July 13, 1998 | Center for Data Analysis Report on Social Security
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.
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.
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.
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.
-- William W. Beach is John M. Olin Senior Fellow in Economics and Director of the Center for Data Analysis at The Heritage Foundation.
1. David Koitz, "Benefit Analysis of Three Recent Social Security Reform Proposals," Congressional Research Service Memorandum for Congress, June 16, 1998. The CRS examined three reform proposals, including one advanced by Robert M. Ball, a former commissioner of Social Security. The Center for Data Analysis examined only the proposals by Members of Congress: the Moynihan-Kerrey and the Gregg-Breaux-Kolbe-Stenholm/NCRP proposals.
6. For details on Heritage's calculations of rates of return, see William W. Beach and Gareth G. Davis, "Social Security's Rate of Return," Heritage Foundation Center for Data Analysis Report No. CDA98-01, January 15, 1998.