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Investment-Based Social Security Saving Social: Security for Our Parents, for Our Children
December 1998
Funding the Transition
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"Transition funds come from: (1) recapture of corporate profit tax, (2) the federal budget surplus and (3) redeeming 29 percent of the trust fund's assets." "Recapture will apply only to new investment occuring as a result of the new system." "The federal government will have to repay 29 percent of the money borrowed from the current Social Security system."
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Figure X shows the total cash flow required to fund both the transition to an investment-based system and the cost of funding the baby boom retirements taken from Figure IX. The shaded areas of Figure X identify funding sources for the transition.
Corporate Profit Tax Recapture.
As noted above, Feldstein and Samwick have calculated that investors in the private capital market earned a real rate of return of 5.5 percent over the 67-year period from 1926 to 1992. The rate of return actually paid by the capital market over that period was a much larger number: 8.5 percent. As shown in Figure XI, no investor ever saw this 8.5 percent real rate of return, however, since 24.7 percent or 2.1 percentage points was lost to federal corporate income taxes and 10.6 percent or 0.9 percentage points to state and local taxes.
Feldstein and Samwick argue that it would be desirable to exempt Social Security investments from the federal corporate income tax to give retirees the full benefit of their investment income. However, there is no practical way of doing this. It is conceptually possible, though, to earmark for the Social Security system a conservative estimate of those federal corporate income taxes collected solely on the earnings of new investments funded by individual Social Security investment accounts. Through a process we will call recapture, the tax revenues will be collected by the Treasury and remitted to the Social Security system, just as taxes on existing Social Security benefits are now earmarked for Social Security. These are new revenues on new investment that would not exist except for the new Investment-Based Social Security system.
The recapture rate is based on the assumption that 80 percent of the funds going into Social Security investment accounts will be net additions to national investment (20 percent will be offset by reductions in other forms of savings and investment).12 It is further assumed that 10 percent of the Social Security investment funds will be invested abroad and so not subject to U.S. corporate taxes and that 5 percent of the investments will escape corporate taxes (subchapter S corporations taxed as individuals, for example).
These assumptions reduce the effective federal corporate tax rate recapture to 23.9 percent, down from the statutory level of 35 percent. Each year, the level of federal corporate taxes collected on Social Security investment will be estimated by taking the actual returns earned by Social Security investment accounts, prior to all taxes, and multiplying the dollar value of those returns by 23.9 percent. At the end of each fiscal year, this estimated amount will be transferred by the Treasury to the Social Security system. The recapture will apply only to the new investment occurring in the economy as a result of investment-based Social Security and will not significantly alter the amount of corporate taxes that would have been collected in the absence of an investment-based system.
Though small at first, federal corporate tax collections on SI Account investments will grow as the level of investment in SI Accounts build up. The corporate profit tax recapture is shown in Figure X. Recapturing federal corporate profit taxes on SI Account investments for the Social Security system provides a funding source that grows from zero in 2000 to $81 billion by 2020, to $143 billion in 2030 and to $280 billion by 2050 as the level of SI Account investments builds up to $4 trillion, $7 trillion and $13.7 trillion respectively.
Federal Budget Surpluses. The Congressional Budget Office (CBO) now projects a cumulative federal budget surplus of $2.2 trillion over the next decade.13 That surplus, which will persist until after 2020 but decline as the baby boom generation retires, is shown in light shading in Figure X. The CBO-projected surplus, when added to the corporate tax recapture, will fully fund the transition cost to an Investment-Based Social Security system and the baby boom cost explosion through 2017. If the projected surplus of $63 billion in FY 1999 was impounded now and rolled into 2000 to help fund the transition, the CBO-projected surplus would be even larger.
If only the portion of the budget surplus needed in each fiscal year to fund the transition were dedicated to that purpose, a total of $1.11 trillion be required. The remainder of the surplus could be used for other purposes. If the surplus above the amounts needed in each fiscal year to fund the transition were rolled forward to fund the transition in future years, the CBO surplus and the corporate income tax recapture alone would roughly fund the transition.
Redeeming Assets of the Social Security Trust Fund. Assuming that only the portion of the annual surplus needed to fund the annual transition cost in each year is dedicated to that purpose, it will be necessary to require the federal government to repay the Social Security Administration approximately 29 percent of the money it has borrowed from the system since 1983 in order to fill the funding gap. That repayment, $1,594 billion, would average roughly $84 billion per year over 19 years.14
By using part of the projected CBO budget surpluses, redeeming 29 percent of the Social Security Trust Fund and recapturing the net new corporate profit taxes flowing to the federal government from taxing Social Security investment income, we can fund both the transition cost and the built-in cost of the baby boom retirement explosion of the present system without cutting benefits or raising payroll taxes.
Conclusion
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"If America retains the current Social Security system, it will be forced to choose between lost opportunity for out children and abandoned security for our parents." "There is a better way: Doing what Social Security promised but never delivered." |
America is about to enter a new millennium. While the promise of that new era seems secure for the first decade, increasing uncertainty hangs over every year thereafter. That uncertainty is the burgeoning cost of entitlements that begins when the baby boom generation starts to retire. Social Security's bankruptcy won't be just a financial crisis, it will be a human tragedy, not unlike the turmoil of the Great Depression.
After all the revenue projections, demographics and benefit calculations, the funding crisis of Social Security under the status quo boils down to two bad choices: America will have to choose between lost opportunity for our children and abandoned security for our parents. If we choose the path of higher taxes, a tax rate that was 2 percent on our parents will be 18.4 percent on our children. With Medicare, the payroll tax will almost certainly exceed 30 percent.
Choosing higher taxes means our children's and grandchildren's future will be marked by crumpled resumés, rejection notices and pink slips. It will be jobs they hoped for but didn't get, raises they needed but were denied and advancements they earned but couldn't achieve. If we choose the path of reduced benefits, retirement benefits will be cut by a third or more. That path means our parents' future will consist of discarded financial plans, harassing calls from bill collectors and penny-pinching at the grocery store. It will be dream vacations canceled, deserved retirements delayed and favorite hobbies and activities abandoned.
Think about American families in which two of our most powerful human emotions are pitted against each other: the desire to do anything to help our children get ahead and the determination to provide security and dignity for retired parents.
Children versus parents, grandchildren versus grandparents, the dreams of our children versus the security of our parents - this is what the battle for Social Security will entail. And it will be waged by real people through sleepless nights of worry, around kitchen tables where, despite boundless imagination and ingenuity, the pencils, papers and calculators of breadwinners cannot navigate the barriers erected by government policies which, however well intended, are failing.
There is a better way. It requires doing what Social Security promised but never delivered. It requires that we employ one of the fundamental principles outlined by Franklin Roosevelt for Social Security: "Compulsory contributory annuities which in time will establish a self-supporting system for those now young and for future generations." It requires that we do what the Finance Committee chairman, Sen. Pat Harrison, called for in the original Social Security debate: "[an] annuity system [that] will give to the worker the satisfaction of knowing that he himself is providing for his old age." It requires that we save and invest now rather than tax and borrow later. But it is not just money at stake here. Save today and we save our children's dreams tomorrow. Invest today and we invest in our parents' security. Tax tomorrow and we diminish our children's future, cut benefits tomorrow and we harden our parents' retirement.
NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.