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NONPARTISAN SOCIAL SECURITY REFORM PLAN …
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Language: english
Created: Wed Dec 14 08:35:34 2005
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NONPARTISAN SOCIAL SECURITY REFORM PLAN
Jeffrey Liebman, Maya MacGuineas, and Andrew Samwick1
December 14, 2005
OVERVIEW
The three of us former aides to President Clinton, Senator McCain, and President Bush
did an experiment to see if we could develop a reform plan that we could all support.
The Liebman-MacGuineas-Samwick (LMS) plan demonstrates the types of compromises
that can help policy makers from across the political spectrum agree on a Social Security
reform plan. The plan achieves sustainable solvency through progressive changes to taxes
and benefits, introduces mandatory personal accounts, and specifies important details that
are often left unaddressed in other reform plans. The plan also illustrates that a
compromise plan can contain sensible but politically unpopular options (such as raising
retirement ages or mandating that account balances be converted to annuities upon
retirement) -- options that could realistically emerge from a bipartisan negotiating
process, but which are rarely contained in reform proposals put out by Democrats or
Republicans alone because of the political risk they present.
The LMS plan contains four key elements:
Benefit cuts (through progressive reductions in PIA factors and an increase in the
retirement age).
New revenue (through a mandatory additional 1.5 percent contribution into personal
retirement accounts and a gradual increase in the payroll tax cap to 90 percent of
earnings).
Mandatory personal retirement accounts (equal to 3 percent of earnings, funded half
by new contributions and half redirected from the Social Security Trust Funds, with full
annuitization required upon retirement).
Other updates to the traditional system (minimum benefit for low-wage workers,
increase in widow(er)s' benefits, decrease in spousal benefits, possible progressive
matches for accounts).
1
Jeffrey Liebman is Professor of Public Policy at Harvard University. From 1998 to 1999, he was Special
Assistant to President Clinton for economic policy and coordinated the Clinton Administration's Social
Security reform technical working group. Maya MacGuineas is Director of the Fiscal Policy Program at
the New America Foundation. She was a Social Security adviser to Senator McCain during the 2000
presidential campaign. Andrew Samwick is Professor of Economics and Director of the Nelson A.
Rockefeller Center for Public Policy at Dartmouth College. From 2003 to 2004, he was Chief Economist
on the staff of President Bush's Council of Economic Advisers, where his responsibilities included Social
Security.
1
The major compromises in the plan include:
Revenue increases versus spending reductions - To fill the Social Security funding
gap, roughly half the changes would come from benefit reductions and half from revenue
increases. (Over the 75-year horizon, benefits cuts would equal 2.7 percent of payroll and
revenue increases would equal 2.5 percent of payroll.)
Level of traditional benefits In the long run, traditional benefits would be no smaller
and no larger than the existing 12.4 percent payroll tax. Not allowing benefits to grow as
promised would keep them from crowding out spending on other programs and minimize
the need for distortionary tax increases and government borrowing. Not allowing them to
fall below 12.4 percent would alleviate fears about starting down the slippery slope to
total privatization. This level of benefit reductions is intermediate between price indexing
and wage indexing. The benefit reductions are completely phased in by 2050 and benefits
grow with real wages thereafter.
Level of benefits versus length of time of collecting benefits Under the plan, the
combination of traditional benefits and the money accumulated in accounts produces
replacement rates (the ratio of retirement income to pre-retirement earnings) roughly
equal to those that are currently promised. In addition, replacement rates from the
traditional benefit alone are kept higher than they would otherwise be because benefits
would be collected over a shorter period of time due to the increase in the age when
participants become eligible for benefits.
Sources of PRA financing Half of the revenue needed to fund the PRAs would come
from mandatory worker contributions (an "add-on") and half would come from
redirecting money from the Social Security Trust Funds (a "carve-out"). Rather than
borrowing to cover the cost of the redirected funds, they would be paid for by raising the
payroll tax cap and cutting benefits.
Storage for saving While new money would be devoted to the Social Security system,
on net, all of the new revenue would be stored in personal accounts rather than in
government trust funds. Accounts wall off funds from the rest of government, thereby
increasing the likelihood that they would contribute to national saving. Devoting the new
revenues to accounts would also decrease their distortionary effects, as workers will be
less likely to perceive their required contributions as a pure tax if they see those
contributions being directed to an account that they own.
Size of the accounts At three percent, personal accounts would be large enough to
accumulate significant wealth for participants and to keep the administrative costs
manageable but not so large as to overshadow traditional benefits.
Level of progressivity Revenues and traditional benefits would be made more
progressive but not so much as to undermine support for the universal social insurance
system.
2
DETAILS
I. Benefit Cuts
The LMS plan reduces scheduled benefits so that they can be covered by the current 12.4
percent payroll tax.2 This represents a 35 percent reduction in aggregate spending
relative to current benefit formulas. Because benefits for the disabled and young
survivors are not reduced, the retirement benefit cut for a typical worker is larger--about
43 percent.3 The benefit cuts are implemented by changing the primary insurance amount
(PIA) formula and by increasing the full benefit age.
Changing the PIA Formula
The reductions in benefits via the PIA formula are done in such a way that benefits are
reduced by a greater percentage for high earners than for low earners. The upper (15)
and middle (32) PIA factors are gradually cut in half--to 7.5 and 16 percent,
respectively. The lower PIA factor (90) is reduced by only a quarter, to 67.6 percent.
The reduction in the top PIA factor is phased in for beneficiaries first becoming eligible
for benefits between 2008 and 2045. The reductions in the other two PIA factors are
phased in between 2013 and 2050. The speed at which the reductions are implemented is
designed to align with the speed at which PRA balances accumulate so that total
replacement rates (from the sum of traditional benefits and PRA annuities) remain
roughly constant across cohorts.
Increasing the Retirement Age
Under current law, the age at which a worker can receive full retirement benefits is
scheduled to rise from its current level of 66 to 67 between 2017 and 2022. The LMS
plan would advance this transition by eleven years, starting the increase in 2006, and then
would continue the increase in the full benefit age (FBA) until it reached 68 for those
attaining age 62 in 2017. Absent a change in retirement date, an increase in the FBA
represents a benefit reduction for beneficiaries.
The plan also includes an increase in the earliest eligibility age (EEA). Starting for
people born in 1955, there would be an increase the EEA (which is currently 62) by 2
months per year until it reaches 65. When people delay receiving Social Security
benefits, their remaining benefits are increased by an amount that is roughly actuarially
fair. Therefore, an increase in the EEA has essentially no impact on Social Security's
finances. However, it is likely to have positive labor market effects.
2
The payroll base for this calculation is the currently scheduled one, not the expanded one described
below. Note also that these cuts to the traditional benefit are deeper than those required to bring the pay-as-
you-go system into balance since revenue under the status quo includes both payroll tax revenue and
revenue from the taxation of Social Security benefits.
3
These benefit reductions refer to traditional benefits only; they do not reflect the level of total benefits,
which would be larger due to the combination of traditional benefits and the personal accounts.
3
Raising the FBA and EEA reflects that with rising longevity and improved health at each
age, an important part of reforming Social Security should be to pay benefits primarily at
older ages, thereby encouraging people to work longer (in part by changing societal
norms about when retirement should begin). We raise the EEA, even though it has no
impact on Social Security's finances, because we want to maintain replacement rates in
light of benefit cuts (particularly to protect individuals who might shortsightedly retire
too early if given access to their Social Security benefits at too young an age).4
Protecting the Disabled and Child Beneficiaries from Benefit Cuts
Benefits for disabled workers and their dependents and for child beneficiaries would not
be subject to the reductions in benefits from changing the PIA formula. These
beneficiaries would continue to receive benefits under the current formula. For disabled
beneficiaries who reach the full benefit age and are then converted to retired worker
status, benefits would be paid as a weighted average of the benefits under the new
formula and the old formula. Specifically, the benefits will equal the share of years the
worker was not disabled times the new formula plus the share of years the worker was
disabled times the old formula. Disabled workers will have access to their PRA annuities
under the same terms as retired workers i.e. they may choose to convert balances to an
annuity and start receiving benefits at any age between 62 and 68.
II. New Revenue
There are two sources of new revenue in the plan: mandatory account contributions and
an increase in the level of earnings subject to the payroll tax.
Mandatory Account Contributions
The personal retirement accounts (described in detail below) are financed half with
mandatory new contributions from individuals and half with revenue diverted from the
trust funds. The accounts are 3 percent of earnings, so the mandatory new contributions
equal 1.5 percent of covered earnings.
Our plan would end the practice of using Social Security surpluses to fund general
government operations. Thus, so long as Social Security surpluses exist, they would be
directed to the personal retirement accounts and the required individual contributions
would be less than 1.5 percent of payroll. For example, in 2008 the trust fund
contribution rate would be 2.30 percent of payroll and the individual contribution rate
would be 0.70 percent, in 2014 the trust fund contribution rate would be 1.94 percent of
4
We recognize that the choice of an EEA involves balancing the well-being of myopic individuals who
claim benefits too soon (and are therefore helped by an increased EEA) against the well-being of
individuals for whom it is optimal to retire before the EEA and who are liquidity constrained. 65 is the age
at which benefits were first available in the first two decades of Social Security's existence, and recent
research indicates that the typical 69 year old is at least as healthy as a 62 year old was in 1961 the year
that men first became eligible for Social Security benefits. Therefore, we believe an increase in the EEA is
likely to result in a net increase in well-being.
4
payroll and the individual rate would be 1.06 percent. Starting in 2018, the long run
position is reached with 1.5 percent from the trust fund and 1.5 percent from individuals.
Raising the Taxable Maximum
A bit more than two-thirds of the 1.5 percent of payroll diverted from the trust fund is
replaced by gradually restoring the percentage of earnings that is subject to the OASDI
payroll tax to 90 percent (where it was in 1982) and maintaining it at that level thereafter.
This increase in the taxable maximum would be phased in between 2008 and 2017. The
new long run taxable maximum is equivalent to $171,600 at today's wage level.5 The
maximum level of earnings to be included in benefit calculations remains the maximum
taxable earnings in current law--workers receive no incremental benefits from the
increase in maximum taxable earnings.
III. Mandatory Personal Retirement Accounts
In order to keep total expected retirement benefits at levels comparable to those specified
in current law, the LMS plan establishes personal retirement accounts equal to 3 percent
of taxable payroll (using the current-law maximum as the cap).
The investment options for PRAs are designed to limit administrative costs and the risks
to investors. PRAs would be invested with one of 15 private fund companies certified by
the government to be eligible to receive PRA deposits. Each of these fund companies
would be required to offer 5 broadly diversified investment options, patterned after the
Federal Employee Thrift Savings Program. A central clearing house would handle
transactions. Social Security actuaries estimate that administrative charges associated
with PRAs would be approximately 30 basis points per year.
All payments from PRAs would be paid as annuities, which would initially be required to
be fixed, inflation-indexed annuities provided by the Social Security Administration as
part of a beneficiary's regular Social Security benefit. Full annuitization by age 68 is
required, but beneficiaries can choose to spread annuitization between 62 and 68 if so
desired. Married beneficiaries would be required to purchase joint and two-thirds
survivor annuities. Annuities would be 10-year certain annuities to provide payouts to
heirs of those who die soon after annuitization. The total balances in the accounts of the
two spouses in a married couple would be split equally in the case of divorce.
Investment options are restricted and full annuitization is required because Social
Security is meant to provide a basic level of retirement income support. For an average
earner, the combination of the traditional benefit and PRA annuity will provide a
replacement rate of about 35 percent. Retirement planners typically advise that retirees
5
Our objective in raising the taxable maximum is to bring more revenue into the system in a way that
reflects ability to pay. An alternative to raising the cap would be to tax all earnings above the cap at a
lower rate or to do some combination such as raising the cap (but not all the way to 90 percent of
earnings) and then taxing earnings above the new cap at a lower rate. All three of us would be comfortable
with any of these alternatives.
5
need an income level that is 70 to 80 percent of their pre-retirement earnings in order to
maintain their standard of living. Thus, Social Security is designed with the expectation
that the typical retiree will need to do additional saving (individually and/or through a
pension plan at work) above and beyond Social Security. To the extent that retirees
would like a different mix of investments or a different stream of payments in retirement,
they can achieve that through their non-Social Security investments.
The progressivity in our plan comes on the revenue side from raising the taxable
maximum and on the benefit side from reducing traditional benefits by a greater fraction
for high earners than for low earners. But because the PRAs in our plan are equal to 3
percent of a worker's earnings, expected benefits are higher--relative to currently
scheduled benefits--for high earners than for low earners. For example, as Table I
shows, total benefits (including both traditional benefits and payments from a PRA
annuity) for a 2-earner married couple are 96 percent of present law scheduled benefits
for a scaled low-earner, 102 percent of present law benefits for a scaled medium earner,
and 109 percent of present law benefits for a scaled high earner. In viewing these
numbers it is important to remember that they show only the benefit side of the equation.
They do not reflect the fact that high earners under the plan are paying a disproportionate
share of the new revenues. However, all three of us support the use of progressive
matches to augment the personal accounts of low-income workers as long as a funding
mechanism for the matches is identified. Thus, we would support, for example,
integrating a paid-for Saver's Credit with Social Security PRAs so that low-earners
would have their PRA contributions matched by the government. We did not incorporate
such a provision in our plan because changes to tax policy outside of Social Security are
beyond the scope of our proposal.
Table 1
Benefits as Percent of Present Law Scheduled Benefits, 2056
(Assumes Expected Yield on Mixed Portfolio)
Traditional Traditional + PRA Traditional + PRA Traditional + PRA
Benefit Two-Earner Couple, Two-Earner Couple, One-Earner Couple
Only Married Widowed
Low 62.6 96.3 107.5 85.3
Earner
Medium 56.2 101.6 116.7 86.8
Earner
High 54.2 109.0 127.3 91.2
Earner
6
IV. Other Updates to the Traditional Benefit System
Our proposal calls for making three other changes to update the Social Security system.
These additional changes were not incorporated in the Actuaries' estimates of our plan
because they have a relatively small impact of actuarial balance but would have added
considerable complexity of the Actuaries' modeling task.
First, we would adopt the minimum benefit provision included in Model 2 of the
President's Commission to Strengthen Social Security. This provision provides a
minimum benefit for workers who work a large number of years at low-wages.
Second, we would adopt the provision from the President's Commission to Strengthen
Social Security that would guarantee a widow(er) 75 percent of the benefit the couple
was receiving before the first spouse passed away. Poverty rates among widows are
around 20 percent and this provision would concentrate extra resources on this high
poverty population.
Third, we would reduce spousal benefits for those married to high earners. The current
Social Security system provides higher spousal benefits for someone married to a high
earner than for someone married to a low earner, implicitly placing more value on the
work done in the home of people married to high earners than of people married to lower
earners. We propose gradually moving to a cap on spousal benefits at 50 percent of the
PIA of the average worker in the worker's cohort. This provision would help pay for the
other two provisions.
ADVANTAGES OF THE LMS PLAN
Sustainable solvency is achieved The Social Security actuaries find that actuarial
balance would improve by 2.14 percent of taxable payroll over the 75-year projection
horizon. The current Social Security deficit is 1.92 percent of payroll. Therefore, the
changes in the plan would lead to a 0.22 surplus. Trust fund balances in the last year of
the actuaries' projection period are positive and increasing.
(See http://www.ssa.gov/OACT/solvency/Liebman_20051117.pdf).
Table 2
Contributions to 75-year Actuarial Balance
Policy Improvement in Actuarial Balance
(% of payroll)
Raise Taxable Maximum 1.00
Change in Benefit Formula 2.08
Increase in Full Benefit Age 0.62
Diversion of Trust Fund Revenue to PRAs -1.56
Total 2.14
7
Fiscally responsible plan The plan puts great emphasis on fiscal responsibility
borrowing less from general revenues than any other plan that has been scored by the
Social Security actuaries in recent years. Table 3 compares the LMS plan with other
recent Social Security reform plan. The first column compares general fund transfers to
the OASDI Trust Funds. This is one measure of how much a plan relies upon
unspecified resources from outside of Social Security to bring the system into balance.
The LMS plan does not rely at all on general fund transfers, and instead uses changes to
benefits and revenues to bring Social Security into balance. The second column shows
the sum of all Social Security cash-flow deficits. In years in which Social Security
benefits exceed revenues, the shortfall must be made up by the general funds of the
government either through reductions in other government spending, increases in taxes,
or issuing additional debt. Paying all currently scheduled benefits would require the rest
of the government to come up with $6,372 billion in funds over the next 75 years. Under
the LMS plan this number is reduced to $1,456 billion. None of the other 18 other plans
scored by the Office of the Actuary in the past three years has lower cash-flow deficits
than the LMS plan.
Table 3
Comparison with Other Plans
General Fund Transfers Total Cash-Flow
(Present Value 2005 Deficits
Dollars) (Present Value
(1) 2005 Dollars)
(2)
Scheduled Benefits 6,372 billiona 6,372 billiona
LMS Nonpartisan Plan 0 1,456 billion
Kolbe-Boyd 824 billiona b 1,956 billion b
Shaw 4,817 billiona b 1,906 billion b
Ryan-Sununu 8,920 billiona b 9,891 billion b
Ball 0 1,972 billiona b
Hagel 3,778 billion b 5,423 billion b
Pozen 1,994 billion b 3,778 billion b
Graham 3,696 billiona b 4,109 billiona b
Diamond-Orszag 0 2,424 billion b
Source: Plan memos from SSA Office of the Actuary.
a
Deficits continue beyond 75-year projection window. Numbers represent only 75-
year deficits.
b
Numbers in actuaries' memo converted to 2005 dollars using 5 percent nominal
interest rate.
Many practical reforms are included The plan includes a number of sensible policies
including an increase in the retirement age to reflect growing life expectancies;
mandatory rather than voluntary accounts (which greatly simplifies the system,
particularly by eliminating the need for benefits offsets); and required annuitization of
accounts balances to help ensure that participants do not spend down their savings too
quickly.
8
Economically beneficial The plan has two features that are highly likely to increase net
national saving. First, all projected future Social Security surpluses and all net new
revenues are invested in personal accounts rather than the Social Security trust funds.
Historically, it appears that when the Social Security system has been in surplus, the
expenditures on non-Social Security programs have increased or tax cuts have been
implemented to absorb the funds. Certainly, that is the case now, with an explicit deficit
reduction plan that ignores the distinction between Social Security and other revenues.
Second, the plan does not rely on borrowing to fund the personal accounts. Borrowing to
fund accounts will not in general raise national saving. The plan also raises revenue in a
relatively non-distortionary way: the individual worker contributions are deposited
directly into the worker's personal retirement account.
Good for future generations By phasing in policy changes more quickly than most
other plans, the LMS plan spreads the costs across more generations, thereby decreasing
the burden any one generation must bear. Also, by prefunding the Social Security system
in an economically meaningful way, future generations would expect to see higher real
wages due to the increase in the capital stock. The prefunding of accounts also helps to
preclude the need to increase the current 12.4 percent payroll by up to 6 percentage
points, as would be the case if the system remained pay-as-you-go at currently projected
replacement rates.
Balanced compromise The plan represents a number of balanced compromises on
issues of solvency, adequacy, and funding. These compromises show that while
differences exist, there is a range of Social Security reform options that can receive
support across the political spectrum. Key differences over things like the relative
amount of taxes and benefits and about the amount of choice people should have in
making their investments are along a continuum and can be resolved through
compromise.
9