V I E W P O I N T

Private Accounts, Super-Sized Benefit Cuts and an Inflated Solvency Gap are the President's Faulty Premises for Unraveling Social Security

President Bush Has Not Given Up on Privatizing Social Security

While President Bush says he wants to begin a bipartisan discussion on ways to strengthen Social Security for the future, at the same time he has renewed his push to privatize Social Security. For the third year in a row, the President has included in his presidential budget (FY 2008) his plan to divert payroll tax revenues out of Social Security into private accounts. In addition, he continues to support drastic cuts in Social Security benefits by means of a plan known as “price-indexing.” The President also insists payroll tax increases will not be a part of his plan.

The huge Social Security benefit cuts in the President's proposal are due to his insistence on private accounts funded out of Social Security and his demand that the Social Security funding gap be addressed solely with benefit cuts. The challenges facing Social Security can be met. However, the current push for Social Security cuts under the guise of entitlement reform distorts the real picture of Social Security affordability and ignores the impact of huge cuts on the already modest benefits of middle-class Americans.

Private Accounts Will Take Money Out of Social Security, Make Drastic Cuts in Social Security Benefits, and Increase the Federal Debt Dramatically

Private accounts are not a plan to save Social Security, and they do nothing to improve solvency. Because private accounts are financed by taking money out of Social Security, they actually increase the funding gap and move up the date at which Social Security will no longer be able to pay full benefits from 2040 to 2030 ¹.

Under the President's plan, individuals who take the risk of investing in private accounts would have their Social Security benefits reduced dollar for dollar by the amount of their contribution to their private accounts compounded at a real rate of interest of three percent. They would see a reduction in their Social Security benefits regardless of how their account performed. A middle-class American (i.e., average wage-earner) retiring in 2050 would have his traditional Social Security benefit cut by 45 percent. When combined with the cuts under the President's “price-indexing” plan (described below) the total reductions in Social Security benefits would be 66 percent.

In his FY 2008 budget, the President calculates that his private account plan will cost $637 billion in the first 10 years. Private accounts would increase the national debt by nearly $5 trillion in the first 20 years of full implementation. The costs would continue to grow thereafter. After four decades, the additional debt resulting from privatization would reach more than 20 percent of Gross Domestic Product ². The cost of private accounts would impose a huge new debt burden on current and future generations.

The President's “Price-Indexing” Plan Would Impose Substantial Benefit Cuts on Middle-Class Americans.

President Bush continues to press for a plan to accompany his private accounts that would make drastic cuts in Social Security benefits. His so-called “price-indexing” plan would slash benefits over time by as much as 50 percent. Under his plan, everyone earning over $20,000 would have his or her benefits reduced. That means that over 70 percent of future retirees would suffer a benefit cut. Middle-class Americans making $38,000 a year would have their Social Security benefits cut by more than one-quarter. For people earning $90,000, benefits would ultimately be cut in half ³.

Social Security benefits currently rise with the standard of living of each group of new retirees. Under the President's plan, Social Security benefits would no longer be indexed by wages which keep up with the standard of living, but by prices which only keep up with inflation, typically a lower rate. F uture retirees would be subjected to a reduction in their standard of living compared to other Americans. According to Alicia H. Munnell of the Center for Retirement Research at Boston College, if Social Security benefits in 1951 had been indexed to prices, as the President suggests, rather than wages as is currently the case, a middle-class person retiring today would receive about half as much in Social Security benefits ⁴.

Social Security Benefits Are Not Too Generous

Much of the discussion about the cost of entitlement programs has focused on the macro-economic forecast for the future. The real impact of cuts in Social Security benefits on middle-class Americans is being lost in the debate because the focus has been on the long-term economy and distant federal budgets.

Social Security benefits are not overly generous. The average monthly Social Security retiree check in 2007 is just over $1,000. That provides a modest income of about $12,000 a year. For one in five Social Security beneficiaries that is the only income they have. For two-thirds of retirees, Social Security is most of their income.

A woman earning the average wage who retires at age 65 this year will receive a Social Security check of $858 a month – or about $10,300 a year.  Her Social Security check will be smaller than her male counterpart because women work at lower wages and spend fewer years in the workforce due to child rearing responsibilities. In addition to this smaller Social Security check, she very likely will have a smaller pension income and fewer savings to supplement her Social Security.

As a result of changes made in 1983, Social Security benefits are already being reduced. The phased increase in the retirement age will affect everyone born after 1937. For Americans who reached age 62 in 2005, the full retirement age has risen from 65 to 66 years. The age will continue rising until it reaches age 67 for those born in 1960 and thereafter.

The existing increase in the retirement age means Social Security benefits will be smaller for everyone. In the year 2000, the Social Security “replacement rate” for a middle-class median earner retiring at age 65 was 41 percent; that is, Social Security benefits were equal to 41 percent of the individual's previous earnings. By 2030, the replacement rate for a similar median earner retiring at age 65 will be only about 36 percent. With this size cut in benefits already in place, middle-class Americans will find it difficult to sustain the huge additional cuts in Social Security benefits proposed by the President ⁵.

The President's Super-Sized Cuts Would Drive Down Social Security Benefits for Middle-Class Retirees to an Unacceptable Level 

The President wants to make significant cuts in Social Security as part of his privatization plan. These cuts are much steeper than is necessary to fix Social Security's funding gap. Moreover, the President and his privatization allies insist this funding gap must be resolved only through huge cuts in benefits. This continued insistence on oversized cuts will eventually drive Social Security benefits for middle-class retirees to an unacceptable level. The President's proposals don't fix Social Security; but they will shrink it to a poverty program and strip it of its middle-class protections.

We Can Afford Social Security

Much of the discussion of the cost of entitlements is based on the notion that we cannot afford Social Security benefits for the baby boom generations. Sound economic data refutes this common misconception ⁶.

The Economy Can Support an Increased Number of Retirees

Those who support the President's plan to make huge cuts in Social Security benefits and divert Social Security resources into private accounts often cite the increase in the number of beneficiaries to workers as the baby boom generation retirees. The number of Social Security beneficiaries per 100 workers will increase from about 30 in 2005 to 50 in 2050.

Dependent- to -Worker Ratio

The “retiree-to-worker ratio” leaves the impression that resources will not be sufficient in the future to support the large number of retirees in the baby boom generation. However, this ratio does not take into account people other than Social Security beneficiaries who also rely on workers for support. Some experts have suggested that a more accurate measure might be a “dependent-to-worker ratio” which compares the number people who are dependent upon workers for their support by age; that is, children under the age of 20 and retirees 65 and over. By that measure, there were 90 dependents to 100 workers in 1960 when the baby boom generation was in school. In 2000, the number of dependents had dropped to 69 per 100 workers due to a dramatic decrease in the number of children. As the number of retirees begins to climb after 2010, the ratio of dependents to workers will grow. By 2050, the ratio rises to just over 80 dependents per 100 workers. While the ratio of dependents to workers in the distant future is high, it never exceeds the ratio of dependents to workers in the 1960s.

Consumer-to-Worker Ratio

Another measure of the cost of the baby boom generation is the ratio of consumers of all ages, including those under 20 as well as those 65 and over, to the number of workers. This “consumer-to-worker support ratio” reflects the notion that workers must produce what everyone (including themselves) consumes. By this measure, in 1960, there were 268 consumers per 100 workers. The support burden was at its lowest in 2000 at 201 consumers per 100. Thereafter, the burden rises slightly until it reaches 216 per 100 by 2050. The total support burden is never again as high as it was in 1960.

The Cost of Social Security as a Proportion of the Economy Is Not Insurmountable

Social Security currently represents about 4.3 percent of GDP. By 2030, Social Security costs will rise to 6.2 percent of GDP. This 1.9 percentage points increase over nearly a quarter of a century is significantly less than the 2.8 percentage points increase (from 2.5 percent to 5.3 percent) in the share of the economy spent on public education in the 25 years between 1950 and 1975. The country had much less time to prepare for the unexpected increase in births that occurred in the 1950s than it has to prepare for the increase in retirees.

Average Wages for Workers Would Continue to Rise Even if Social Security Were Brought into Balance Solely by Increasing Payroll Tax Contributions

Even if the Social Security funding gap were fixed entirely by increasing Social Security contributions, the average earner in 2050 would still have wages that were nearly 60 percent higher than the wages of today's average earner. No one has suggested that Social Security should be balanced solely by means of increasing Social Security payroll contributions. However, even if that were done, the increase in real wages, after adjusting for inflation and deducting both the employer and employee share of payroll contributions, would still grow significantly. Workers in the future would still have substantially higher real net wages than they do today.

Conclusion

America can afford Social Security.  Strengthening Social Security for the long term is an attainable goal. However, the President's push for the privatization of Social Security combined with huge benefit cuts does not preserve nor strengthen the program's long-term outlook and should be rejected.

Ibid.

Jason Furman, Center on Budget and Policy Priorities, An Analysis of Using “Progressive Price Indexing” To Set Social Security Benefits (May 2, 2005).

According to Munnell's calculations, Social Security benefits for the average earner in 2004 were $14,700 a year. Had Social Security been indexed to prices rather than wages starting in 1951, the average benefit in 2004 would have been only $7,950 a year.

Alicia H. Munnell, Center for Retirement Research, Boston College , The Declining Role of Social Security (February 2003).

Virginia Reno and Joni Lavery, National Academy of Social Insurance, Can We Afford Social Security When Baby Boomers Retire? (May 2006) and the 2006 Report of the Trustees of the Old-Age, Survivors and Disability Insurance Trust Funds.

Government Relations and Policy, February 2007