Social Security: Challenges & Opportunities Jeffrey R. Brown January 13, 2005

Outline 1. What is the problem? 2. What solutions are available? Approaches that do not solve the problem Approaches that do solve the problem 3. The role of personal accounts

3.3 today 2.0 in in in 1960

CASH DEFICITS

Options for Restoring Fiscal Balance 1. On pay-as-you-go basis Increase taxes Reduce benefits (or benefit growth) 2. Pre-fund Save more today to reduce future burden Trust Funds vs. Personal Accounts

Four Different Approaches Two that do NOT restore fiscal balance The “Do Nothing” approach The “Free Lunch” approach Two that DO restore fiscal balance Reduce benefit growth (President’s Commission) Increase taxes (Diamond-Orszag)

The “Ostrich Strategy,” aka, The “Do Nothing” Plan “There is no problem” “No immediate danger” “We can grow our way out” “The forecasts are unreliable” “Minor tweaks will solve it”

“The higher return on stocks will save the system” “No cuts in benefit growth are necessary” “We can guarantee present law benefits with no new revenue” Free The “Free Lunch” Plan

Slowing Benefit Growth: The President’s Commission Don’t touch benefits of today’s seniors Price index future starting benefits – Future retirees would get at least as much as today’s retirees, adjusted for inflation Puts system on permanently sustainable path within existing payroll tax rates

Raising Taxes: Diamond-Orszag Reduce benefit growth – Longevity indexing Increase taxes – Tax rate increase for longevity – Increase maximum earnings subject to tax – “Universal legacy charge,” aka, tax increase – “Legacy tax above earnings cap” Tax increases account for approximately 85% of improvement in actuarial balance

Cost of D-O versus Current Law (as % of GDP)

CBO Estimates of Economic Impact (as of 2080 relative to TF financed baseline) President’s Commission Plan would: – Increase GDP by 3 – 4% – Increase national wealth by10 – 12% – (Minimal effect on labor supply) Diamond-Orszag Plan would: – Reduce GDP by 1.5% – Lower national capital stock by 0.8% - 1.4% – Reduce labor supply by 1.8 – 1.9%

Why Personal Accounts? Provide opportunity for ALL Americans to participate in financial markets and build wealth Improve work incentives Provider superior mechanism for the country to save for the future and reduce future burden