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INTRODUCTION
Just a few years after the first baby boomers change from taxpayers into retirees, Social Security will begin paying out more in benefits than it collects in revenues. For the next three decades, working Americans are expected to come up with the income taxes necessary to pay interest and principal on bonds held by the Social Security trust fund, thus technically enabling it to run deficits for a while. By about 2040, however, those deficits will have led to the exhaustion of the trust fund, most baby boomers will have retired, and Social Security taxes will be sufficient to cover only about two-thirds of the benefits promised under current formulas.
Health programs for the elderly face the same demographic pressures as Social Security, plus rising health care costs. Because these programs rely heavily on general revenues as well as Social Security taxes, they are reducing the share of government revenues available for other important programs. The United States is not alone. Most developed countries are even further along in the process of devoting more and more government revenues to consumption by the elderly and near-elderly.
Almost everyone agrees that the current situation is untenable and unsustainable, but they hold different views on what to do about it. Maintaining promised benefits entirely by means of fiscal adjustments would require either raising payroll taxes or relying even more upon general revenues to pay for Social Security benefits; however, higher tax rates could further reduce the already dwindling support for programs benefiting the young and middle-aged. The growth rate of future benefits could be scaled back to match expected tax revenues, but this alternative raises the important issues of how to provide for the retirement income security of Americans and how large the basic benefits and the cutbacks in benefit growth should be.
Neither of these alternatives is as attractive as continuing with a system whose benefits consistently exceed its revenues—without requiring anyone to make up the shortfall. Such a system is not feasible, yet proposals for Social Security reform often seem to be judged against this unrealistic benchmark. Moreover, the gains and losses that would result from changing the system are calculated from a baseline that implicitly assumes a future of high benefits and low taxes. Faced with such unrealistic standards, it is hardly surprising that policymakers are wary of embracing proposals for reform that inevitably dash the public's hope that somehow the system can be brought into balance relatively painlessly.
The search for a palatable cure for what ails Social Security has revived an old debate about the fundamental character of the system. Should it be a pay-as-you-go system, where taxes are paid out almost immediately as benefits, or should it involve real saving? Several proposals have been put forward to privatize Social Security or to put additional saving into the existing Social Security trust fund. Such proposals confront an unavoidable fiscal reality, however: The money needed to generate this additional saving is over and above that needed to avoid the very large Social Security deficits projected in the future.1 If the additional saving is undertaken early, it might generate additional returns to help meet future deficits. Still, creating a permanent surplus generally requires larger and earlier adjustments than simply bringing the system back into a permanent state of balance.
Proposals for privatization differ from each other in important specifics, but all share several common features. Individuals would be required to save for retirement. At least a portion of this government-mandated saving could be invested in private securities. Ownership of assets would be ascribed almost immediately to individuals, and they would exercise some control over their assets. Finally, most proposals would retain a significant pay-as-you-go Social Security transfer program as well.
Closely related to the concept of privatization are proposals to increase funding and saving within Social Security. Many of these proposals would also have the Social Security system invest a fixed portion in private securities. Some, like a recent proposal put forward by President Clinton, are intended to shore up Social Security with non-Social Security taxes that could have been used to fund other government spending or returned to taxpayers through tax cuts. These plans could even allow for individual accounts that receive the average rate of return from a pooled investment within the public system.
This primer attempts to clarify the principal issues surrounding privatization of Social Security and related proposals to fund Social Security and to dispel some misconceptions that have arisen in the debate about whether to privatize. In particular, it evaluates proposals to reform Social Security on the basis of whether they achieve fiscal balance, protect the truly old and poor, and avoid saddling the government with any large contingent liability that would unfairly burden future workers.
Notes from this section of the report
1. The objective of generating increased saving for retirement is separate from that of restoring a balance between promised benefits and taxes. Restoring fiscal balance to the system would increase national saving to the extent that it lowers future projected deficits, but it would not require households to lower current consumption over and above the amount needed to make the Social Security system solvent.
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Disclaimer: The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.
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