even unsophisticated investors to use, and is still backed up by a social safety net. It operates like the Federal Employee Thrift System, and like the Chilean system for personal accounts adopted over 20 years ago. Workers invest their personal account funds by choosing from a list of investment funds managed by major private investment firms, which are approved and regulated expressly for this purpose. Workers only have to choose one or more of the funds. Sophisticated private sector fund managers then choose the particular stocks and bonds for the funds. Matthews: But what if the market declines significantly just before a worker retires? Ferrara: First, the system still has a safety net. The legislation provides that workers who choose the accounts would be guaranteed that they would get at least as much as they would have received from Social Security. The cost of this guarantee was included in the chief actuary’s score of the plan, and is fully paid for in the legislation. Second, long-term market returns are so much higher than the returns Social Security now pays that there is just no way that a lifetime of investments in the markets would generate less than Social Security would pay. The long-term real return on stocks is 7 to 7.5%; the long-term real return on corporate bonds is 3 to 3.5%. For most workers today, even if Social Security could somehow pay all of its promised benefits, the real return from the program would be 1 to 1.5%, or less. For many it would be zero or even negative. If we raised taxes or cut benefits to close the program’s current long-term financing gaps, the return would be even worse. This enormous gulf between market returns and Social Security returns is why the guarantee discussed above is viable. But it is important to realize that workers don’t give up all of their personal account investments on the day they retire. Those investments continue to support their retirement benefits for the rest of their lives. If the stock market dives just when a worker retires, the worker would already have a large accumulation of funds from the decades he was working. And his account would begin to grow again when the market inevitably comes back. Also, under the reform plan, workers are not required to invest in the stock market. They could choose corporate and government bonds, even bank certificates of deposit if they want. But these alternatives won’t provide nearly as much in returns and benefits over the long run as a diversified portfolio of stocks and bonds. Matthews: You know liberals see blood when conservatives talk about personal Social Security accounts. Is this proposal politically viable? Ferrara: Charlie Jarvis of the United Seniors Association commissioned a poll on the proposal by McLaughlin Associates, a major Washington political polling firm. The poll found that by 62% to 29% the public favors allowing workers the freedom to choose a personal account for half of their Social Security payroll taxes, which is what this plan does. When voters were told of the guarantee of current benefits, the support among even traditionally liberal constituencies soared: 64% among Democrats, 70% among African-Americans, 76% among Hispanics, and 72% among Independents. Numerous polls have shown support in this range for personal accounts for about 10 years. The debate has already been won among the general public; it is Washington that’s behind the curve. Matthews: How does the bill handle the transition financing costs? Ferrara: There is a transition financing issue because we have to continue to pay full benefits to current retirees. This transition is covered under the bill by four elements, which were scored as sufficient by the chief actuary of Social Security:

    1. The short term Social Security surpluses projected until 2018 are devoted to the reform. 2. The rate of growth of federal spending would be reduced by one percentage point per year for eight years, with the savings going to the transition. The bill establishes a federal spending limitation measure providing for this reasonable and moderate spending restraint. The proposal, therefore, provides a vehicle for beginning to get runaway federal spending under control. The savings from reduced spending for those years are maintained until all short-term debt issued to fund the transition is paid off in full. For conservatives, this spending restraint is just another net advantage of the reform plan. 3. The money from the personal accounts used to buy stocks and bonds goes to the corporations that sell those stocks and bonds. The corporations would then use those funds for investments in new plant and equipment, new business ventures, the hiring of new workers, etc. Those investments would earn profits that would be taxable to the corporation, resulting in increased revenues to the government, which the legislation would devote to the reform. This is based on the work of Harvard Prof. Martin Feldstein, chairman of the National Bureau of Economic Research. 4. Excess Social Security trust fund bonds would be sold to the public when needed to ensure the payment of all Social Security benefits in any year. But this is just paying Social Security back for all the surpluses it has lent to the federal government in the past, which was used for other government spending. Under the current system, those bonds are going to be redeemed for cash from the federal government anyway after 2018, until the trust fund is exhausted in 2042.

The chief actuary’s score shows that the trust funds remain permanently solvent under this plan. Moreover, after just 24 years, the reform plan goes into permanent long-term surplus. Those surpluses are sufficient over the following 15 years to pay off all of the bonds sold to the public during the earlier years to finance part of the transition. So the net impact on debt held by the public is zero. Indeed, through this process Social Security’s current unfunded liability of $10.5 trillion is eliminated completely. So in the process we have eliminated government debt almost three times as large as the current national debt, the biggest reduction in government debt in world history.

Written By

Merrill Matthews is a resident scholar with the Institute for Policy Innovation in Dallas, Texas. Follow him on Twitter: @MerrillMatthews.

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