Social Security Reform without Illusion: The Five Percent Solution

Studies | Social Security

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


Evolution of the Reformed System

Figure III - Alternative Cost Rates

“Initially, the reformed program will cost more than the current program.”

Figure III shows two alternative annual costs of funding the OASI program. The status quo cost rate line shows the tax rate necessary to finance scheduled OASI benefits on a pay-as-you-go basis. By 2080 a 16.82 percent tax rate will be needed. The other line, the reformed cost rate, is equal to the sum of the PRA contributions plus the cost of paying the reformed defined benefits as outlined above. As the figure shows, by 2037, the reformed program’s cost falls below the cost of maintaining the program as currently structured.

“Ultimately, the reformed program will cost much less.”

Figure IV shows the relative cost of reform versus pay-as-you go financing, expressed as the difference between the reformed cost rates and the status quo cost rates. Every reform that attempts to prepay benefits imposes costs on current generations that pay-as-you-go financing would have imposed on future generations. The trade-off is clear in this graph. Between 2004 and 2036, the reform is more expensive than continuation of the status quo. However, in all years beyond 2036 the costs are lower. To appreciate the extent of the reduced costs we must imagine the graph continuing into the indefinite future. There are also real economic benefits of reform not captured in this graph. As discussed below, this reform will increase the nation’s capital stock significantly. The increased means of production will result in higher earnings for all future generations. Although we have not accounted for these higher earnings, they must be considered as a significant advantage of prepayment relative to pay-as-you-go financing.14Figure IV - Reform Costs Less Status Quo Costs

“The Trust Fund has a $17 billion balance in 2038, and thereafter no draws on the Trust Fund will be necessary.”

Figure V identifies the evolution of the Trust Fund in 2004 dollars. Between now and 2016, the Trust Fund actually rises as credited interest payments exceed draws. However, by 2038, the first year in which reformed costs are less than reformed revenues, the Trust Fund has a $17 billion balance, and thereafter no further draws on the Trust Fund will be necessary.

Figure V - Trust Fund (OASI) Under the Reform Plan

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