Social Security Reform without Illusion: The Five Percent Solution

Policy Reports | Social Security

No. 272
Friday, December 17, 2004
by Andrew J. Rettenmaier & Thomas R. Saving

Paying the Cost of Transitioning to a Funded System

The reform plan presented here is based on a time-honored principle: There is no such thing as a free lunch. While the benefits of reform are substantial, they cannot be realized without sacrifice. Realistically, today’s generation of workers face a double burden: They must secure the retirement benefits of their parents and simultaneously begin funding their own retirement benefits.

Who must sacrifice and how much? This reform plan makes explicit certain budget requirements that already exist implicitly: (1) expected Social Security surpluses over the next decade must be reserved exclusively for Social Security, and (2) the promises represented by the current Social Security trust fund must be redeemed.

“Initially, employees and employers would each contribute 1.25 percent of wages to fund the accounts.”

The projected surpluses and the redemption of the trust fund will provide part of the finances necessary to fund personal retirement accounts. The workers who expect to benefit must shoulder the rest of the burden of reform. In order to fully realize promised benefits, employees must be willing initially to set aside and invest an additional 1.25 percent of payroll (matched by their employer) rising gradually to 1.75 percent after eight years. Over time, private accumulations of assets will replace government promises. In fact, the youngest workers will be able to fully fund their own retirement without the need to impose any new taxes on future generations.

This plan stands in stark contrast to reform plans that require unrealistic and unspecified spending cuts, unrealistic and unspecified tax increases, and/or large amounts of federal borrowing. A reform plan that promises to pay scheduled benefits without new revenues requires significant reductions in other federal spending:

  • As noted above, paying Medicare and Social Security benefits with no reform will require one-in-four income tax dollars by 2020 in addition to payroll tax collections and premium payments.
  • A personal retirement account reform plan that does not include additional contributions from employees or their employers would require almost one-in-two income tax dollars by 2020!

The reform plan proposed here makes the costs of prepayment explicit, so that costs can be compared to the benefits.

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