The Heritage Foundation

Executive Summary #1735 on Social Security

March 25, 2004

March 25, 2004 | Executive Summary on Social Security

Executive Summary: Providing Social Security Benefits in th eFuture: A Review of the Social Security System and Plans to Reform It

Social Security is the best-loved American government program, but how it works and is financed is almost completely unknown. Most Americans have a vague idea that they pay taxes for their benefits and that their benefits are linked somehow to their earnings. Many also know that the program is in trouble and needs to be "fixed" sometime soon to deal with the retirement of the baby boomers. Beyond this, their knowledge of the facts is severely limited and often colored by rumors and stories.

Most politicians exploit this lack of knowledge and limit their statements on Social Security to platitudes and vague promises. To make matters worse, reformers tend either to be content with similar platitudes or to speak in such detail that few outside the policy world can understand what they are saying. The simple fact is that today's Social Security is extremely complex, and any reform plan that is more than fine words will be similarly complex.

This paper attempts to simplify the reform debate by comparing various plans (including the current system) side by side. Each of the six sections of this paper compares how the current system and the reform plans handle a specific subject. Only reform plans that have been scored by Social Security's Office of the Chief Actuary are included in this comparison, using numbers contained in the 2003 Report of the Social Security Trustees. The six corresponding tables contain general reviews of aspects of the current system and the reform plans, with more details in the footnotes.

While looking at just one or two sections of special interest may be tempting, this approach would probably be misleading. For the best effect, each section should be considered together with the other sections in order to form a complete picture of the plan. Using simply one section by itself to judge an entire plan will not yield an accurate result.

The Current System
Social Security currently pays an inflation-indexed monthly retirement and survivors' benefit, based on a worker's highest 35 years of earnings. Past earnings are indexed for average wage growth in the economy before calculating the benefit. The benefit formula is progressive, meaning that lower-income workers receive a benefit equal to a higher proportion of their average income than upper-income workers receive. The program is expected to continue to collect more in payroll taxes than it pays out in benefits until about 2018.

Unused payroll taxes are borrowed by the federal government and replaced by special-issue Treasury bonds. After the system begins to pay out more than it receives, the federal government will cover the resulting cash flow deficits by repaying the special-issue Treasury bonds out of general revenues. When the bonds run out in about 2042, Social Security benefits will automatically be reduced to a level equal to incoming revenue. This is projected to require a 27 percent reduction in 2042, with greater reductions after that.

Reforming Social Security
Both the current Social Security system and every plan to reform it will require significant amounts of general revenue money in addition to the amount collected through payroll taxes. In short, both the current system and all known reform plans would have to find the necessary general revenues from some combination of four sources: borrowing additional money, collecting more taxes than needed to fund the rest of the government, reducing other government spending, or reducing Social Security benefits more than is called for under either current law or any of the reform plans.

The most important thing to remember is that the existing Social Security system and the reform plans all face this problem. This is not a weakness limited to personal retirement account (PRA) plans or any other reform plan. The only questions are when the cash flow deficits begin and how large they will be.

Seven Important Rules for Real Social Security Reform
It would be wise for reformers to follow a set of general principles to ensure that any Social Security reform both resolves Social Security's problems and provides workers with greater retirement security. This comparison of plans makes no effort to examine whether the Social Security reform plans included in it meet or violate any or all of the principles.

  • The benefits of current retirees and those close to retirement must not be reduced. If the benefits of younger workers cannot be maintained, then they should have the opportunity to make up the difference through a personal retirement account.
  • The rate of return on a worker's Social Security taxes must be improved.
  • Americans must be able to use Social Security to build a nest egg for the future.
  • Personal retirement accounts must guarantee an adequate minimum income.
  • Workers should be allowed to fund their Social Security personal retirement accounts with some of their existing payroll tax dollars.
  • For currently employed workers, participation in the new accounts must be voluntary.
  • Any Social Security reform plan must be realistic, cost-effective and reduce the unfunded liabilities of the current system.

Conclusion 
In the long run, a reform plan should do more than just preserve the current Social Security system with its many flaws. At a minimum, it should allow workers to pass on some of what they earned and paid in Social Security taxes to improve their spouses' retirement benefits. It should also allow workers the flexibility to use their entire account for retirement benefits or take a smaller retirement benefit and use the balance to pay for a grandchild's college education, start a small business, or pass on money to a later generation.

Social Security should not be reformed or "saved" for its own sake, but only if it more effectively provides the benefits workers need at a price they can afford.

David C. John is Research Fellow in Social Security and Financial Institutions in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

About the Author

David C. John Senior Research Fellow in Retirement Security and Financial Institutions
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Social Security