Saving Social Security
Peter R. Orszag
Director, Retirement Security Project
Joseph A. Pechman Senior Fellow, Brookings
January 13, 2005
The Brookings Institution, Washington, D.C.
www.brookings.edu
Social Security’s role
•
Social Security is intended to provide core layer
of financial security during particular times of
need:
1. Retirement
2. Disability
3. Death of a family wage earner
•
Not designed to be sufficient by itself:
1. Recommended “replacement rate” at retirement:
70 percent
2. SS replacement rate at age 62 (most common age for
claiming benefits) for medium earners:
32 percent
3. Average retirement benefit: <$1,000/month
The Brookings Institution, Washington, D.C.
www.brookings.edu
For the bottom tier of financial security,
several beneficial attributes
•
Benefits protected against:
1. stock market collapses
2. inflation
3. risk of outliving assets
•
Benefit formula is progressive:
1. Higher replacement rate for lower than higher earners
2. Protects against career not turning out well
•
Benefits provided to family members. Some
examples:
1. Children of workers who die
2. Surviving spouses
3. Spouses of disabled workers
The Brookings Institution, Washington, D.C.
www.brookings.edu
Individual Accounts: An Overview
• Individual accounts, such as 401(k)s
and IRAs, provide critical supplements
to Social Security – and several
common-sense reforms would
substantially raise saving in them
• But individual accounts don’t make
sense as part of the core tier
The Brookings Institution, Washington, D.C.
www.brookings.edu
Make It Easier To Save:
The Automatic 401(k)
Participation rate
Opt-in
100
Opt-out
86
80
75
80
60
35
40
19
20
13
0
Females
Source: Madrian and Shea
The Brookings Institution, Washington, D.C.
Hispanic
Under
$20,000 in
earnings
www.brookings.edu
But accounts don’t make sense
within Social Security
• As pension system moves toward individuals
bearing more risks, individual accounts in Social
Security make even less sense
• Individual account system may respond to
political pressure for:
• early withdrawals
• no annuitization
which would undermine retirement security
• Significant financing issues
The Brookings Institution, Washington, D.C.
www.brookings.edu
Addressing the long-term deficit
in Social Security
The Brookings Institution, Washington, D.C.
www.brookings.edu
Projected Social Security deficit:
0.7% of GDP
7
Expenditures
6
Percent of GDP
5
Tax Revenue
4
3
2
1
20
04
20
07
20
10
20
13
20
16
20
19
20
22
20
25
20
28
20
31
20
34
20
37
20
40
20
43
20
46
20
49
20
52
20
55
20
58
20
61
20
64
20
67
20
70
20
73
20
76
20
79
0
The Brookings Institution, Washington, D.C.
www.brookings.edu
Social Security is not the main problem….
Social Security
Medicare
Medicaid
14
12
10
8
6
4
2
The Brookings Institution, Washington, D.C.
20
78
20
75
20
72
20
69
20
66
20
63
20
60
20
57
20
54
20
51
20
48
20
45
20
42
20
39
20
36
20
33
20
30
20
27
20
24
20
21
20
18
20
15
20
12
20
09
20
06
20
03
0
www.brookings.edu
Diamond and Orszag,
Saving Social Security
• Restore long-term sustainable solvency
• Do not destroy program in order to save it
• No accounting gimmicks or magic
asterisks
• No general revenue transfers, no ignoring
risks of stocks
• Combine benefit reductions and revenue
increases, rather than relying solely on
either
• Follow precedent of 1983 Greenspan reforms
The Brookings Institution, Washington, D.C.
www.brookings.edu
A Progressive Reform
• Protect most vulnerable: disabled
workers, young surviving children,
lifetime low earners, widows
• Average earners: modest sacrifices
• Higher earners: somewhat larger role in
reaching long-term balance
-- differential earnings growth, life expectancy
increases
The Brookings Institution, Washington, D.C.
www.brookings.edu
Bottom line: Benefits for
medium earners
Age in
2004
55
45
35
25
Percentage change in
benefits from those
Inflation-adjusted benefit at
under current benefit
full benefit age relative to
formula
55-year-old in 2004
0.0%
100%
-0.6%
110%
-4.5%
118%
-8.6%
125%
• Benefit reductions less substantial for lower earners and more
substantial for higher earners.
• Real benefit levels continue to increase from one generation to
the next because of ongoing productivity growth.
The Brookings Institution, Washington, D.C.
www.brookings.edu
Bottom line: Payroll tax rate
2005
2015
2025
2035
2045
2055
Employee
rate
6.2%
6.2%
6.4%
6.6%
6.8%
7.1%
Combined
employeremployee rate
12.4%
12.5%
12.7%
13.2%
13.7%
14.2%
Note: Combined rate
needed to finance
benefits under current
benefit formula
12.4%
12.4%
12.4%
12.4%
17.0%
17.7%
• If 2045 increase implemented this year, $35,000 earner would pay
extra $37 per month in combined employer-employee taxes
• For 25-year-old average earner, present value of additional lifetime
tax is 0.3 percent of career wages
The Brookings Institution, Washington, D.C.
www.brookings.edu
Conclusions
• Individual accounts do not make sense as
part of Social Security
• Social Security is like a car with a flat tire.
Let’s fix the flat tire, not replace the car.
• Exciting new evidence on ways to boost
saving on top of Social Security for lowand moderate-income households
• Retirement Security Project, funded by Pew
Charitable Trusts
The Brookings Institution, Washington, D.C.
www.brookings.edu