From the WSJ Opinion Archives
SOCIAL SECURITY
A 'Progressive' Solution
We can have private accounts and reduce debt. Here's how.
(Editor's note: This article appeared in The Wall Street Journal, March 15. President Bush cited Mr. Pozen's proposal in his press conference last night.)
Ever since President Bush first floated the idea of personal retirement accounts as part of Social Security reform, fiscal hawks have been going berserk: "This will only increase future government borrowing when the federal deficit is already sky high!," they say. Well, they're wrong. There is a way to have personal retirement accounts, or PRAs, and actually decrease the government debt. If PRAs of modest size are combined with something called the "progressive indexing" of benefits, the government borrowing needed to finance Social Security would be dramatically reduced.
What is progressive indexing and how does it work? Under the current Social Security system, the annualized career earnings of all workers are increased by the amount wages in the whole U.S. economy have risen over their careers. Under progressive indexing, by contrast, the average career earnings of all workers with over $113,000 per year would be increased by the amount that prices have generally risen over their careers.
The initial Social Security benefits of workers with average career earnings between $25,000 and $113,000 per year would be increased by a proportional mix of wage and price indexing. For example, the initial Social Security benefits of a worker with average career earnings of $69,000 per year would be increased half by wage indexing and half by price indexing.
Under progressive indexing, Social Security benefits would remain exactly the same for three groups--all workers already in retirement, those retiring before 2012, and those retiring in 2012 and later with average career wages of $25,000 or less per year. The Social Security benefits of this third group, comprising 30% of all workers, would be preserved because they depend almost entirely on these benefits for retirement income. This group has minimal participation in retirement programs like 401(k)s and IRAs, whose tax advantages are enjoyed mainly by high- and medium-wage earners.
Since wages regularly rise over 1% per year faster than prices in the U.S., the adoption of progressive indexing would dramatically improve the solvency of Social Security and drastically reduce the government borrowings required to sustain the system. At the same time, the Social Security benefits of all workers with average career earnings below $113,000 per year would grow in both real and nominal terms, and the Social Security benefits for workers with higher average career earnings would still keep pace with the consumer price index.
In order to finance the currently scheduled level of Social Security benefits, the federal government must borrow $3.7 trillion over the next 75 years--the standard period for measuring the solvency of Social Security. Because projected revenues into the Social Security Trust Fund will be insufficient to support scheduled benefit payments, Congress will have to authorize huge transfers from the Treasury's General Fund to the Social Security Trust Fund to avoid substantial benefit cuts. This intergovernment transfer will be financed primarily by issuing large amounts of Treasury debt.
By contrast, the combined plan for progressive indexing of Social Security benefits and PRAs of modest size would make Social Security solvent and financially self-sustaining by the end of the 75 years, according to the Chief Actuary of Social Security. No government transfers would be required to finance this combined plan until 2030 and all such transfers would be completed by 2073. Most importantly, as calculated by the Chief Actuary of Social Security, the combined plan would require $2 trillion less in total government borrowings than the current system for Social Security over the next 75 years.
Nevertheless, some commentators will oppose the slower growth of Social Security benefits for medium and higher wage workers as a "benefit cut" relative to the current schedule. How can this opposition to slower growth of benefits be overcome? By offering workers the chance to allocate 2% of their FICA wages (up to $3,000 per year indexed to price inflation) to a PRA invested conservatively in a low-cost balanced account. All such allocations would be invested by the trustees of the Federal Thrift Plan in a balanced account, composed 60% of an S&P 500 index fund and 40% in a high-quality bond index fund. Such an account, rebalanced at the end of each year with expenses of 30 basis points per year, would have returned over 8% per year (before inflation) on average for all cohorts starting work in 1949 and contributing consistently to their PRAs over 35 years.
Of course, the 2% allocated to PRAs would initially increase the borrowings needed by Social Security, but would reduce such borrowings in later years. The workers making such allocations would be required to accept lower retirement benefits from Social Security, since they would also be receiving payouts from their PRAs. Moreover, the initial drain on the system by PRAs would soon be more than counterbalanced by the large improvements in Social Security's solvency resulting from progressive indexing.
In short, while the creation of PRAs alone would increase government borrowings, the combined plan for progressive indexing and 2% PRAs would decrease by $2 trillion the government borrowings needed to finance the Social Security system. In this way, Social Security reform could be a key factor in reducing the long-term budget deficit.
Mr. Pozen is chairman of MFS Investment Management.
