Coalition Offers Fix for Social Security

The Social Security system is expected to run short of money by 2042 -- a moot point for many retirees and working people now, but a real concern for the under-40 crowd.

Groups ranging from the Bush administration to AARP have been calling for solutions that range from minor tweaks to a major overhaul. Last week a coalition called Alliance for Retirement Prosperity came out with its own plan, which would effectively put half of all Social Security taxes under the contributor’s control.

The group, energized by recent comments by Federal Reserve Chairman Alan Greenspan calling for Social Security reform, has cobbled together support from 18 groups mainly representing conservative senior, small business and tax reform groups. Its message: Social Security can be fixed without raising taxes or cutting benefits, but only if Congress is willing to fund the system in advance rather than financing it on a pay-as-you-go basis.

The cornerstone of the plan is a system of personal accounts that taxpayers would be able to monitor and direct in a select group of investments, much like a 401(k) plan.

“The rate of return on personal account investments is so much higher than what Social Security now pays that you get a flood of new resources,� said Peter Ferrara, senior fellow at the Institute for Policy Innovation, a Washington free-market think tank. “This is an immediate issue for working people because they can get much higher returns and bigger benefits with personal accounts.�

President Bush is a longtime advocate of individual accounts and has asked industry and government leaders to come up with just this type of proposal.

“Reforms are necessary because the money is not there for the future unless we fix the system,� said White House spokeswoman Claire Buchan. “Benefits should not be changed for those who are retired or near retirement, but younger workers should have the option of setting aside a portion of their contributions in personal accounts.�

Variety of Proposals

Personal accounts are one of several proposals that have been floated over the last several years to help put the Social Security system on firmer financial footing while giving contributors more control over their tax money. Other proposals include cutting cost-of-living adjustments for retirees, raising the retirement age, boosting Social Security tax rates and raising the amount of income that’s subject to Social Security taxes.

The alliance’s plan, spelled out in a 20-page policy paper on the IPI’s website (www.ipi.org), would provide a government guarantee that Social Security benefits would remain at least at current levels. Under the group’s plan, if an individual’s personal account proved insufficient to pay promised benefits, the federal government would make up the shortfall.

There also would be no change to the structure of benefit payments, which are due to retirees, people who are permanently disabled and to beneficiaries of deceased recipients. The plan also would not alter the normal retirement age, as spelled out in current law.

The big and noteworthy change: Those who pay into the Social Security system would be able to both monitor their account balances and choose how to invest the personal account portion of their funds. Half of the 12.4% of pay that now goes into Social Security would be directed into personal accounts. As with a 401(k) plan, the contributor would choose how to invest that money among a limited number of investment options pre-screened by the plan “sponsor,� which in this case would be the federal government.

If an individual’s account performed better than anticipated, he or she would be able to live better in retirement or bequeath any remaining Social Security assets to heirs, said Ferrara, who developed the plan. Anyone happy with the current system could stay in it, he added. His proposal requires that personal accounts be optional. If participants prefer the old system’s simple guarantee of lifetime benefits, they remain in it.

But because his projections anticipate that everyone -- whether rich or poor -- would do better under the personal account program than under the current system, Ferrara foresees 100% participation. Social Security now provides about a 1% return on taxpayers’ “investment� -- the taxes they pay, Ferrara said. Investments in stocks and bonds historically have returned 3% to 7% even after adjusting for inflation. That difference, over the course of a working career, he said, adds up to a vast amount.

A person earning $50,000 annually would pay about $6,200 annually in Social Security taxes through payroll deductions. Invested at 7% over 40 years, that amount would generate a $1.3-million nest egg. But the same amount invested at a 1% annual return generates just $304,777.

Actuaries say there’s no faulting Ferrara’s math, but he makes optimistic assumptions that may not all come true. In particular, to make this proposal work, Social Security must shift from being a pay-as-you-go system to being funded in advance. That would allow participants to earn an investment return on their money -- something that’s not currently possible because the government is spending Social Security revenues as fast as they come in.

But it would also create a transition period during which demands on the system from current retirees would be far greater than the revenues coming in to pay them. (Because half of workers’ Social Security contributions would go into personal accounts that couldn’t be tapped to pay current benefits -- or finance other government operations -- only half of tax revenues would be available to pay those benefits.)

Ferrara suggests that this shortfall be covered by shifting general tax revenues -- money not specifically earmarked for Social Security -- to pay Social Security benefits for a limited time. This loan could be repaid by the surpluses that would eventually accumulate in the system, he said.

Iffy Assumptions?

But that would almost certainly require tax increases or spending cuts in other programs, said Ron Gebhardtsbauer, senior pension fellow at the American Academy of Actuaries. If the government was willing to spend that kind of money to fix Social Security, it could do it without personal accounts, he said.

Then, too, Ferrara’s plan is based on projections of investment returns, which the recent bear market confirmed are anything but certain, said David Certner, director of federal affairs at AARP, formerly known as the American Assn. of Retired Persons. Certner said he much preferred the security of today’s benefit formula.

Still, experts maintain that it’s important to discuss this and other options. Every day lost makes the solutions more costly, they say.

“If we were to wait until 2040 -- no changes were made to the system before then -- the demographics at that point would make it much more difficult,� said Steve Goss, chief actuary for the Social Security Administration.

At that point, the choices would boil down to two. The system could cut benefits to what it could afford -- about 73% of current benefit levels. And keep cutting because, under the current formula, the system’s shortfalls would get increasingly worse.

Or it could raise taxes to pay full benefits. The current Social Security tax rate of 12.4% -- half paid by employers, half by workers -- would have to rise to about 18.9% by the end of the 75-year projection period to maintain the status quo, Goss said.

Those numbers, part of a Social Security trustee’s report, are worrisome enough that there’s growing bipartisan support for reform. The only questions are when and what.

“We are trying to make Social Security reform a national mandate for both parties,� said former GOP Rep. Jack Kemp, who heads the Washington nonprofit Empower America and is co-chair of the Alliance for Retirement Prosperity. “It brings to working men and women the ability to control their retirement, and it helps pay off the unfunded liability, which is a terrible problem waiting to happen.�