Mending Social Security

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Many good books and studies have been written developing the rationale for allowing workers the freedom to choose a personal savings and investment account in place of at least part of their current Social Security coverage. What is needed now is a specific proposal for reform that delivers on the promise of personal accounts.

In a study released today by the Institute for Policy Innovation, I propose a specific, detailed, progressive reform plan, which provides a broad range of benefits for working people, lower income workers, African-Americans, Hispanics, women and others. The plan has already been publicly endorsed by Jack Kemp, Newt Gingrich, Steve Moore and the Club for Growth, Grover Norquist and Americans for Tax Reform, and Charlie Jarvis and the United Seniors Association.

The plan would allow workers the freedom to choose to save and invest in their own personal accounts 5 percentage points of the total 12.4 percent Social Security payroll tax (10 percentage points of the tax go to finance retirement benefits). On the first $10,000 of wage income, however, this would be doubled to 10 percentage points, including both the employer and employee shares of the tax.

This would enable lower-income workers to save a higher percentage of their incomes in the accounts than higher-income workers. As a result, lower-income workers would gain as much from the accounts as middle- and upper-income workers.

Indeed, exercising such an account option over their entire working lives and earning just standard market investment returns on a diversified portfolio of stocks and bonds, workers across the board would retire with 60 percent to 75 percent more in benefits than Social Security promises, but cannot pay.

The Treasury Department would contract with a number of private fund managers to offer investment funds to workers who exercised the personal account option, as in the Federal Employee Thrift Savings program. Other investment firms can apply to be added to the list, all regulated for safety and soundness.

Workers exercising the personal account option would choose among these alternatives on the Treasury Department's list for investment of their funds. The worker would consequently only have the responsibility of choosing among these funds, and the fund managers would pick the particular stocks, bonds or other investments.

The entire system would be backed up by a safety net providing a guaranteed minimum benefit equal to what Social Security would have paid without the account. There would be no change in current Social Security benefits for those retired today, or in future Social Security benefits for those who did not exercise the option.

Social Security disability and pre-retirement survivors benefits would continue to be paid by the old Social Security framework as today. Workers would be free to choose to stay in the current Social Security system as is.

Such personal accounts would unwind the long-term Social Security deficits, and eliminate the program's unfunded liabilities, with nothing more than the positive features of the accounts themselves. If almost all workers ultimately exercise the personal account option, eventually we would reach the point where virtually all workers are relying on the accounts for their retirement benefits in place of the old Social Security framework.

At that point, the old Social Security system would bear little or no benefit obligations, and there would consequently be no deficit or unfunded liability of any consequence in that old system.

Such personal accounts would also provide low- and moderate-income earners their only real chance to participate in investment markets like higher-income workers, and accumulate substantial savings and capital. This would result in much broader and much more equal ownership of wealth and capital, which would greatly enhance social solidarity and harmony.

The transition would be financed through current Social Security surpluses, the extra taxes produced through higher savings and investment and higher economic growth, and reductions in the growth of other federal spending. Indeed, just reducing the rate of growth of federal spending by 1 percentage point yearly would, along with the other factors mentioned above, probably eliminate the net transition deficit from the reform within 15 to 20 years, leaving net surpluses from the reform thereafter.

Before that point, the net remaining transition deficits each year would be financed by issuing federal bonds in an off-budget federal account. The account would consequently not be part of the annual deficit or surplus calculations in the general federal budget.

These bonds do not involve new government debt, but just explicit recognition of the effective debt already existing in the unfunded liabilities of Social Security. These bonds could then be paid off over 30 years or so, using the surpluses ultimately generated by the reform as discussed above.

The goal is to expand the support for this reform plan over time until it includes the president of the United States, and Republican and Democratic leaders of the Congress.

Peter Ferrara is director of the International Center for Law and Economics and president of the Virginia Club for Growth.