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PERSPECTIVE ON RETIREMENT

A Plan to Fix Social Security

Planned 'reforms' are stop-gap measures that will be obsolete before they're begun.

April 05, 1998|LAURENCE J. KOTLIKOFF and JEFFREY D. SACHS | Laurence J. Kotlikoff is a professor of economics at Boston University. Jeffrey D. Sachs is a professor of economics at Harvard University and director of the Harvard Institute for International Development

Notwithstanding all the attention on the current budget surplus, the nation's finances are in crisis. The reason is that two huge programs, Medicare and Social Security, are heading into the red.

Medicare, which is being addressed by a special commission, will run out of money around 2010. This is about 10 years later than it would have been absent last year's budget agreement. But without fundamental reform, Medicare will need a massive payroll tax hike, ranging from 5 cents to 10 cents of every dollar we and our kids earn.

The Social Security system, its trustees tell us, is in better shape. Its trust fund won't run out of money until 2030, and keeping it afloat requires only another 2.2% of our paychecks. Would that the truth were only this bad.

The actuarial projection generating this estimate extends only 75 years. Unfortunately, huge deficits loom in years 76 and beyond. Indeed, one of the main reasons that Social Security's finances are again a cause for concern, after having been "saved" by the Greenspan Commission in 1983, is the failure to look beyond 75 years. Seventy-five years is a very long time, but every year that passes adds a large deficit to the current projection period. Since 1983, 14 years of deficits have been added.

How much would it take to pay for Social Security on a permanent basis without cutting benefits? The answer, according to the system's actuaries, is not 2% more of our pay, but 4.7% more.

That's bad enough, but the trustees also claim that their 2.2% solution is based on "intermediate" demographic and economic assumptions. Not true. Consider life expectancy. The trustees assume it will take 45 years for Americans to start living, on average, as long as the Japanese now live. Most top demographers think that's way off. They see twice the increase in life expectancy. Or consider the trustee's "intermediate" wage-growth assumption. It's 0.9% per year after inflation, more than twice the rate we've averaged since 1975.

Assuming the faster growth in life spans and the slower growth in wages, permanently fixing Social Security without cutting benefits requires a 5.9% payroll tax hike. Moreover, we'd need to start handing the government this extra money now. Waiting, say 10 years, requires jacking the tax rate up by roughly 6.7%. The current Social Security tax rate (employer plus employee) is 12.4%. What we're talking about is a 50% increase in Social Security's payroll tax rate.

The bottom line is that Social Security is in deep water. We need to fix it for good, from the ground up.

Social Security's reform should be transparent. It should be fair across and within generations. It should protect the poor. And it should mandate individual responsibility. Such a reform can best be achieved through a system of individual accounts of the type that has been adopted by a growing number of countries around the world, including Chile and Britain.

We favor the following eight-point plan, called the Personal Security System, which includes a way to pay for the reform:

* Guarantee current retirees their current benefits and current workers the benefits they've accrued under the existing system.

* Preserve the disability and survivor parts of the system, including the payroll tax contributions used to finance them.

* Have workers contribute into private accounts the money that they are now paying to the retirement (old age insurance) component of Social Security.

* Protect nonworking spouses and people who divorce by requiring workers to split their contributions evenly with their spouses.

Have the government make a matching contribution for low contributors based on the size of their preretirement contributions to the new system.

* Require that all account balances be invested in a highly diversified and regulated portfolio, such as a global index fund that limits risk and the ability to play the market, and earns everyone the same rate of return.

* Require that account balances be collectively converted into inflation-protected pensions as each generation reaches retirement age. Collective conversions prevent insurance companies from picking off the best risks.

* Finally, pay off old age insurance due under the existing system by cutting corporate welfare, reducing excessive defense and other federal purchases, fixing the consumer price index, raising "sin" taxes and imposing a targeted retail sales tax or business cash-flow tax.

This plan, which has been endorsed by 75 of the nation's leading economists, meets all the legitimate concerns of opponents of Social Security reform while fixing the system for good.

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