STRUCTURAL REFORM OF SOCIAL SECURITY Martin Feldstein Presented by Agata Narożnik

Outline: Background – Social Security Social Security in the United States Drivers for a change Mixed system - operations Mixed system – critics Alternatives to the mixed system Conclusions

Social Security System: A Pay-As-You-Go system:  current taxes pay for current benefits. A Fully Funded system:  current fund has balances sufficient to pay the present value of all future obligations

Social Security in the United States: Old-Age, Survivors, and Disability Insurance (OASDI) program:  Old Age and Survivors 10,6%  Disability Insurance 1,8%  Medicare 2,9% The surplus is loaned to the government through trust fund. Total payroll tax: 15,3%

Drivers for a change: the long-term change in the ratio of retirees to workers  high life expectancy  low birth rate. The Social Security Administration estimates the payroll tax rate would have to increase 48% (from today’s 10.6% to 15.7%) to finance currently projected benefits with the present pay-as-you-go structure by year 2075.

Mixed system – description: 10.6% OASDI tax:  1.5% to the personal retirement accounts  9.1% payroll tax revenue remains unchanged (pay-as-you-go)  1.5 % individual contribution out-of-pocket to the personal retirement accounts on a voluntary basis

Mixed system - “benchmark” benefits specified in current law: 60% - a pay-as-you-go benefit 40% - the personal retirement account annuities

Mixed system - “benchmark” benefits specified in current law: At retirement age, the individual might be given the choice of annuitizing the accumulated fund or taking out all or some in cash. Even if the individual took the entire personal retirement account accumulation in cash pay- as-you-go annuity would remain.

Mixed system - Requirements: Current retirees receive the full pay-as-you-go benefits specified in current law. For all future cohorts of retirees, the combination of pay-as-you-go benefits plus the expected investment- based personal annuities will equal or exceed the benefits that current law projects for that cohort. The tax rate and relative tax base will not be increased. The financing solution will be permanent, implying that the Social Security trust fund in 2075 (the end of the forecast period of the Social Security actuaries) will be both positive and growing. There will be no use of existing general revenue to finance Social Security benfits.

Expected benefits (Feldstein and Samwick (2002)) 1 : % of the benchmark benefits scheduled in current law, consisting of  61 % from a personal retirement account annuity  60% from a pay-as-you-go benefit % of benchmark benefits  75 % from a personal retirement account annuity  60% from a pay-as-you-go benefit 1 for individuals with average lifetime earnings

Critics: administrative costs, risk, income distribution

Administrative costs - Transition path: First five years - pay-as-you-go benefits are reduced by 0.3% per year 0.6% for the next five years, followed by 0.9% and 1.2% and eventually 1.5% per year up to a cumulative maximum reduction of 40% from the benchmark level of benefits.

Income distribution: „mixed system need not change the overall distributional character of Social Security but could offer greater benefits to retiree groups that remain poor under current Social Security rules”

Risk: continued role of the pay-as-you-go benefits rules governing personal retirement accounts investments private market guarantees for individuals willing to give up some expected yield for greater certainty of future benefits.

Alternatives: Two percentage point increase in the payroll tax  eliminate the “75 year deficit” of the program,  increase the deadweight loss due to higher marginal tax rates To increase the ceiling on earnings subject to the payroll tax (e.g. Diamond and Orzag, 2004)  It would raise the marginal tax rate for the affected individuals from 33% now to about 43%, causing the deadweight loss of the tax system to rise by 70%

Alternatives: Mixed system in which the investments in real capital through stocks and bonds would be in the Social Security trust fund.  have the same economic advantages on national saving and labor market deadweight loss as the personal retirement accounts.  raise a very serious risk of government interference in the economy.

Conclusion Changes are unavoidable Mixed system  Permits retirement incomes to be maintained with less reliance on taxes  Causes problems with administrative costs, risk and income distribution

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