Comparing Proposals for Social Security Reform

Studies | Social Security

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


Figure X - Source of Benefits for New Retirees

The National Center for Policy Analysis (NCPA) and the Private Enterprise Research Center (PERC) have developed a proposal that resembles several of the plans currently before Congress. Like the Gramm-Domenici and Archer-Shaw proposals, this plan works within the constraints of the projected budget surplus and seeks to replace projected Social Security benefits without lowering those benefits or raising taxes. However, rather than having all workers contribute a constant percentage of their earnings into private accounts, we suggest that younger workers contribute at a higher rate than older workers.

There are two reasons for proposing the different contribution rates. First, the first generation that spends its entire work life under the plan will for the most part replace its Social Security with private savings during retirement. Of the three other proposals studied here, only the Gramm-Domenici plan provides for workers eventually to fully fund their retirement, and even under that plan full funding takes place in the distant future. Second, the nation's capital stock will grow more rapidly in the early years of the transition if withdrawals from the private accounts are postponed until the current young retire. As a consequence, national income and taxes will grow more rapidly.

Accordingly, our final simulation assumes that beginning in 1999, 4.5 percent of the taxable earnings of individuals born in 1981 (today's 18-year-olds) and later goes into PRAs. The 4.5 percent contribution rate is chosen because on average it will replace Social Security benefits and provide a 10 percent bonus.38 We also continue to impose a constraint equal to 2.5 percent of aggregate taxable earnings during the transition - the maximum that can go into PRAs from the budget surplus. The budget surplus thus in effect is a transition tax.

"The higher contribution rate to PRAs of younger workers creates a capital stock that grows more rapidly."

To determine the contribution rate for workers born in 1980 and earlier, we subtract the aggregate of the 4.5 percent contributed by those born in 1981 and later from an amount equal to 2.5 percent of aggregate earnings for all workers. Between 1999 and 2026, this difference - an ever-declining amount as an increasing portion of the labor force is made up of workers born in 1981 and later - can be used to partially fund the accounts of those born in 1980 and earlier. The difference is divided in such a way that the private accounts replace a gradually increasing proportion of each cohort's Social Security benefits, so there is no "notch generation" in the future.

Figure XI - Total Taxes Needed for Government-Funded Benefits As a Percent of Taxable Payroll

The higher contribution rate to PRAs of younger workers creates a capital stock that grows more rapidly and produces larger earnings from that capital stock. The incremental earnings exceed the budget constraint in 2026 - the same year the aggregate contributions of the younger-worker cohorts exceed the constraint. Beyond 2026, the gradual increase in aggregate PRA contributions to 4.5 percent of taxable earnings is funded by recaptured corporate taxes.

"By 2050, average new retirees draw their entire benefits from the private accounts."of taxable payroll."

The results of a simulation structured in this way are presented in Appendix B, Table B-V. As Figure X shows, the percentage of new workers' benefits paid from private accounts lags behind those of the other plans examined in the early years because the relatively older workers are contributing at a lower rate. For example:

  • Individual PRAs provide only 23 percent of the benefits of new retirees in 2030 but rise to provide 70 percent of benefits by 2040.
  • By 2050, average new retirees draw their entire benefits from the private accounts.

"By 2050, average new retirees draw their entire benefits from the private accounts."of taxable payroll."

Changing the contribution rate from one that is constant over time and across individuals to one that is higher for young workers and is allowed to rise over time, as this plan is doing, results in a more rapid increase in capital stock because the young, who are contributing at the higher rate, do not draw benefits until 2048. As a result of the more rapid growth of national income and thus of tax revenues:

  • By 2050 the tax on Social Security benefits can be eliminated and the net payroll tax reduced to 1.97 percent.
  • By 2060, all payroll taxes can be eliminated and corporate taxes reduced.
  • By 2075, the end of the simulation horizon, the only tax required is a corporate tax equal to 1.93 percent of taxable payroll, the amount required to maintain the redistributive nature of the Social Security benefit formula.39 [See Figure XI.]

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