The Proof Is In: PRAs Can Save Social Security

Commentary by Pete du Pont
Social Security needs saving.

Currently, Social Security is a pay-as-you-go program, with payroll taxes from today's workers used to fund the benefits of today's retirees. Yet with people now living longer and the baby boom generation near retirement, there soon won't be enough people left working to pay the retirees without a substantial tax hike. In fact, according to Social Security's trustees, to sustain the program payroll taxes will have to rise by more than 50%, or benefits will have to be cut by one-third.

Any major increase in taxes is likely to lower national productivity and the incomes of future generations. Similarly, any substantial cut in benefits will lower the standard of living of future retirees. Maybe it's just me, but this doesn't sound like my idea of the American Dream.

It doesn't seem to be a future that some in Congress want either. Some have proposed plans to save the retirement entitlement with private accounts. Unlike the administration's "USA Accounts," which really have nothing to do with Social Security, most reform proposals actually fundamentally change the system. While each is different, each plan staves off bankruptcy, and most do so with a higher benefit than the status quo.

Recently, the National Center for Policy Analysis published a comparative analysis of the three major reform proposals before Congress. What we found is that the future funding crisis in Social Security can be averted by allowing workers to put a portion of their payroll tax dollars into personal accounts invested in the private market. This means Social Security can be saved without raising the taxes of workers or cutting the benefits of seniors.

So what is in these plans and how do they differ?

A proposal by Texas Senator Phil Gramm and New Mexico Senator Pete Domenici would allow workers to divert a portion of their payroll taxes into personal retirement accounts (PRAs), invested in professionally managed portfolios. Since the plan promises no new taxes and no benefit cuts, initial deposits must be limited to the amount that can be funded from the projected surpluses. Retirement benefits would be guaranteed to at least match current expectations. Retirees can also purchase a lifetime annuity with their private accounts.

Reps. Bill Archer (R-TX) and Clay Shaw (R-FL) also propose the creation of PRAs. However, they suggest that workers receive an annual refundable income tax credit equal to 2% of wages to fund their PRA deposits. Although the funding for PRAs accounts appears substantially different, the initial funding source is the same - projected budget surpluses. Like Gramm-Domenici, retirees are guaranteed to receive a benefit package of no less than that currently promised. In contrast to the Gramm plan, however, Archer-Shaw would have the government, rather than private firms, administer the annuities during a worker's retirement.

The final proposal analyzed was a bipartisan proposal by Sens. John Breaux (D-LA), Judd Gregg (R-NH) and Bob Kerrey (D-NE), and by Reps. Jim Kolbe (R-AZ) and Charlie Stenholm (D-TX). Their proposal would allow workers to divert 2% of their earnings into a PRA, with the government matching deposits of low-income workers. To eliminate Social Security's unfunded liability, the bipartisan proposal would raise payroll taxes and reduce benefits. Depending on how effectively a PRA is invested, it is possible to generate benefits in excess of what is currently promised. However, it is the only plan that has the potential to generate lower overall benefits.

While each plan moves in the direction of privatization, there are two crucial differences. First, the plans differ in the extent to which PRAs replace benefits coming from traditional Social Security. Under the Archer-Shaw plan, today's young workers would rely on their PRA for about half of their retirement benefits, compared to two-thirds of all benefits under Gramm-Domenici. Under the bipartisan plan, that percentage would grow to 70% of all benefits; however, those benefits could be significantly smaller.

Another substantial difference between the plans, is how high the payroll tax rate will have to be to fund the system. In the year 2070, if nothing is done, payroll taxes will have to be hiked to 19% just to pay for Social Security's unfunded liability. At the same time, the Social Security tax rate under Gramm-Domenici would be 7.1% of payroll, compared to the bipartisan plan's 8.2% and Archer-Shaw's 10%.

While there are significant differences between these three plans, the important thing to remember is that reform and PRAs can work. Pay-as-you-go is not going to work much longer, so a plan such as these will need to be decided upon soon.



The National Center for Policy Analysis is a public policy research institute founded in 1983 and internationally known for its studies on public policy issues. The NCPA is headquartered in Dallas, Texas, with an office in Washington, D.C.