Comparing Proposals for Social Security Reform

Studies | Social Security

No. 227
Wednesday, September 01, 1999
by Liqun Liu and Andrew J. Rettenmaier

The Gramm-Domenici Proposal

Figure III - Source of Benefits for New Retirees

"The Gramm-Domenici proposal provides a 20 percent bonus over currently scheduled benefits."

24Sens. Gramm and Domenici's Investment-Based Social Security plan would gradually replace the pay-as-you-go Social Security system with a fully funded investment-based system, using personal retirement accounts (PRAs).25 By their estimate, the total transition would take about 50 years. Workers would invest an increasing portion of their payroll taxes (from three percentage points in 2000 to an eventual eight percentage points) in investment funds managed by professional money managers, certified for safety and soundness and regulated by a new Social Security Investment Board. There would be no increase in the payroll tax, and the government would guarantee that everyone would fare no worse under the investment-based system than under the current system.26

On retirement, retirees would receive the scheduled benefits from the current system plus an amount equal to 20 percent of the annuity they can purchase with their private account. If the account contains more than the amount needed for the annuity, the retiree could withdraw the remainder. If the accumulated balance is insufficient to pay for the guaranteed benefit, as would be true for those workers who are closer to retirement at the beginning of the transition, the entire balance would be turned into an annuity and Social Security would pay the difference between the annuity and the guaranteed benefit. Over time, with an increasing portion of wage earnings invested in the individual accounts, and a lengthening period of investment, new retirees would obtain a greater proportion of their after-retirement income from their private annuities.

"After 20 years of transition, private accounts will fund 15 percent of new retirees' benefits."

Contributions to PRAs under the Gramm-Domenici plan are funded in two ways: (1) by using all current and projected budget surpluses,27 and (2) by "recapturing" new government revenue generated by the PRAs.28 Using the budget surplus to finance the PRA deposits is equivalent to the government making contributions on behalf of individuals to their private accounts, and we estimate that the budget surplus could fund PRA contributions equal to 2.5 percent of taxable payroll. As the recaptured corporate taxes as a percent of taxable payroll begin to exceed 2.5 percent in 2028, they are able to fund a gradually rising contribution rate - reaching 4.85 percent by 2058. [See Appendix B, Table B-II.] The result:

Figure IV - Total Taxes Needed for Government-Funded Benefits As A Percent of Taxable Payroll
  • After 20 years of transition (in 2020), private accounts will fund 15 percent of new retirees' Social Security benefits (including the 20 percent bonus). [See Figure III.]
  • The fraction of retirement income paid from private accounts rises to 31 percent in 2030, to 53 percent in 2040 and to 67 percent by 2050.

These percentages refer to the average retiree, however. For reasons given above, higher-income retirees will replace more of their benefits with PRA investments; lower-income retirees will replace less.

By 2058 the average individual entering the workforce will contribute at the rate necessary to prefund an annuity equal in value to promised Social Security benefits plus a 20 percent bonus (4.85 percent). Beyond that point, a dramatic reduction in government funding will be possible [see Figure IV and Appendix B, Table B-IIa] and, accordingly, the payroll tax can be substantially reduced. Specifically:

  • The payroll tax is kept at 8.10 percent under this plan until the year 2050.
  • Beyond that point, it is possible to eliminate the Social Security benefits tax and gradually reduce the payroll tax - relying on increased revenues from a larger economy to fund the remaining government obligations.
  • By the year 2075, the payroll tax rate can be reduced to less than 1 percent.
  • This compares to a 19 percent payroll tax that will be needed without reform.

Read Article as PDF