Can Individual Accounts Really Rescue Social Security?

Number 12 in Series, "The Retirement Project"

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President Bush has proposed allowing workers to divert part of their current Social Security tax to their own individual accounts, and his Commission to Strengthen Social Security (CSSS) has recently outlined these models. Critics of the approach contend that diverting current tax revenues to individual accounts will reduce Social Security revenues and weaken the system's finances. Proponents counter that individual accounts will provide current workers with a higher return on their taxes, allowing Congress to reduce traditional benefits and thus narrow the system's financing gap.

This brief uses the Social Security Policy Analysis Model (SSPAM), a new model developed by the Actuarial Research Corporation, to analyze the impact of individual accounts.¹ Using several different assumptions about the accounts' structure and average rates of return, it reviews the impact on the financial status of Social Security and the general federal budget, assuming that general budget funds are used to cover some of the transition costs.²

The analysis shows that most of the individual account scenarios examined worsen the long-range deficit of the Social Security system. To have a positive effect on the system's financing, an individual account program would need to have a centralized management structure, invest a sizable chunk of all account balances in equities, realize equity returns at least as high as those in historical experience, and include a mechanism taxing away at least 75 percent of the account balances at retirement. Even if the program did not worsen the long-range deficit, the government would have to borrow as much as $6 trillion (at today's prices) to finance the transition.

Notes

1. The SSPAM model is a demographically based cell model that simulates the benefits received by 140 representative workers for each cohort. At the time this brief was issued, the Actuarial Research Corporation was updating its model to reflect the 2001 Trustee assumptions and to introduce other technical changes in the estimating methodology. The new assumptions, however, are not expected to have a significant impact on the estimates presented here.

2. The analysis ignores any second-order effects of changes in savings or labor force participation rates as a result of the shift to individual accounts.

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