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346 April 25, 1984 REBUILDING SOCIAL SECURITY PART 2 TOWARD LASTING REFORM INTRODUCTION Despite costly 1983 bailout legislation, the Social Security program remains plagued by the overwhelming Problems described in Part I of this study. Not only do serious financing deficiencies threaten future benefits, but even if all t h e benefits promised to today's young workers are somehow paid, Social Security will still be a bad retirement deal for these workers. The program impedes economic qrowth, thanks to the payroll tax and its dampen ing effect on saving, and inflicts on retir ees an inequitable, crazy-quilt benefit structure Two workers paying the same taxes, for instance, can receive widely differing benefits. And the poor, blacks, and other minorities face severe discrimination in benefit levels. These problems can no longer be ignored. They require funda- mental reform based on the partial privatization of the system. This reform must begin by paranteeing current retirees all their promised benefits-by providing a federally backed Social Security bond to each retiree. The ne xt step would be to create a Super IRA for each worker. This would enable workers to take a 100 percent income tax credit for IRA contributions, in return for proportionate reductions in their future Social Security benefits. Workers would, of course be free to forego this Super IRA option and remain in Social Security.. This reform would strengthen Social Security by easing the program's long-term financing problems. In addition the Supef IRA would provide today's young workers with higher retirement ben efits than they are promised under Social Security. The re form could also massively increase national savings--generating more capital investments, job.opportunities and economic growth. And in contrast to Social Security's numerous inequities the Super IRA would allow minorities and the poor at last to look forward to fair and secure retirement benefits i I 2 TBE STEPS TO REFORM Four steps are needed Lo save the bankrupt Social Security system while providing a sound vehicle for retirement savings. STEP 1 The first element of any reform package must be an iron-clad guarantee that the elderly will continue to receive their promised Social Security benefits-in full. The Supreme Court he ld in a 1960 decision, Flemminq v. Nestor, that Congress can reduce or cut off Social Security benefits to any or all of the elderly at any t1rne.l But this decision was based on the Court's interpretation of the statutory intent of Congress. Consequently , the decision can be reversed by statutory changes. Congress, therefore, should enact a law granting each worker upon retirement a U.S. government bond stating a contractual en- titlement to the Social Security benefits promised under the ex- isting law. Current retirees would receive.a similar bond. The bond would guarantee specific monthly benefits for the rest of the retiree's life, plus cost of living adjustment (COLA) in- creases, based on the law in effect when the person retired. Congress would sti ll retain its authority to reduce the benefits to be.received by new beneficiaries, and could thereby reduce the growth in benefit expenditures over time. This would give Social Security the same legal status as any U.S. Treasury bond. The Constitution prohibits the federal government from reneging on its duty to pay interest and principal on such bonds. STEP 2 Allow workers to contribute an amount equal to a maximum of 20 percent of their Old Age and Survivors Insurance (OASI) taxes to an IRA and take a t ax credit equal to that amount (same for employer share) aqainst income taxes. The worker's Social Secur ity benefits would b e reduced by th e lifetime percentage con- tributed in this way. the option of beginning to rely on Individual Retirement Account s IRAs) in place of part of their Social Security coverage. ing on January 1, 1986, workers would be allowed to contribute to The second element of the reform Package would give workers Start 363 U.S. 610. 3 their IRAs each year, on top of any other sum th e y might contribute under current tax law, an amount up to 20 percent of their OASI taxes. Instead of the usual income tax deduction for these IRA contributions, however, workers would receive a full dollar-for- dollar income tax credit equal to the amount of such contribu- tions. Workers would be allowed to direct their employers to contribute up to 20 percent of the employer share of the OASI tax to their IRAs, on top of any other contributions,.with each em- ployer also receiving a full income tax credit for these amounts. Workers who utilized the credit option, however, would have their future Social Security benefits reduced proportionally. A worker who opted for the full credit during his entire working career, for instance, would have his Social Secur ity benefits reduced by 20 percent. Workers could decline this tax credit option, of course, making tax-deductible IRA contributions under current law, without any reduction in their future Social Security benefits. The tax credit option in effect, would grant workers a re- bate of part of their Social Security taxes-to the extent that they reduced their reliance on Social Security and increased their reliance on IRAs. income taxes=-not payroll taxes--Social Security's revenue base would be left intact Bu t since the credit would be taken against Since the proposal provides for a tax credit rather than a deduction, low-income and high-income workers would receive ex- actly the same tax advantage from the Super IRA option. Since the maximum tax credit.propos e d for employees is 20 percent of the employee share of the payroll tax (which is now leveled at 7 percent of wage income virtually all employees would have suf- ficient income tax liability to offset against the credit. Insuf- ficient income tax liability would, however, be a problem for some employers. to grant a rebate of payroll taxes, however, the credit could be made refundable for the small proportion of cases where the firm's income tax liability would otherwise be insufficient Since the rationale b ehind the income tax credit is STEP 3 A third element of the reform packaqe would beqin January 1 19 90. Workers would be allowed to contribute additional amounts to their IRAs each year, up to a maximum of 10 percent of the employee's OASI taxes, to be us ed for the purchase of term life insurance. Workers could direct their employers to contribute up 4 to this amount to their IRAs for such purchases and employer would receive an income tax credit equal to the amount of these contributions, instead of the u sual IRA deduction Both employee An employee with no dependents would be allowed to devote these additional contributions to securing better retirement bene fits. An employee with one dependent would be allowed to use half of these contributions for his ' retirement. Social Security currently pays survivors benefits on behalf of a deceased taxpayer who leaves a wife and young children or an elderly spouse For workers under 65, private term life insurance can entirely perform this function. Under Step 3 of t he plan, a worker who died before 65 would have Social Security survivors benefits reduced to the extent he had used the tax credit option to purchase term life insurance in force when he died. A worker who had fully utilized the credit to purchase life i n surance would have no survivors benefits paid on his behalf. For a worker who had used only half the credit to purchase such insurance survivors benefits would be reduced by half credit option, in effect, would be a rebate of Social Security taxes for tho se who chose to rely more on IRAs and less on Social Security. Social Security benefits--without any-need for general revenues. And just as in Step 2, the credit option would reduce Social Security expenditures-to the extent it was utilized by workers wil ling to forego benefits Like the retirement credit, this additional life insurance But it would leave payroll taxes fully intact to pay STEP 4 Eventually allow workers to place an amount equal to all their Old Aqe, Survivors, Disability and Hospital Insur a nce (OASDHI taxes into a "Super IRA which would p rovide for retirement survivors' beneiits, disability, and medicare coverage The three steps already outlined would constitute an im portant initial Social Security reform packaye legislation could expand the private IRA option even further. But subsequent 100 percent IRA Credit The.maximum credit for IRA contributions could be'increased to 100 percent of OASI taxes, for both employees and employeers in return for the worker accepting further Social Security bene fit reductions. Medicare and Disability IRA Workers could be allowed to purchase disability and old-age health insurance through their IRAs in return for reduced reliance 5 on Social Security? Ultimately, workers could rely entirely on IRAs for their retirement needs. IMPACT OF THE REFORM PACKAGE ON SOCIAL SECURITY Social Security Framework Strengthened Such reforms would leave the Social Security framework in place, yet make it financially secure. Workers could choose to remain entirely in Social Security and receive the full benefits available under current law. But the Social Security structure would be expanded and strengthened by the reform package. Workers would be free to choose the best mix of public and private vehicles for their retiremen t needs. quired legally to choose some vehicle for retirement and insurance protection. But they would continue to be re The reform would reduce Social Security expenditures over time, to the extent that IRA tax credit options were utilized and Social Security benefits foregone. Yet projected payroll tax revenues would remain the same, since the reform would do nothing to reduce such revenues. As a'result, the reform would help close Social Security's long-term funding gap, strengthening the entire program. Income Tax Revenue Effect of Step 2 The Treasury revenue loss due to these reforms wou ld be relatively modest, especially considering the huge problems ad- dressed. If the first income tax credit for IRA contributions discussed above (scheduled for 1986) were in effect in the cur- rent fiscal year (1984 and if all workers took full advanta g e of it the income tax revenue loss would be $31 billion for this year.i But it is highly unlikely that all workers would utilize fully the credit option when first made available just as most workers do not have IRAs today. Assuming workers initially uti l ized the credit at double the rate they currently use con- ventional IRAs, the maximum revenue loss in the current fiscal year would be $12.5 billion.4 The tax credit option also would result in reductions in Social Security expenditures. Though these red u ctions would be A detailed proposal for allowing workers the option of substituting a Health Bank IRA" for Medicare recently has been advanced in Peter J. Ferrara, John C. Goodman, Gerald Musgrave, and Richard Rahn, Solving the Problem of Medicare (Dallas , Texas 1984). National Center for Policy Analysis Calculated from Social Security Board of Trustees, 1984 Annual Report of the Board of Trustees of the Old-Age and Survivors Insurance and Disa- bility Insurance Trust Funds (Washington, D.C., April 5, 1984 4 rl a 6 small at first, eventually they would offset the tax revenue losses entirely. In addition the credit option would mean in creased savings held in IRAs, which would mean more funds for the trustees of the accounts to invest in American industry-= and added revenues to the Treasury from corporate taxation of the returns to this investment. Implications for Government' Borrowing There 'should be $1 in new savings through IpAs for every $1 in lost revenues because the tax credit would only be allowed for long-term IRA saving So even if the federal deficit were in creased temporarily by the amount of the net revenue loss, the U.S. pool of savings from which the deficit is financed would be increased crowding out" in the credit markets, because addition a l federal borrowing would be offset by new private savings As such, there would be no net increase in government Effects of Step 3 The second income tax credit of 10 percent, described in Step 3, would result in a revenue loss of $16 billion if it were in force in Fiscal Year 1984, and all workers fully utilized it.6 But complete utilization of the credit in the first year would be unlikely If utilized at double the rate of current IRA use, the revenue loss this year would amount to $6 billion.7 The Social Security expenditure reductions resulting from this credit would accrue far more rapidly than in the case of the 20 percent credit proposed in Step 2. There would be a reduction in the survivors benefits for dependents of workers who died prior to the re tirement age, in the first year of the credit--with private life insurance making up the difference claims expired, benefit expenditures would decline to zero if all workers utilized the full credit and relied on private life insur ance. In addition, incr e ased business investment could be expected since the amounts paid in life insurance premiums would be set Once existing To avoid the danger of a mere shifting of existing savings into IRAs to obtain the credit, workers should be prohibited from withdrawin g before retirement IRA contributions, for which they obtained the credit, and the returns associated with those contributions. This would make the IRA savings unsuitable as a substitute for nonretirement savings since they could not be used for nonretirem e nt purposes benefits would be reduced for tax credited IRA contributions, the IRA savings would be needed to replace those lost benefits, and therefore would not be available as a substitute for other retirement savings either. As a result of these factor s, any shifting of existing savings into IRAs rather than new savings to obtain the tax credit should be negligible, because such IRA savings would no longer be able to perform the function of other savings. See footnote 3. Ibid Because Social Security 7 aside to finance the stream of benefits for workers' dependents This would generate new tax revenues, which would offset the revenue loss due to the credit ADVANTAGES FOR BENEFICIARIES AND WORKERS Young Workers Young workers would receive full market retu r ns on the money paid into IRAs. Consequently, they would.be able to earn higher benefits than they could possibly receive for the same contribu tions to Social Security, as explained in Part I of this study If the complete Super IRA option were eventually phased in most young workers could expect to receive between three and six times the retirement benefits promised under Social Security. Even low-income earners would receive about double the benefits promised to them by Social Security-and a couple with maximum taxable incomes could expect at least eight times the benefits The private IRA benefits, moreover, would be' financed on a fully funded basis, which would secure them against the financing problems inherent in Social Security's current pay-as-you- go sys tem. The IRAs would also allow workers greater freedom to choose their retirement age, since they would not lose benefits if they chose late retirement, as is the case with Social Security. Reduction of Inequities Affecting Small Families The propos ed reforms would mitigate many of the inequities in the current Social Security benefit structure study noted that single workers without children and many two earner couples must pay for Social Security survivors benefits even though such benefits will n e ver be paid on their behalf married workers without children are not eligible for survivors benefits until after retirement The package would allow these workers, in effect, to use some of their Social Security tax money to purchase private term life insu r ance instead insurance would pay full benefits to whomever the worker desig nated as his or her beneficiaries Part I of this And this The reforms thus would increase greatly the flexibility of the retirement/insurance system, enabling workers to tailor co v er age to their personal needs and preferences package would eliminate one of the worst inequities in the current Social Security system i In so doing, the i A Better'Deal for the Poor and Minorities I The poor and minorities especially would be helped by the proposed reform package. Though lower income workers tend to leave school and start work earlier than other workers, Social Security credits these workers with little if any additional 8 benefits for their early years of work and tax payments. With an IRA, on the other hand, these workers would receive greater bene fits for early contributions, since the funds would have more years to accumulate interest befoxe retirement ity pays additional benefits for married workers, yet single workers are much mor e likely to be poor. Married and single workers would receive the same returns with an IRA. With a private IRA, moreover, a retired worker would be able to leave his entire, accumulated IRA fund to his dependents upon his death, whereas Social Security lim its benefits to the much smaller survivors benefits. This aspect of an IRA would be par ticularly beneficial to the poor and to blacks and other minority groups with significantly lower than average life expectancies. The typical black male born today, for instance, can only expect to live to 64, and so would not receive a single day of full Social Security benefits. An IRA would enable him to leave his accumulated retirement savings to his family. It should be noted that, under the proposed reform, the S up plemental Security Income program (SSI) would continue to provide means-tested, general revenue-financed welfare benefits to the elderly poor, thus ensuring that the income of retired Americans would not fall below a basic minimum. The better returns a v ailable from an IRA, however, would reduce the demands on this program And Social Secur Eliminating Risks to the Elderly The proposed reform would carry no threat to the elderly--or anyone.else--since promised Social Security benefits would be constitutio nally guaranteed. But the capacity of Social Security to finance those benefits would be improved, since outlays'would be reduced thanks to increased reliance on IRAs instead of Social Security. Nor does the reform package pose any threat whatsoever to I t hose workers who desire to remain exclusively within the Social Security system. Moreover, workers who chose the private IRAs would receive full credit, in the form of benefits, for the con tributions they paid into Social Security IMPACT ON THE ECONOMY t i onal savings would be increased by the new IRAs options became more familiar, virtually all workers could be ex pected to take full advantage of them This could mean tens of billions of dollars in new savings each year,.providing the capital for technolog ical innovation, the creation of new jobs, and faster economic growth. With a full option to rely on IRAs, private s avings could be almost doubled, with potentially hundreds of billions of dollars in increased savings flowing into the capital markets each year. In a study prepared while he was at Harvard, Council of Economic Advisors Chairman Martin Feldstein estimated that such an increase The proposed reform package would boost the economy Na As the credit 9 in savings would increase GNP by almost 20 percent.8 And since the proposed reforms would reduce Social Security expenditures, job-killing payroll taxes eventuall y could be reduced. Reduction in the Federal Role The reforms would "denationalize" the large portion of the pension and insurance industry now represented by Social Security shifting those functions to the private sector that can be per- formed by private firms. Transferring these functions would re- duce government spending significantly. private sector IRAs could mean more than a one-fourth reduction in federal pend ding Given that Social Security, Medicare, na- tional defense, and debt interest account for almost three-fourths of the federal budget, it is hard to imagine a substantial reduc- tion in the size and scope of government without such a reform Complete reliance on CONCLUSION Social Security remains in deep trouble with staggering financing pro b lems and inequities that must be addressed. the time to embark on fundamental, innovative reforms based on a true understanding of these problems, rather than wait for the next crisis and the accompanying hysteria. The most promising reform would allow wo r kers gradually to substitute Super IRAs for Social Security. This would take nothing away from workers or retirees--it would merely allow workers greater freedom to choose how to provide for their retirement and income security It is a reform of benefit t o old and young, rich and poor, and both black and white Americans. currently plaguing Social Security pared to its enormous benefits. With the elderly assured of their benefits, Social Security strengthened, and today's workers merely allowed increased fr e edom and control, there is no reason why the reform should be anything but merely popular. It should, in fact, be considered a I1populist1' proposal Now is Yet it would solve the enormous problems The temporary revenue costs of the reform are minimal com Prepared for The Heritage Foundation by Peter J. Ferrara, a Washington attorney Martin Feldstein Social Insurance,It Harvard Institute of Economic Research, Discussion Paper No. 477, May 1976, p. 33. As noted in Part I of this study, Social Security, inclu ding Medicare today accounts for almost 30 percent of the entire federal budget the insurance function of Social Security performed in the private sector most of this spending would be taken out of the federal budget altogether and shifted to the private sector. Formerly a senior staff member in the White House Office of Policy Devel opment With
346 April 25, 1984 REBUILDING SOCIAL SECURITY PART 2 TOWARD LASTING REFORM INTRODUCTION Despite costly 1983 bailout legislation, the Social Security program remains plagued by the overwhelming Problems described in Part I of this study. Not only do serious financing deficiencies threaten future benefits, but even if all t h e benefits promised to today's young workers are somehow paid, Social Security will still be a bad retirement deal for these workers. The program impedes economic qrowth, thanks to the payroll tax and its dampen ing effect on saving, and inflicts on retir ees an inequitable, crazy-quilt benefit structure Two workers paying the same taxes, for instance, can receive widely differing benefits. And the poor, blacks, and other minorities face severe discrimination in benefit levels. These problems can no longer be ignored. They require funda- mental reform based on the partial privatization of the system. This reform must begin by paranteeing current retirees all their promised benefits-by providing a federally backed Social Security bond to each retiree. The ne xt step would be to create a Super IRA for each worker. This would enable workers to take a 100 percent income tax credit for IRA contributions, in return for proportionate reductions in their future Social Security benefits. Workers would, of course be free to forego this Super IRA option and remain in Social Security.. This reform would strengthen Social Security by easing the program's long-term financing problems. In addition the Supef IRA would provide today's young workers with higher retirement ben efits than they are promised under Social Security. The re form could also massively increase national savings--generating more capital investments, job.opportunities and economic growth. And in contrast to Social Security's numerous inequities the Super IRA would allow minorities and the poor at last to look forward to fair and secure retirement benefits i I 2 TBE STEPS TO REFORM Four steps are needed Lo save the bankrupt Social Security system while providing a sound vehicle for retirement savings. STEP 1 The first element of any reform package must be an iron-clad guarantee that the elderly will continue to receive their promised Social Security benefits-in full. The Supreme Court he ld in a 1960 decision, Flemminq v. Nestor, that Congress can reduce or cut off Social Security benefits to any or all of the elderly at any t1rne.l But this decision was based on the Court's interpretation of the statutory intent of Congress. Consequently , the decision can be reversed by statutory changes. Congress, therefore, should enact a law granting each worker upon retirement a U.S. government bond stating a contractual en- titlement to the Social Security benefits promised under the ex- isting law. Current retirees would receive.a similar bond. The bond would guarantee specific monthly benefits for the rest of the retiree's life, plus cost of living adjustment (COLA) in- creases, based on the law in effect when the person retired. Congress would sti ll retain its authority to reduce the benefits to be.received by new beneficiaries, and could thereby reduce the growth in benefit expenditures over time. This would give Social Security the same legal status as any U.S. Treasury bond. The Constitution prohibits the federal government from reneging on its duty to pay interest and principal on such bonds. STEP 2 Allow workers to contribute an amount equal to a maximum of 20 percent of their Old Age and Survivors Insurance (OASI) taxes to an IRA and take a t ax credit equal to that amount (same for employer share) aqainst income taxes. The worker's Social Secur ity benefits would b e reduced by th e lifetime percentage con- tributed in this way. the option of beginning to rely on Individual Retirement Account s IRAs) in place of part of their Social Security coverage. ing on January 1, 1986, workers would be allowed to contribute to The second element of the reform Package would give workers Start 363 U.S. 610. 3 their IRAs each year, on top of any other sum th e y might contribute under current tax law, an amount up to 20 percent of their OASI taxes. Instead of the usual income tax deduction for these IRA contributions, however, workers would receive a full dollar-for- dollar income tax credit equal to the amount of such contribu- tions. Workers would be allowed to direct their employers to contribute up to 20 percent of the employer share of the OASI tax to their IRAs, on top of any other contributions,.with each em- ployer also receiving a full income tax credit for these amounts. Workers who utilized the credit option, however, would have their future Social Security benefits reduced proportionally. A worker who opted for the full credit during his entire working career, for instance, would have his Social Secur ity benefits reduced by 20 percent. Workers could decline this tax credit option, of course, making tax-deductible IRA contributions under current law, without any reduction in their future Social Security benefits. The tax credit option in effect, would grant workers a re- bate of part of their Social Security taxes-to the extent that they reduced their reliance on Social Security and increased their reliance on IRAs. income taxes=-not payroll taxes--Social Security's revenue base would be left intact Bu t since the credit would be taken against Since the proposal provides for a tax credit rather than a deduction, low-income and high-income workers would receive ex- actly the same tax advantage from the Super IRA option. Since the maximum tax credit.propos e d for employees is 20 percent of the employee share of the payroll tax (which is now leveled at 7 percent of wage income virtually all employees would have suf- ficient income tax liability to offset against the credit. Insuf- ficient income tax liability would, however, be a problem for some employers. to grant a rebate of payroll taxes, however, the credit could be made refundable for the small proportion of cases where the firm's income tax liability would otherwise be insufficient Since the rationale b ehind the income tax credit is STEP 3 A third element of the reform packaqe would beqin January 1 19 90. Workers would be allowed to contribute additional amounts to their IRAs each year, up to a maximum of 10 percent of the employee's OASI taxes, to be us ed for the purchase of term life insurance. Workers could direct their employers to contribute up 4 to this amount to their IRAs for such purchases and employer would receive an income tax credit equal to the amount of these contributions, instead of the u sual IRA deduction Both employee An employee with no dependents would be allowed to devote these additional contributions to securing better retirement bene fits. An employee with one dependent would be allowed to use half of these contributions for his ' retirement. Social Security currently pays survivors benefits on behalf of a deceased taxpayer who leaves a wife and young children or an elderly spouse For workers under 65, private term life insurance can entirely perform this function. Under Step 3 of t he plan, a worker who died before 65 would have Social Security survivors benefits reduced to the extent he had used the tax credit option to purchase term life insurance in force when he died. A worker who had fully utilized the credit to purchase life i n surance would have no survivors benefits paid on his behalf. For a worker who had used only half the credit to purchase such insurance survivors benefits would be reduced by half credit option, in effect, would be a rebate of Social Security taxes for tho se who chose to rely more on IRAs and less on Social Security. Social Security benefits--without any-need for general revenues. And just as in Step 2, the credit option would reduce Social Security expenditures-to the extent it was utilized by workers wil ling to forego benefits Like the retirement credit, this additional life insurance But it would leave payroll taxes fully intact to pay STEP 4 Eventually allow workers to place an amount equal to all their Old Aqe, Survivors, Disability and Hospital Insur a nce (OASDHI taxes into a "Super IRA which would p rovide for retirement survivors' beneiits, disability, and medicare coverage The three steps already outlined would constitute an im portant initial Social Security reform packaye legislation could expand the private IRA option even further. But subsequent 100 percent IRA Credit The.maximum credit for IRA contributions could be'increased to 100 percent of OASI taxes, for both employees and employeers in return for the worker accepting further Social Security bene fit reductions. Medicare and Disability IRA Workers could be allowed to purchase disability and old-age health insurance through their IRAs in return for reduced reliance 5 on Social Security? Ultimately, workers could rely entirely on IRAs for their retirement needs. IMPACT OF THE REFORM PACKAGE ON SOCIAL SECURITY Social Security Framework Strengthened Such reforms would leave the Social Security framework in place, yet make it financially secure. Workers could choose to remain entirely in Social Security and receive the full benefits available under current law. But the Social Security structure would be expanded and strengthened by the reform package. Workers would be free to choose the best mix of public and private vehicles for their retiremen t needs. quired legally to choose some vehicle for retirement and insurance protection. But they would continue to be re The reform would reduce Social Security expenditures over time, to the extent that IRA tax credit options were utilized and Social Security benefits foregone. Yet projected payroll tax revenues would remain the same, since the reform would do nothing to reduce such revenues. As a'result, the reform would help close Social Security's long-term funding gap, strengthening the entire program. Income Tax Revenue Effect of Step 2 The Treasury revenue loss due to these reforms wou ld be relatively modest, especially considering the huge problems ad- dressed. If the first income tax credit for IRA contributions discussed above (scheduled for 1986) were in effect in the cur- rent fiscal year (1984 and if all workers took full advanta g e of it the income tax revenue loss would be $31 billion for this year.i But it is highly unlikely that all workers would utilize fully the credit option when first made available just as most workers do not have IRAs today. Assuming workers initially uti l ized the credit at double the rate they currently use con- ventional IRAs, the maximum revenue loss in the current fiscal year would be $12.5 billion.4 The tax credit option also would result in reductions in Social Security expenditures. Though these red u ctions would be A detailed proposal for allowing workers the option of substituting a Health Bank IRA" for Medicare recently has been advanced in Peter J. Ferrara, John C. Goodman, Gerald Musgrave, and Richard Rahn, Solving the Problem of Medicare (Dallas , Texas 1984). National Center for Policy Analysis Calculated from Social Security Board of Trustees, 1984 Annual Report of the Board of Trustees of the Old-Age and Survivors Insurance and Disa- bility Insurance Trust Funds (Washington, D.C., April 5, 1984 4 rl a 6 small at first, eventually they would offset the tax revenue losses entirely. In addition the credit option would mean in creased savings held in IRAs, which would mean more funds for the trustees of the accounts to invest in American industry-= and added revenues to the Treasury from corporate taxation of the returns to this investment. Implications for Government' Borrowing There 'should be $1 in new savings through IpAs for every $1 in lost revenues because the tax credit would only be allowed for long-term IRA saving So even if the federal deficit were in creased temporarily by the amount of the net revenue loss, the U.S. pool of savings from which the deficit is financed would be increased crowding out" in the credit markets, because addition a l federal borrowing would be offset by new private savings As such, there would be no net increase in government Effects of Step 3 The second income tax credit of 10 percent, described in Step 3, would result in a revenue loss of $16 billion if it were in force in Fiscal Year 1984, and all workers fully utilized it.6 But complete utilization of the credit in the first year would be unlikely If utilized at double the rate of current IRA use, the revenue loss this year would amount to $6 billion.7 The Social Security expenditure reductions resulting from this credit would accrue far more rapidly than in the case of the 20 percent credit proposed in Step 2. There would be a reduction in the survivors benefits for dependents of workers who died prior to the re tirement age, in the first year of the credit--with private life insurance making up the difference claims expired, benefit expenditures would decline to zero if all workers utilized the full credit and relied on private life insur ance. In addition, incr e ased business investment could be expected since the amounts paid in life insurance premiums would be set Once existing To avoid the danger of a mere shifting of existing savings into IRAs to obtain the credit, workers should be prohibited from withdrawin g before retirement IRA contributions, for which they obtained the credit, and the returns associated with those contributions. This would make the IRA savings unsuitable as a substitute for nonretirement savings since they could not be used for nonretirem e nt purposes benefits would be reduced for tax credited IRA contributions, the IRA savings would be needed to replace those lost benefits, and therefore would not be available as a substitute for other retirement savings either. As a result of these factor s, any shifting of existing savings into IRAs rather than new savings to obtain the tax credit should be negligible, because such IRA savings would no longer be able to perform the function of other savings. See footnote 3. Ibid Because Social Security 7 aside to finance the stream of benefits for workers' dependents This would generate new tax revenues, which would offset the revenue loss due to the credit ADVANTAGES FOR BENEFICIARIES AND WORKERS Young Workers Young workers would receive full market retu r ns on the money paid into IRAs. Consequently, they would.be able to earn higher benefits than they could possibly receive for the same contribu tions to Social Security, as explained in Part I of this study If the complete Super IRA option were eventually phased in most young workers could expect to receive between three and six times the retirement benefits promised under Social Security. Even low-income earners would receive about double the benefits promised to them by Social Security-and a couple with maximum taxable incomes could expect at least eight times the benefits The private IRA benefits, moreover, would be' financed on a fully funded basis, which would secure them against the financing problems inherent in Social Security's current pay-as-you- go sys tem. The IRAs would also allow workers greater freedom to choose their retirement age, since they would not lose benefits if they chose late retirement, as is the case with Social Security. Reduction of Inequities Affecting Small Families The propos ed reforms would mitigate many of the inequities in the current Social Security benefit structure study noted that single workers without children and many two earner couples must pay for Social Security survivors benefits even though such benefits will n e ver be paid on their behalf married workers without children are not eligible for survivors benefits until after retirement The package would allow these workers, in effect, to use some of their Social Security tax money to purchase private term life insu r ance instead insurance would pay full benefits to whomever the worker desig nated as his or her beneficiaries Part I of this And this The reforms thus would increase greatly the flexibility of the retirement/insurance system, enabling workers to tailor co v er age to their personal needs and preferences package would eliminate one of the worst inequities in the current Social Security system i In so doing, the i A Better'Deal for the Poor and Minorities I The poor and minorities especially would be helped by the proposed reform package. Though lower income workers tend to leave school and start work earlier than other workers, Social Security credits these workers with little if any additional 8 benefits for their early years of work and tax payments. With an IRA, on the other hand, these workers would receive greater bene fits for early contributions, since the funds would have more years to accumulate interest befoxe retirement ity pays additional benefits for married workers, yet single workers are much mor e likely to be poor. Married and single workers would receive the same returns with an IRA. With a private IRA, moreover, a retired worker would be able to leave his entire, accumulated IRA fund to his dependents upon his death, whereas Social Security lim its benefits to the much smaller survivors benefits. This aspect of an IRA would be par ticularly beneficial to the poor and to blacks and other minority groups with significantly lower than average life expectancies. The typical black male born today, for instance, can only expect to live to 64, and so would not receive a single day of full Social Security benefits. An IRA would enable him to leave his accumulated retirement savings to his family. It should be noted that, under the proposed reform, the S up plemental Security Income program (SSI) would continue to provide means-tested, general revenue-financed welfare benefits to the elderly poor, thus ensuring that the income of retired Americans would not fall below a basic minimum. The better returns a v ailable from an IRA, however, would reduce the demands on this program And Social Secur Eliminating Risks to the Elderly The proposed reform would carry no threat to the elderly--or anyone.else--since promised Social Security benefits would be constitutio nally guaranteed. But the capacity of Social Security to finance those benefits would be improved, since outlays'would be reduced thanks to increased reliance on IRAs instead of Social Security. Nor does the reform package pose any threat whatsoever to I t hose workers who desire to remain exclusively within the Social Security system. Moreover, workers who chose the private IRAs would receive full credit, in the form of benefits, for the con tributions they paid into Social Security IMPACT ON THE ECONOMY t i onal savings would be increased by the new IRAs options became more familiar, virtually all workers could be ex pected to take full advantage of them This could mean tens of billions of dollars in new savings each year,.providing the capital for technolog ical innovation, the creation of new jobs, and faster economic growth. With a full option to rely on IRAs, private s avings could be almost doubled, with potentially hundreds of billions of dollars in increased savings flowing into the capital markets each year. In a study prepared while he was at Harvard, Council of Economic Advisors Chairman Martin Feldstein estimated that such an increase The proposed reform package would boost the economy Na As the credit 9 in savings would increase GNP by almost 20 percent.8 And since the proposed reforms would reduce Social Security expenditures, job-killing payroll taxes eventuall y could be reduced. Reduction in the Federal Role The reforms would "denationalize" the large portion of the pension and insurance industry now represented by Social Security shifting those functions to the private sector that can be per- formed by private firms. Transferring these functions would re- duce government spending significantly. private sector IRAs could mean more than a one-fourth reduction in federal pend ding Given that Social Security, Medicare, na- tional defense, and debt interest account for almost three-fourths of the federal budget, it is hard to imagine a substantial reduc- tion in the size and scope of government without such a reform Complete reliance on CONCLUSION Social Security remains in deep trouble with staggering financing pro b lems and inequities that must be addressed. the time to embark on fundamental, innovative reforms based on a true understanding of these problems, rather than wait for the next crisis and the accompanying hysteria. The most promising reform would allow wo r kers gradually to substitute Super IRAs for Social Security. This would take nothing away from workers or retirees--it would merely allow workers greater freedom to choose how to provide for their retirement and income security It is a reform of benefit t o old and young, rich and poor, and both black and white Americans. currently plaguing Social Security pared to its enormous benefits. With the elderly assured of their benefits, Social Security strengthened, and today's workers merely allowed increased fr e edom and control, there is no reason why the reform should be anything but merely popular. It should, in fact, be considered a I1populist1' proposal Now is Yet it would solve the enormous problems The temporary revenue costs of the reform are minimal com Prepared for The Heritage Foundation by Peter J. Ferrara, a Washington attorney Martin Feldstein Social Insurance,It Harvard Institute of Economic Research, Discussion Paper No. 477, May 1976, p. 33. As noted in Part I of this study, Social Security, inclu ding Medicare today accounts for almost 30 percent of the entire federal budget the insurance function of Social Security performed in the private sector most of this spending would be taken out of the federal budget altogether and shifted to the private sector. Formerly a senior staff member in the White House Office of Policy Devel opment With
