Saving the Surplus

Studies | Social Security

No. 241
Wednesday, January 31, 2001
by Dr. Liqun Liu, Dr. Andrew J. Rettenmaier, and Thomas R. Saving


Executive Summary

This report compares two alternative uses of the Social Security surpluses.

The plans differ in the way they dispose of projected Social Security surpluses over the next decade. Under both plans, the surpluses will vanish about the time the baby boom generation begins to retire. Moreover, because of other entitlement obligations, higher taxes will be needed beginning in the third decade of this century - no matter which plan is adopted.

However, how we dispose of the surplus today has a large impact on the solvency of Social Security during the years when today's young people will be drawing their retirement benefits.

Under one alternative, the surpluses are used to allow workers to invest some of their payroll taxes in personal retirement accounts (PRAs). We estimate that the total investment will equal about 2 percentage points of taxable payroll for the next 10 years. These funds will be invested in private securities, earning a much higher rate of return than the rate implicitly promised by Social Security. We assume that total benefits will continue to be paid as scheduled but that the growth of the private accounts will substitute for the government's obligations to pay benefits - thus reducing the need to raise payroll taxes in future years:

  • Using the Congressional Budget Office's long-term forecasts, we find the payroll tax needed to pay benefits under the current system will rise from about 12.4 percent today to approximately 19 percent by the year 2050.
  • However, with personal retirement accounts, Social Security obligations can be met in the year 2050 with about the same payroll tax that we have today.

The other alternative is to use the surplus to pay down government debt and use the interest savings (from lower debt) to pay benefits in the future years. Under this plan:

  • By the year 2022, the government will have to start borrowing again.
  • By the year 2029, we will have the same debt that we have today.

From that point forward, we have to make some assumptions about how the government will meet its obligations. We considered two options:

  • Under Scenario One, the government maintains the same debt as it has under the PRA plan and increases taxes to meet its spending obligations.
  • Under Scenario Two, the government raises taxes to match the PRA tax burden and borrows to fund any additional obligations.

Under Scenario One:

  • The payroll tax will have to rise to 19.6 percent by the year 2050 (compared to 12.5 percent under the PRA plan).
  • The payroll tax will have to rise to 21.3 percent by 2070 - almost twice the tax rate needed under the PRA plan.

To put this in perspective, if the burden of Medicare (parts A and B) is also expressed as a percent of payroll, the total burden of elderly entitlements under this plan will be 34.8 percent in 2050 and 37.3 percent in 2070. Thus, future workers will have to pay more than one-third of their income in taxes if promises to today's young people are to be kept.

Under Scenario Two:

  • By the year 2050, the country will have four times as much debt as it will have under the PRA plan.
  • By the year 2070, the country will have 35 times as much debt as it will have under the PRA plan.

Thus, although paying down debt initially frees us from government's outstanding debt, in the long run we end up with much greater debt because nothing has been done to solve the structural problem of Social Security.


Read Article as PDF