Class Discussion of Social Security Reform October 18, 2006

Outline Finish discussion of economic effects of Social Security Effect on national savings Role of the Trust Funds Class discussion of reform Some reform options Ten myths

National Savings National saving = individual saving + gov’t saving We care about national savings because it provides the “fuel” for investment, and thus long-term economic growth Understanding effect of government policy is often difficult Ex: Do 401(k) plans increase national savings? Individual saving rate clearly rises But government revenues decline Which is larger? (For 401(k)s, most believe there is net increase)

SS and National Saving Individuals have 12.4% of their income go to pay Social Security payroll taxes In return, they receive retirement benefits in the future Individuals save less because they know they will have some SS income in retirement But there is no corresponding increase in government saving because of “pay-as-you- go” nature of the program

How Big is the “Crowd-Out”? There is a substantial body of economic research examining this question using Changes in savings over time Differences across individuals Differences across countries Each $1 of “Social Security Wealth” (i.e., the present value of future Social Security benefits) crowds out private saving by cents. Keep in mind that this is a huge program! U.S. capital stock may be trillions smaller than it would otherwise be …

What difference does it make? Lower national saving rate  less capital available for investment Less investment  lower rate of economic growth Lower economic growth  the “size of the economic pie” is smaller in the future One key issue to consider when discussing potential Social Security reforms is what effect it will have on national (public + private) saving

What about the Trust Fund? Any surpluses from Social Security are credited to OASDI trust funds Trust fund creates a legal liability for the U.S. Treasury When SSA redeems the bonds, Treasury must find the money to pay for them The bonds are an asset to SSA, but a liability for the U.S. Treasury

The Trust Fund and Savings At end of 2004, the trust fund held nearly $1.86 trillion in government bonds Does this mean that the government “saved” $1.86 trillion over the past two decades? If we hold constant all non-SS spending and taxes, then running a $1 surplus in Social Security increases national saving by $1 But should we hold other spending constant?

TF and Budget Accounting Social Security is “Off Budget” But the “unified budget” includes Social Security One view is that the presence of large SS surpluses made it easier for Congress to spend more money in rest of the budget Use the SS surpluses to hide deficits elsewhere “Raiding the trust fund” Did not happen from accounting perspective Might have happened from economic perspective

The “Lock Box” Featured prominently in 2000 election (and on Saturday Night Live!) Idea was to “lock the surpluses away” so that they would be saved, not spent But the lock box was soon broken Large deficit spending Is there a better lock box?

Four Groups White House Senator Harry Reid AARP Americans for Tax Reform

In your groups … What is your position on the severity of the problem facing Social Security? If you believe there is a problem, what specific proposals do you support to fix it? Benefit cuts? Tax increases? What is your view about personal accounts? “Carve-out” vs. “Add-on” Part of Social Security vs. outside of Social Security

Prepare to Report to Class … Choose one person as a spokesperson Be prepared to provide 2-3 minute summary of your group’s position to the class Entire group should be prepared to answer questions from class

Now Form Teams Across “Groups” Make sure each team has at least one member from each of the four groups WH, Reid, AARP, ATR Each individual should continue to hold their group position – can you agree on any steps toward reform? What policies might satisfy all parties? What are the major stumbling blocks?

The 2005 SS Debate State of the Union State of the Union (minutes 12-22) Democratic Response Democratic Response (minutes 5-7:20) AARP response How debate evolved over summer 2005

Top Ten Myths of Social Security Reform

Ten Myths of Social Security Reform 1.Social Security is financially sound for “decades to come” 2.Economic growth will eliminate the existing problem 3.Social Security is in “crisis” and will not be there when today’s younger workers retire

Ten Myths of Social Security Reform 4.Personal accounts can save Social Security without benefit cuts or tax increases 5.Allowing individuals to redirect their contributions from the trust fund to personal accounts will provided a higher rate of return 6.Personal accounts will worsen Social Security’s financial problem

Ten Myths of Social Security Reform 7.Personal accounts will cause benefit cuts 8.Personal accounts are risky and the current system is safe 9.Transitioning to personal accounts is too costly 10.Social Security reform is bad for the poor / women / minorities

Methods to Reduce Shortfall See SSAB Handout … Changes to benefit formula AIME calculation - # years, indexing, etc. PIA calculation – change bend point factors Increase retirement age Changes to tax base Raise taxable maximum Changes in coverage State and local workers Many others

Pros of Personal Accounts Perhaps a better way to “save” SS surpluses than the trust funds (and thus increase national savings) Possibly improve labor supply incentives because contributions no longer viewed as a pure tax Potential to extend asset ownership to 50% of households that lack it Offers opportunity to pursue higher expected returns

Cons of Personal Accounts Exposes individuals to increased financial market risk Voluntary But might government bail-out “losers”? Need to finance the transition from pay- as-you-go system to funded system Possibly erode long-term support for social insurance aspects of the system