On
June 18, 1998, the Congressional Research Service (CRS) released an
analysis of major Social Security reform proposals.1 The study, requested by
Representative Charles Rangel (D-NY), purports to show that a
Social Security reform plan proposed by Senators Daniel Patrick
Moynihan (D-NY) and Robert Kerrey (D-NE), and a similar plan by
Senators Judd Gregg (R-NH) and John Breaux (D-LA) and
Representatives James Kolbe (R-AZ) and Charles Stenholm (D-TX)
(based on a proposal by the National Commission on Retirement
Policy [NCRP]), will result in large benefit cuts for future
retirees. This study has been used to give the impression that
under these two plans--which both allow for the investment of two
percentage points of payroll taxes in private retirement
accounts--workers would be left with lower retirement incomes. But
in accordance with the instructions given by Representative Rangel,
the CRS report looks only at Social Security benefit changes and
ignores the offsetting retirement income that future retirees would
receive from their private retirement accounts.
The
report's author drew attention to these "important omissions" in
the memorandum of transmission to Representative Rangel:
As
your staff specified, the analysis is confined to the potential
reductions in Social Security benefits prescribed by the various
provisions of the three reform packages. Accordingly, the
memorandum does not examine the impact of the changes in payroll
taxes included in the packages, the potential benefits or annuities
that may result from the "personal savings" components of the
packages, nor...the elimination of the Social Security retirement
earnings test.
Those
using the report to suggest it "proves" privatization would hurt
most retirees ignore this crucial omission from the analysis. In
fact, if the study is adjusted for the omission of personal savings
income, it shows the opposite.
A
Statistical Analysis of the Report's Findings
To
give a proper picture of the effects of these plans on the
retirement income of workers, analysts from The Heritage
Foundation's Center for Data Analysis calculated the amount that
low-, average-, and maximum-wage workers would accumulate in their
private accounts under those two plans. The results of the Heritage
study, summarized in Tables 1 through 3, demonstrate that under
both plans, workers would be likely to accumulate large amounts in
their private accounts by retirement. These funds would be
available as retirement income at age 65.
Table 1
shows the amount that low-, average-, and maximum-income
39-year-old workers would accumulate in their accounts by their
retirement in 2025 at age 65. Under the Moynihan-Kerrey plan, a
low-wage worker (earning 45 percent of the average) could expect to
accumulate $31,260 ($12,874 in 1998 inflation-adjusted dollars) by
retirement if he or she invested in an ultra-safe portfolio made up
of 50 percent U.S. Treasury Bonds and 50 percent blue-chip stocks.
With a similar portfolio, the Gregg-Breaux-Kolbe-Stenholm/NCRP plan
would enable the same low-wage worker to accumulate $37,518
($15,451 in 1998 inflation-adjusted dollars) by retirement. With a
50 percent bond/50 percent equity portfolio, an average-wage worker
would accumulate $69,467 ($28,608 in 1998 dollars) by retirement
under the Moynihan-Kerrey plan. This same worker would accumulate
$83,373 ($34,335 in 1998 dollars) under the
Gregg-Breaux-Kolbe-Stenholm/NCRP plan. A maximum-wage worker would
accumulate $168,078 ($69,219 in 1998 dollars) under the
Moynihan-Kerrey plan and $201,726 ($83,076 in 1998 dollars) under
the Gregg-Breaux-Kolbe-Stenholm/NCRP proposal.
Table 2
shows the annual retirement income that would be likely to be
generated by annuitizing these accumulations at retirement. Under
the Moynihan-Kerrey plan and with a mixed portfolio of equities and
bonds, the low-wage worker's portfolio could be expected to
generate $2,909 ($1,198 in 1998 dollars) per annum; under the
Gregg-Breaux-Kolbe-Stenholm/NCRP plan, it would generate $3,491
($1,438 in 1998 dollars) in annual income. With a similar
portfolio, the average-wage worker's account could be expected to
earn $6,464 ($2,662 in 1998 dollars) per year under the
Moynihan-Kerrey proposal and $7,758 ($3,195 in 1998 dollars) under
the Gregg-Breaux-Kolbe-Stenholm/NCRP plan.
Table 3
shows the net overall effect on annual retirement income after
offsetting lower Social Security benefits with retirement income
from private savings accounts. With a mixed portfolio and assuming
annuitization of the retirement account, the retirement income
received by a low-income worker would increase by 4.9 percent over
what is promised by Social Security under the Moynihan-Kerrey plan
and by 6 percent under the Gregg-Breaux-Kolbe-Stenholm/NCRP plan.
Under the same assumptions, retirement income for an average-wage
worker would increase by 10.4 percent over Social Security's
benefits under the Moynihan-Kerrey plan but fall 7.3 percent under
the Gregg-Breaux-Kolbe-Stenholm/NCRP plan. For a maximum-income
worker, retirement income would increase by 26.3 percent under the
Moynihan-Kerrey plan and by 0.8 percent under the
Gregg-Breaux-Kolbe-Stenholm/NCRP plan.
As
this analysis shows, the retirement income of a low-wage worker
would be higher than under current law under every investment
portfolio when earnings from the worker's private account are
included.
Under
both the Moynihan-Kerrey and Gregg-Breaux-Kolbe-Stenholm/NCRP
plans, a worker earning 45 percent of the average wage could expect
to see his or her retirement income increase between 5 percent and
6 percent with a mixed portfolio of bonds and equities. Under the
Moynihan-Kerrey proposal, the retirement income of an average-wage
worker would be likely to increase by between 5.9 percent and 16.4
percent, depending on the investment options chosen.
Average workers would fare less well under
the Gregg-Breaux-Kolbe-Stenholm/NCRP plan, with income falling by
13.4 percent if the worker invested entirely in Treasury Bonds and
by 7.3 percent if the worker invested in a mixed bond-equity
portfolio. If the worker invested entirely in equities, however,
the income from the private account would more than offset the 33
percent reduction in benefits proposed by the plan.
Workers who have incomes above the maximum
taxable threshold (which in 1998 is $68,400) would do well under
the Moynihan-Kerrey plan. These workers generally are better off
under the Gregg-Breaux-Kolbe-Stenholm/NCRP proposal, too, except
for those who invest their payroll taxes entirely in Treasury
Bonds; their net change in retirement income is a negative 8.4
percent.
Note on
Risk
It
should be noted that advocates of the current system argue that
Social Security provides "guaranteed" retirement benefits compared
with the uncertain level of income that workers could receive from
investing their payroll tax dollars privately. In no sense,
however, can the benefits offered by the current system be held to
be "safe, reliable or guaranteed."2 The Social Security system,
as it currently exists, is estimated by its own actuaries to be
underfunded to the amount of $3.7 trillion and thus is financially
incapable of delivering promised benefits.3 Moreover, as the
U.S. General Accounting Office has noted, if the rate of return on
equities fell, then not only would private accounts deliver less
retirement income, but a Social Security trust fund invested in
equities would be unable to pay benefits.
Unlike
individually held accounts, moreover, which are private property
and thus constitutionally protected, the U.S. Supreme Court has
ruled that Congress can alter Social Security benefits.4 Workers also run the risk of
dying prematurely, and thus collecting little or nothing in Social
Security benefits. Considering today's demographic conditions, a
worker alive in 1998 and planning to retire at age 65 in 2025 has
been estimated by the National Center for Health Statistics to have
a 16 percent chance of dying before even beginning to collect
retirement benefits.5 Only in a small minority of
these cases will the families of these workers be able to collect
Social Security benefits.
Key
Assumptions6
- Rate of
Return on Private Accounts: Heritage analysts calculated
the rate of return from three investment strategies: a portfolio of
100 percent equities, a portfolio of 100 percent Treasury Bonds,
and a portfolio made up of 50 percent equities and 50 percent
Treasury Bonds. Workers are assumed to annuitize their accounts at
age 65 at the rate of return prevailing on long-term Treasury Bonds
A nominal rate of return of 6.3 percent (2.8 percent when adjusted
for inflation) on Treasury Bonds was assumed. This is equal to the
long-term interest rate on U.S. government bonds assumed in the
1998 Social Security Trustees' report. A nominal rate of return of
10 percent (6.5 percent after inflation) on equities was assumed.
This rate is below the 7 percent post-inflation rate of return on
equities found to exist by the 1994-1996 Social Security Advisory
Council.7
Heritage's assumptions also are lower than the long-term historical
average yield on equities. Between 1926 and 1997 (a period that
includes the Great Depression and World War II), the rate of return
on large company equities averaged 11 percent, and the return on
small company equities averaged 12.7 percent.8
- Reduction in
benefits: The reduction in benefits payable to workers retiring
at age 65 in 2025 under each of the plans was calculated directly
from Table 3 of the CRS memorandum "Benefit Analysis of Three
Recent Social Security Reform Proposals." The percentage reductions
in this table were applied directly against the dollar benefits
payable to low-, average-, and high-wage workers as published in
Table III.B5 of the 1998 Annual Report of the Trustees of the
Federal Old-Age and Survivors Insurance and Disability Insurance
Trust Funds.
--
William W.
Beach is John M. Olin Senior Fellow in Economics and Director
of the Center for Data Analysis at The Heritage Foundation.
--
Gareth G. Davis is a former Research Assistant at The Heritage
Foundation.
Endnotes