Briefing Book

White House Conference

Yung-Ping Chen University of Massachusetts Boston Gerontology Institute 100 Morrissey Boulevard Boston, MA 02125-3393 Tel 617 287-7300 Fax 617 287-7080 A New Social Security: Combining Social Insurance with Individual Accounts I propose a compromise reform plan that would maintain social insurance features of Social Security and add to it the potential for augmenting retirement income from individually-owned saving/investment accounts. The plan thus embodies individual and collective responsibility, reflecting all the principles espoused by President Clinton, the Senate Republican Leadership Task Force on Social Security, and a Bipartisan Social Security Coalition in the Senate. This plan, called "New Social Security," would divide the current Social Security program in two: a defined-benefit social insurance component, like the one we have now, and a defined-contribution individual account, which would be new. The social insurance benefit would preserve the traditional old-age, survivors and disability (OASDI) protections, to be funded on a pay-as-you-go (PAYGO) basis using 10.8 percentage points of the current FICA for the next two dozen years. Funded by 1.6 percentage points of the current FICA, the individual account would be created without additional taxes or contributions. Such financing is feasible because we do not need these funds to pay benefits during the next couple of decades or so. The current FICA of 12.4% would remain. This plan would remove the unfunded liabilities under the current Social Security program, keep the progressive benefit formula that protects low-income and disabled persons, cut FICA in order to create individual accounts, repeal the earnings test, and set moderate PAYGO rates over the next 75 years (10.8% for 1999-2022; 12.4% for 2023-2032; 13.2% for 2033-2042; 13.5% for 2043-2052; and 13.9% for 2053-2074). To complement the PAYGO rates in shoring up the long-range financing, this plan also incorporates several provisions common to other plans, such as gradually increasing the retirement age, moderately raising the wage cap, covering state and local new hires, extending the benefit computation years, and taxing Social Security benefits like other pensions. A unique feature of this plan is that the individual accounts would be mandatory now but voluntary in the future. In 2023--when the FICA needs to return to 12.4 percent-- individual accounts will no longer be required. At that point, it is likely that workers who have had favorable experiences with individual accounts would continue to contribute to them. Other people would follow suit. If experiences have been unfavorable for most people, then why should the mandate continue? If the experiences turn out to be mixed, as seems likely, it would be sensible to allow individuals to choose whether or not to continue their accounts. I propose that individual accounts be established on a time-limited basis (e.g., during the next two decades or so), as an experiment or a demonstration project, akin to the medical savings account in the Kassebaum-Kennedy bill (Health Insurance Portability and Accountability Act of 1996). The experiment would yield much data on individual accounts, such as the investment behavior and preferences of people by key demographic and economic variables (e.g., age, sex, and wage/salary), among other things. Such empirical "laboratory" data would serve as a useful guide in setting future policy. The proposed experiment raises a legitimate question about the safety of retirement income, a major concern about privatization in general. What if a person with an individual account loses everything he or she put into it during the demonstration period? Because Social Security benefit is a guarantee and receipt from individual accounts is added to that guarantee, people still will be assured of their Social Security benefits. Other concerns about individual accounts exist. Many fear that unwise and unlucky investment decisions, or lack of investment knowledge, would make individual accounts an uncertain source of income. Others object to the administrative costs that may greatly diminish the returns of small accounts. Avoiding such problems, these accounts could be held and managed by a central authority with a limited number of investment options for account holders, patterned after the federal Thrift Savings Plan. Such a model would have the added advantage of avoiding fraudulent sales practices encountered by some individuals investing on their own. Another distinguishing feature of this plan is the use of PAYGO, which some disapprove on the ground that future tax rates would be exorbitant. However, PAYGO will not entail high tax rates if the growth in benefits is moderated as under this plan. Moreover, using PAYGO, this plan will not involve sizable trust fund investments, so concerns about political interference in investment decisions and corporate governance become moot. Moot also are the controversies about the use of budget surplus and about whether the trust fund is real or illusory. A word about the timing for establishing individual accounts is in order. I suggest we wait until the unified budget is also in surplus before we implement the carve-out for creating individual accounts. Unified budget surplus is estimated to occur in a few years. I therefore urge the Congress to pass legislation now for implementing the New Social Security plan when the unified budget surplus materializes--to create individual accounts using part of the FICA on an experimental basis and to finance the traditional Social Security on a responsible pay-as- you-go basis. * An Economist, Yung-Ping Chen, Ph.D., holds the Frank J. Manning Eminent Scholar 3 Chair in Gerontology, University of Massachusetts Boston. A founding member of the National Academy of Social Insurance, he served on the panel of actuaries and economists of the 1979 Advisory Council on Social Security. He welcomes comments by phone (617-287-7326), fax (617-287-7080) or E-mail (bing.chen@umb.edu).