May 2, 2005
By Stuart M. Butler, Ph.D. and David C. John
changes in the Social Security system are needed to achieve
retirement security for all Americans. The first is to phase in
changes to the structure of traditional Social Security benefits to
create a system of real benefits on which workers and retirees can
depend rather than promised benefits that cannot be paid. This step
requires Congress to slow the growth of traditional benefits for
middle- and upper-income Americans, who are much less dependent on
Social Security for their retirement income, so that the benefits
of lower-income Americans can be protected and improved. President
George W. Bush's bold call for "progressive indexation" recognizes
this need, and Congress should incorporate it into reform
step is to allow workers the opportunity to supplement traditional
Social Security benefits by using part of their current payroll
taxes to create voluntary personal retirements account (PRAs) that
they own. This step is also in the Bush proposal. These accounts
would be invested in safe bonds and mutual funds in order to
produce an additional monthly retirement benefit and a retirement
nest egg. The key to getting the full retirement advantage of PRAs
is to let workers invest as large a slice of their payroll taxes as
is reasonably possible in their PRAs. In this respect, President
Bush's 4-percent "carve out" proposal is the minimum acceptable,
and Congress would do well to expand on it.
two-step reform in place, workers could look forward to larger
monthly retirement checks than today's Social Security can afford
to pay and a nest egg that they could use during retirement or pass
on to their heirs.
Steps To Save Social Security
Bringing Social Security's benefit promises closer to the
reality of its revenues is an essential part of preserving the
program's ability to provide retirement security. President Bush
recognizes this and has endorsed a fair and equitable way to
structure future benefit increases to protect those who rely on
Social Security the most. Called "progressive indexation," this
method provides real retirement income insurance for workers by
focusing traditional Social Security benefits on those who need
them the most during retirement-lower income workers-while
preserving the principle that all Americans both pay into Social
Security and receive benefits.
today makes the false promise that it can pay workers the benefits
that they expect. This is a false promise because previous
Congresses scheduled increases in future benefits that far exceed
projected payroll tax revenues. The money simply will not be there.
While current retirees and those close to retirement will be able
to receive every cent that have been promised, scheduled increases
in benefits for future retirees will need to be scaled back to more
Fortunately for workers, slowing future
increases in traditional Social Security benefits is only one part
of the effort to fix Social Security. Combining changes in
traditional benefits with the opportunity for workers to establish
Personal Retirement Accounts would allow younger workers to receive
the same type of retirement security as their parents and
grandparents. With PRAs, workers could improve their benefits
through a carefully managed investment program that would
yield better returns than the declining rate the government can pay
on the payroll taxes it collects from workers. The combination of
realistic government-paid benefits and a PRA would be far more
secure than today's empty promises.
Running out of Money
Today's Social Security will
require trillions of dollars in damaging tax hikes if it is to pay
all of the benefits that it has promised. Social Security's monthly checks will begin to
exceed projected payroll tax collections in 2017. This gap will
quickly balloon to alarming levels. After adjusting for inflation,
annual deficits in Social Security will exceed $100 billion in 2022
and top $200 billion in 2027-just over 20 years from now. In 30
years, Social Security's annual deficit will be more than $300
billion. If promised benefits are to be paid, Congress will have to
fill this funding gap by raising taxes.
Congress would have to raise and invest $5.7
trillion today to pay all of Social Security's promised benefits
between 2017 and 2080. That includes $1.7 trillion, in net present
value terms, to repay the bonds in Social Security's trust fund and
$4.0 trillion to pay benefits after the trust fund is exhausted in
2041. This money would be in addition to what Social Security
receives during those years from its payroll taxes.
Benefits on Those Who Need Them the Most
Social Security was created to insure Americans against the
risk of running out of money in retirement and to ensure all an
adequate monthly income to afford a decent retirement. The way to
give that assurance real meaning is to focus the system's resources
on those who face the greatest hardship. President Bush's
"progressive indexation" proposed would do that. It would gradually
change Social Security's benefit formula so that lower-income
workers (those who earn less than $25,000 today) who retire in the
future would receive higher traditional Social Security benefits
than lower-income workers who retire in 2005. This is only fair,
because lower-income workers are less likely than other workers to
have any other retirement savings and more likely depend on Social
Security benefits for almost all of their retirement income.
under the President's plan, workers would be promised, for the
first time, a minimum Social Security benefit that will keep them
above the poverty line. This is more than Social Security offers
today. Under today's system, a worker can retire with a Social
Security income that is beneath the poverty line.
middle- and upper-income workers, who are typically able to put
aside money for retirement, would receive smaller increases in
traditional benefits. Under the Bush plan, the benefits of
upper-income workers (those who earn over $100,000 today) would
increase at the rate of inflation, instead of at the rate of wage
growth as they do today. While future upper-income retirees would
not receive any less than upper-income workers who retire today-and
their benefits would still be protected against inflation-their
benefits would also not grow as fast as under today's unsustainable
for upper-income workers is fair and prudent, given Social
Security's finances, because upper-income workers almost always
have significant retirement savings in Individual Retirement
Accounts, 401(k) plans, and other investment vehicles. So while
they would still receive traditional Social Security benefits,
their benefits would just not increase as rapidly as under current
law-and they would be able to rely on retirement income from their
incomes between those two levels ($25,000 ands $100,000) would fall
somewhere in between, depending on their earnings-the lower the
income, the higher the level of benefit growth. No one at any level
would receive benefits less than a worker with a comparable income
retiring today. Again, this change ensures that workers with lower
levels of retirement savings outside of Social Security would
receive comparatively more in traditional benefits.
would not happen suddenly. They would be gradually phased in over
decades so that future retirees would have plenty of time to adjust
their retirement planning. And nobody over the age of 55 today
would be affected by the President's plan at all.
Progressive indexation preserves the principle of social
insurance for workers of every income level. All workers who are
currently in Social Security would continue to pay in
and continue to receive traditional retirement benefits. No
one-not even the Donald Trumps and Bill Gates of the
workforce-would be forced to pay into a system that provides them
with nothing in return. But while the wealthy would continue to
receive traditional benefits-a minor supplement, no doubt, to their
investment income-in return for their taxes, their monthly benefits
would not grow as fast as under current law. These savings on
checks to affluent retirees would enable Social Security to pay
better benefits to lower-income retirees whose need is greater.
law, every worker at every income level would see his or her
promised benefits cut by about 30 percent once the trust fund runs
out of money in just over 35 years. Progressive indexation
addresses this mismatch between revenues and payouts in a fair way
that ensures our children and grandchildren will be protected from
While progressive indexation is a prudent and fair way to
adjust the growth in traditional Social Security benefits to bring
the system's payments in long-term balance with its revenues, it is
only one of the necessary steps for true reform. The other step is
to allow younger workers-if they wish-to put part of their payroll
taxes into a personal retirement account that can be invested in
safe bonds and mutual funds. Workers choosing this option, the
second step of President Bush's plan, could look forward to a
higher return on the money in their PRAs than in traditional Social
Security. When workers with a PRA retire they could choose to
convert the entire account into a supplemental monthly check to
enhance their traditional Social Security benefits (which would be
reduced in line with the taxes they switched to the PRA) or they
could use part of the PRA for that purpose and keep the rest as a
nest egg for themselves and their heirs.
Because of the
higher returns younger workers could expect from money placed in a
PRA, as compared to the steadily declining returns on payroll
taxes, they would be better off under the President's plan-despite
that it would slow the growth of traditional benefits-than under a
Social Security system without PRAs. Indeed, the larger the amount
of payroll taxes that could be placed in a PRA, the better off
workers would be. That is why President Bush's 4-percent "carve
out"-which is phased in very slowly and has tight limits on total
PRA contributions-should be seen as a minimum. Larger PRAs would
achieve faster reform and a faster improvement in retirement
To see how
President Bush's combination of progressive indexation and PRAs
would affect you, visit the Heritage Foundation's PRA Calculator at
David C. John is
Research Fellow in Social Security and Financial Institutions in
the Thomas A. Roe Institute for Economic Policy Studies, and Stuart Butler is Vice
President for Domestic and Economic Policy Studies at The Heritage
A fair and equitable way to fix Social Security.
Stuart M. Butler, Ph.D.
Distinguished Fellow and Director, Center for Policy Innovation
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David C. John
Senior Research Fellow in Retirement Security and Financial Institutions
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