Last December, the chief actuary of Social Security released an official score of a Social Security reform plan I authored for the Institute for Policy Innovation (IPI), which proposed a large personal account option for Social Security. Workers choosing the option would devote on average 6.4 percentage points of the current 12.4 percent Social Security payroll tax to their own, personal, investment account.
The score showed the large accounts would take over so much responsibility for the payment of retirement benefits over time that the long-term deficits of Social Security would be eliminated through the accounts alone, without cutting benefits or raising taxes. Indeed, at standard market investment returns, the accounts would pay much higher benefits than Social Security promises (but cannot pay).
Moreover, the score showed that under the large account plan the payroll tax would eventually be reduced to 31/2 percent, instead of increasing to more than 20 percent to pay all promised benefits under the current system. This would be the largest tax cut in world history.
Nevertheless, there has been considerable confusion over the exact amount of transition deficits and debt resulting under the plan, even though those could be directly calculated from the data in the original score. This week, however, the chief actuary has released an addendum to the original score of the IPI plan that clarifies these issues. (see www.ipi.org or www.ssa.gov).
The addendum presents the exact amount of net additional Social Security trust fund bonds that would have to be redeemed under the plan each year, as shown in the accompanying table. If the transition financing specified in the reform plan is provided, these numbers also show the net transition deficits under the reform and the full amount of new debt that would be issued to the public.
The table shows the deficit and issuance of transition debt would end in 2028, with the new debt totaling about $900 billion in present value dollars. Most importantly, the chief actuary’s original score shows surpluses beginning in 2029 that are sufficient to pay off over the next 15 years all the debt issued in the earlier years of the reform. As a result, the net increase in federal debt under the reform plan is zero.
Shockingly, the Social Security deficits under the current system starting in 2018 would accumulate to about the same amount in 2028, as Empower America Chief Economist Larry Hunter has shown. But if new debt is issued to cover those deficits, it would not be paid off in later years, but continue to grow indefinitely, to well more than 300 percent of GDP, and beyond.
Over the long run, moreover, the reform plan will eliminate the unfunded liability of Social Security, officially estimated today at $10.5 trillion, 3 times the reported net national debt. The reform plan would consequently ultimately achieve the largest reduction in government debt in world history.
The transition deficits of the reform are relatively modest given the enormous magnitude of the change and its sweeping benefits. Issuing debt to cover those deficits would only involve borrowing back a minor portion of the savings accumulating in the accounts, until that debt is later paid off.
The reform plan also provides that these short term deficits and accompanying debt would be off-budget in their own separate account. So they would not be a factor in the annual deficit debates for the rest of the budget. Since the reform plan is eliminating long-term liabilities of the government and likely adding substantially to national savings each year, counting the reform’s temporary deficits as adding to the general federal deficit each year would be misleading and inaccurate.
The transition financing for the reform plan, which again must be provided to achieve all of these results, included first devoting the short-term Social Security surpluses now projected through 2018 to the reform. Secondly, the rate of growth of total federal spending must be reduced by one percentage point each year for eight years, with that savings devoted to the transition each year.
As Americans for Tax Reform Chief Economist Dan Clifton has pointed out, this modest spending restraint is about the same level of restraint achieved during the eight years of the Clinton presidency, with the able assistance of the Gingrich Congress. Indeed, Mr. Bush’s new budget proposes to reduce the growth in spending 3 times as much for the next fiscal year.
The Heritage Foundation already has well developed budget savings proposals that would achieve several times the spending restraint required by the IPI proposal. Legislation to implement the IPI plan would serve as a vehicle for achieving those budget savings, making them far more likely. Such spending restraint is the best possible way to finance the transition to personal accounts.
The final component of the reform plan’s transition financing is increased corporate tax revenues, estimated based on the work of Harvard Professor of Economics Martin Feldstein, chairman of the National Bureau of Economic Research. The investment in stocks and bonds through the accounts would produce a huge influx of cash for corporate investment in new plant and equipment, and business ventures. This investment would produce new income taxed at the business level, producing new tax revenues.
This corporate tax revenue feedback was first scored for the personal account reform plan proposed by former Sen. Phil Gramm years ago. This is just one of the positive economic effects of the reform, which the work of Mr. Feldstein and others shows would be far more extensive. So a complete revenue feedback from all of these effects would actually be much larger.
Legislation is now being drafted to embody this reform plan, along with every good idea for personal accounts advanced by anyone anywhere. A large coalition of conservatives is now joining together to support this reform, which is creating tremendous prospects for truly historic, sweeping reform.
Peter Ferrara is a senior fellow at the Institute for Policy Innovation, and director of the Social Security Project of the Club for Growth.