Representative Paul Ryan
Stephen C. Goss,
Estimated Financial Effects of the "Social Security Personal Savings and Prosperity Act of 2004"--INFORMATION
This memorandum provides estimates of the financial effects of the plan you have developed for modifying the benefit and financing provisions of the Social Security program. Included is a description of the plan reflecting the intent expressed by you and Peter Fotos of your staff. Certain aspects of the plan that do not directly affect Social Security financing but are intended to alter budget scoring rules are not addressed in this memorandum.
This plan would establish voluntary, progressive individual accounts for workers who are under age 55 on January 1, 2005 and would provide for a reduction in the Social Security retirement and aged survivor benefits for those who participate. All participating workers would be guaranteed that the total benefits available from the combination of the OASDI program and their personal account would be at least equal to OASDI benefits scheduled under current law, regardless of the investment option and portfolio allocation they choose. Those who never participate in the personal account option would be provided present-law scheduled benefits, but would not be guaranteed at this level.
Personal savings account (PSA) assets would be invested by individual workers through a central administrative authority with a default allocation 65 percent in broad indexed equity funds and 35 percent in broad indexed corporate bond funds. Annuitization of the portion of the PSA accumulation sufficient to assure that total payments equal scheduled current-law benefits would be required at retirement. PSA contributions would be redirected from the OASDI Trust Funds. The ability of the Social Security Trust Funds to meet benefit obligations would be maintained through transfers from the General Fund of the Treasury that would be specified in the law.
Under the plan specifications described below the Social Security program would be expected to be solvent and to meet its benefit obligations throughout the long-range period 2003 through 2077 and beyond. All estimates are based on the intermediate assumptions of the 2003 Trustees Report plus additional assumptions described below. Estimates are not yet available based on the intermediate assumptions of the 2004 Trustees Report. However, such updated estimates, when available, are not expected to be materially different from those provided in this memorandum.
Personal Savings Accounts
Starting in 2005, all workers who will reach their 55th birthday on January 1, 2005 or later will have the option to enroll in the personal savings account plan. Enrollees with earnings in OASDI (Social Security) covered employment will have a portion of their payroll tax contribution (12.4 percent of taxable earnings in total) redirected from the OASDI Trust Funds to an individual account. The percentage of taxable earnings to be redirected in 2005 will be 10 percent of the first $10,000 of covered earnings for the year, plus 5 percent of earnings in excess of $10,000 up to the OASDI taxable maximum amount (which is $87,900 for 2004). The $10,000 threshold would be indexed by increases in the SSA national Average Wage Index (AWI) for years after 2005. The progressive scale for IA contributions redirected from the OASDI Trust Funds is estimated to amount to about 6.4 percentage points of the 12.4 percent payroll tax rate on average. The total amount redirected from the OASDI contribution rate indicated in Table 1 is less than 6.4 percent of payroll for years through 2029, because workers age 55 and older at the beginning of 2005 have no IA contributions.
All individuals will be allowed to voluntarily enroll or disenroll from the individual account plan at any time during their working years. However, any amounts redirected to the account in earlier years would remain in the account until distribution as described below
While participation in the PSA plan would be optional, and disenrollment allowed, the nature of the plan would provide a high likelihood for most workers that available retirement benefits will be more if enrollment is maintained. Total monthly retirement benefits for each worker who maintains enrollment throughout the period of eligibility would be guaranteed to be at least as large as benefits scheduled under current law for Social Security. In addition, personal account distributions are tax free, unlike Social Security benefits. Thus, participation is assumed to be universal for estimates presented in this memorandum. Individuals who never enroll would receive benefits scheduled under current law.
PSA contributions directed to the PSA of a worker based on a year's earnings are not determinable until earnings are reported to and tabulated by the Social Security Administration. Because this reporting is made by employers on an annual basis, after the end of the calendar year, amounts for individual workers are not determinable for somewhat over a year, on average, after the date on which earnings are paid. Under the proposal, PSA contributions during this initial period would be held in the Tier I fund and would be invested in long-term Treasury bonds, or similar securities. PSA contributions would be credited to the individual personal savings accounts as soon as current reporting permits.
Under the plan, personal savings account (PSA) assets, once credited on an individual basis, would be automatically invested in the Tier II fund through a central administrative authority that would maintain all records of individual transactions and balances. Participants would be offered three investment options, including one with 80 percent in equities and another with 50 percent in equities. Unless otherwise specified, PSA balances would be maintained in the default portfolio with 65 percent in a specified broad index fund consisting of private equities for corporations based in the United States (such as the Wilshire 5000) and 35 percent in a broad index of corporate bonds issued by companies based in the United States. The central administrative authority would group the assets of individuals for the purpose of transactions with private firms. Upon achieving a total PSA balance equivalent to $2,500 in 2005 (CPI-indexed thereafter) a broader range of investment options would be available in the Tier III fund. These options would be provided by qualified private investment companies, but would still be grouped by the central administrative authority for transactions with the investment firms. Due to the nature of the accounts, an ultimate administrative cost of 0.25 percent of assets is assumed to be reasonable.
Annual changes in investment allocation would be allowed. Because the guaranteed benefit level is provided regardless of what investment portfolio is selected by the individual, substantial variation in investment patterns is assumed to occur. This variation will, in turn, result in a relatively wide distribution of achieved life-time investment returns among individuals. However, we assume that a large number of account holders will still retain the default portfolio. On average, we assume that the portfolio allocation for all accounts combined will be close to the default allocation.
PSA Disbursements and Annuitization
At retirement, the participating worker would be required to purchase a life annuity with CPI-indexed payments using the portion of PSA accumulated assets necessary to provide a total monthly payment (including any OASDI monthly benefit under the plan) that is at least equal to the benefits specified under current law from the OASDI program. The annuity would be administered by the central administrative authority, with private investment firms handling the investment of assets on an aggregated (group) basis. It is assumed that the annuity would be computed at retirement based on an assumption of investment of 65 percent in a broad equity index and 35 percent in a broad corporate-bond index, with an assumed administrative expense of 0.25 percent of assets each year. Assets supporting the annuity would, in fact, be invested 65 percent in equities and 35 percent in corporate bonds.
The annuity would be computed using the assumed long-term future returns on equities and corporate bonds as determined by the central administrative authority at the time of annuitization. This central administrative authority would assume all risk associated with guaranteeing this yield on life annuities, regardless of what actual investment returns turn out to be. The central administrative authority would be backed by the Treasury of the United States government. Thus, the General Fund of the Treasury would provide the "insurance" that the full amount of the annuity will be paid for life regardless of actual investment returns.
If less than the total amount of PSA assets is annuitized, the balance of PSA assets may be disbursed or held as the retired worker wishes. All accumulations in and disbursements from personal savings accounts, including annuity payments, would be exempt from Federal personal income tax.
Upon entitlement to retirement or aged survivor benefits under the current rules of the OASDI program, a monthly CPI-indexed annuity amount based on the specifications described above would be computed by the central administrative authority. The annuity would reflect all potential benefits that might be payable under the OASDI program (i.e., retired worker, spouse, child, widow(er), and surviving spouse benefits). Annuity calculations would be made at benefit entitlement based on the then-current expected long-range future yield on invested assets and the then-current expected future death rates for the potential beneficiaries.
For individuals who die before receiving retirement (retired worker or aged spouse) benefits, the IA assets will be transferred to the account of the surviving spouse, if any, but will be allocated as needed to provide annuities for any surviving children of the deceased. If there are no survivors, and the worker dies before such benefit entitlement, then the account balance goes to the worker's estate, tax free.
Social Security Recognition Bonds and Benefit Reduction
OASI retirement and aged survivor benefits will be reduced based on the participation by the worker in the personal account option. Benefits payable to disabled worker beneficiaries (prior to conversion to retired worker status at the normal retirement age), to their dependents, and to survivors other than surviving spouse beneficiaries at age 60 or older are not subject to the reduction.
Reductions in affected OASI benefits would be made based on the proportion of potential lifetime PSA contributions that was realized. Specifically, the benefit reduction would be equal to the present law scheduled OASI benefits multiplied by the ratio of (a) the present value of all contributions redirected to the worker's PSA, to (b) the present value of all potential PSA contributions that might have been made if the plan had been in existence throughout the working lifetime of the worker. Present values would be computed using the realized OASDI annual Trust Fund yields. Potential contributions for years before 2005 would be computed by indexing the $10,000 threshold back to earlier years using the AWI.
Based on the reduction described above, workers who first enter the workforce in 2005 or later, and who choose to participate fully in the personal account through their working lifetime would have their affected OASI benefits reduced to zero. However, as noted above, the OASI program might still pay some benefits in cases where the annuity from fully annuitizing the PSA accumulation would be less than the present law scheduled OASI benefit.
Recognition bonds would be issued to active workers who choose to participate in the PSA on the basis of earnings before January 1, 2005. The recognition bonds would not be marketable but would be redeemable to the trust funds for all benefits scheduled under the OASDI program immediately prior to enactment of this plan, subject to the reduction for plan participation described above.
Personal Social Security Savings Account Board
The personal accounts and special annuities (annuity required to make the total benefit at least equal to the present law scheduled OASI benefit) for all workers will be administered by a single entity, central administrative authority, under the direction of the Personal Social Security Savings Account Board. The central administrative authority would maintain records and issue periodic statements to account holders. The PSA management would be based on the design of the government employee Thrift Savings Plan (TSP), with limited reporting requirements. Aggregated assets would be invested by privately managed investment firms. Through this approach it is assumed that PSA administrative costs can be expected to be modest, ultimately around 0.25 percent of IA assets for each account holder. This might require some Federal subsidy in early years for the PSA, when account balances are low and start-up costs are incurred.
General Fund Transfers to the Trust Funds
The OASDI Trust Funds will receive transfers from the General Fund of the Treasury through three mechanisms. The first two mechanisms are designed to provide revenue in keeping with potential revenue gains associated with other provisions of the proposal that are not directly addressed in this analysis. The transfers from these three mechanisms would eventually be offset by a fourth mechanism for a "reverse" transfer from the Trust Funds to the General Fund.
The first transfer mechanism would provide for amounts to be transferred to the OASDI Trust Funds equal to the potential corporate taxes that might result from investment of IA accumulations and annuities. The transfer amount would be computed assuming that all IA assets are invested in the default portfolio and that all IA accumulations available at retirement would be fully annuitized in the special life annuity offered by the central administrative authority. The computation of potential corporate tax revenue transfer would be specified in the law to follow the parameters adopted by former Senator Phil Gramm in his proposal. The parameters were laid out in the OCACT memorandum to Senator Gramm of April 16, 1999.
"The "recapture of corporate tax" on individual account yield would be directed to the OASDI trust funds. This recapture would be specified in law, intending to reflect the additional corporate taxes resulting from the additional domestic corporate investment from account assets. The plan would specify that the recapture would be assumed to equal 23.9 percent of the real, before tax, corporate return on investments. Because reported real yield on accounts would be after corporate tax, and the 23.9 percent rate is intended to apply to corporate income before tax, the actual rate applied to after tax income would be 31.4% = 23.9% / (1-.239). This provision would provide a substantial and growing source of income to the OASDI program."
The value of 23.9 percent was derived from the assumption of an ultimate average 35 percent rate applied to 68.4 percent of invested IA assets. Thus, the General Fund transfer based on potential corporate tax resulting from IA and annuity investments would equal 31.4 percent of the yield on combined IA accumulation and annuity assets.
The second transfer mechanism would specify transfers from the General Fund of the Treasury to the Trust Funds equal to the potential amount by which Federal Government spending would be reduced from a specific baseline, if growth in spending were reduced by 1 percent each year starting 2005 and lasting for at least 8 years (through 2012). The specified transfer amounts would be computed by a formula assuming that "baseline" Federal spending would equal 20 percent of GDP, and that the continuing 1-percent growth-rate reductions would continue as long as needed so that transfers to the OASDI program would result in combined Trust Fund ratios that would not be projected to fall below 100 percent under the provisions of the plan. Transfers would continue after the last year in which spending growth is assumed to be reduced, using that the cumulative percentage reduction computed for the last year for which an additional 1-percent growth-rate reduction was applied.
The plan would provide direction to the Congress and the President that the growth rate in total actual Federal Government spending should be diminished as specified above for the computation of transfers. Specified transfers to the Trust Funds would, however, not be contingent on achieving these reductions in actual Federal spending.
The third transfer mechanism would provide for the Treasury to issue additional bonds to the public in order to generate revenue to transfer to the Trust Funds if, at any time, the combined OASDI Trust Fund ratio (TFR) is projected to fall below 100 percent under the provisions of the plan, including the first two transfer mechanisms. This provision would guarantee solvency for the Trust Funds in any circumstance.
The fourth transfer mechanism would provide for a "reverse" transfer from the Trust Funds to the Treasury. This transfer would become effective when it is determined that in order to maintain an OASDI annual cash-flow balance (non-interest income less program cost) that is positive or zero for the future (1) the third transfer above is not projected to be needed in the future and (2) the full amount of transfers from the first two mechanisms is not projected to be needed for any future year, under the Trustees intermediate assumptions.
Cuts in OASDI Contribution Rate
If for any year net transfers described above are set at zero and are not projected to be needed in any future year, then the combined payroll tax rate (12.4 percent under current law) will be reduced to a level that maintains the annual OASDI cash-flow balance (non-interest income less program cost) at zero. However, this reduction will apply for any year only to the extent that it does not result in projections of a negative OASDI annual cash-flow balance for any future year under the Trustees intermediate assumptions. In addition, the combined OASDI payroll tax rate would in no case be reduced below 3.5 percentage points, roughly consistent with the minimal cost of providing benefits for disabled workers and their families, and for young survivors, in the future.
The guarantee of total payments at the level of present-law scheduled benefits would be available for all individual-account participants regardless of the portfolio allocation they choose in the Tier II and Tier III funds. The guarantee would assure that their total benefits will be no lower than present-law scheduled benefits from OASDI based on the law in effect just prior to enactment of this plan. Workers who do not participate in the PSA plan, however, may be subject to changes in scheduled benefits in future years. As a result, universal participation in the personal savings account option has been assumed for estimates presented in this memorandum. It is further assumed that most participants will retain the default portfolio allocation provided automatically in the Tier II fund, and that those who select other options will, in aggregate, invest with an allocation that results in a similar yield to that for the default allocation.
The cost of providing the guarantee for individual account participants is estimated assuming variation in realized account yields across years, generations, and individuals within generations. For individuals or generations with account yields substantially below the average expected return, the guarantee may result in additional payments from the Trust Funds. Individuals may be more likely to have yields below average if they choose to either invest conservatively, of if they attempt to make changes in portfolio allocations in an effort to "time the market." For individuals and generations that experience higher than expected returns, little if any cost for the guarantee will be incurred.
As indicated above, estimates provided in this memorandum are based on the intermediate assumptions of the 2003 Trustees Report. Estimates based on the more recent 2004 Trustees Report are not yet available, but are not expected to be materially different from the results presented in this memorandum. In addition, the long-term ultimate average annual real yield assumed for equities is 6.5 percent. This is somewhat lower than the historical real equity yield over the last several decades.
A consensus is forming among economists that equity pricing, as indicated by price-to-earnings ratios, may average somewhat higher in the long-term future than in the long-term past. This is consistent with broader access to equity markets and the belief that equities may be viewed as somewhat less "risky" in the future than in the past. Equity pricing will vary in the future as in the past. Price-to-earnings ratios were very high through 1999, and are now lower. The average ultimate real equity yield assumed for estimates in this memorandum is consistent with an average ultimate level of equity pricing somewhat above the average level of the past.
The assumption for an ultimate real equity yield of 7 percent that was used by the Office of the Chief Actuary until 2001 was developed in 1995 with the 1994-6 Advisory Council. At that time, the Trustees assumption for the ultimate average real yield on long-term Treasury bonds was 2.3 percent. Real yields on corporate bonds are believed to bear a close relationship to Treasury bond yields of similar duration. The 2003 Trustees Report includes the assumption that the ultimate real yield on long-term Treasury bonds will average 3 percent, or 0.7 percentage point higher than assumed in 1995. This increase in the assumed bond yield is consistent with a reduction in the perceived risk associated with equity investments.
It should be noted that the precise effects of implementing a plan that would result in a large demand for equities and corporate bonds on the yields of these securities is not clear. This demand would likely be at least partially offset by reductions in demand for other investment mechanisms. For the purpose of these estimates, it is assumed that there will be no net dynamic feedback effects on the economy or on the financial markets. Moreover, the intended effects on growth in Federal spending are not reflected in these estimates.
Trust Fund Operations
Table 1 indicates that under the intermediate assumptions of the 2003 Trustees Report and the assumed average yields for equities and corporate bonds described above, the OASDI program is projected to solvent throughout the 75-year projection period and beyond. The annual cost rate (cost of the OASDI program as a percent of payroll) declines steadily after 2027, reflecting the increasing extent of benefit reductions associated with PSA participation. The annual balance (net cash-flow balance as a percent of payroll) is projected to reach zero for 2030 and beyond. The trust fund ratio is projected to reach a low point of 138 percent of annual program cost for 2028 and to gradually increase thereafter, because the retained interest on the assets will be more than needed to maintain a constant trust fund ratio.
Net General Fund transfers expressed as a percent of taxable payroll are projected to rise to a peak of 7.35 percent for 2029 and decline thereafter, reaching zero for 2058 and later. The effective OASDI contribution rate is projected to be reduced from the nominal level of 12.4 percent by (1) the amount redirected to personal accounts, which reaches 6.4 percent of payroll for 2030 and later, and (2) the cut in the contribution rate that is projected to be possible starting in 2058, while maintaining an OASDI annual cash-flow balance at zero. The net OASDI contribution rate is projected to decline to 4.22 percentage points for 2078.
The actuarial deficit for the OASDI program over the 75-year projection period would be improved by an estimated 2.19 percent of taxable payroll, from an actuarial deficit of 1.92 percent of payroll projected under current law to a positive actuarial balance that rounds to 0.27 percent of payroll under the plan.
Program Transfers and Assets
Table 1a provides an analysis of General Fund net transfers under the plan and of net OASDI Trust Fund assets. Columns 1 through 3 provide the estimated amounts of annual transfers under the first, second, and fourth transfer mechanisms described above. The reverse transfers (column 3) begin in 2030 and reach the level of the other two transfers combined for 2058 and later. Note that the additional transfers permitted under the third mechanism are not projected to be needed under these assumptions. Column 4 provides the cumulative total amount of net transfers from the General Fund of the Treasury under the plan through the end of each year.
Total projected OASDI Trust Fund assets are shown in column 5. For purpose of comparison, the net OASDI Trust Fund assets are also shown for a theoretical Social Security program where borrowing authority is assumed for the Trust Funds. The theoretical Social Security program with borrowing authority is presented both without and with the net General Fund transfers expected under this plan, in columns 7 and 8, respectively.
If the individual accounts are considered as a part of a "total system", along with the OASDI program, then it is reasonable to consider "total system assets". These would be the sum of net OASDI trust fund assets and PSA assets (columns 5 and 6). Under the intermediate assumptions and assuming full annuitization of IA assets, total system assets are expected to be large and growing in real terms at the end of the 75-year projection period.
Effect on the Federal Unified Budget
Table 1b provides estimates of the effect on federal unified budget cash flows and balances under this plan and these assumptions. All values in this table represent the amount of the change that would be expected as a result of implementing the proposal, from the level that would be projected under current law. The effect of the plan on unified budget cash flow (column 6) would be expected to be negative initially, but positive starting 2043. This total cash flow change is the combination of the specific plan effects shown in columns 2-5. It is important to note that these estimates are based on the intermediate assumptions of the 2003 Trustees Report and thus are not consistent with estimates made by the OMB or the CBO based of their assumptions.
Column 7 provides the projected effect of implementing the plan on the Federal debt held by the public. Column 8 provides the projected effect on the annual unified budget balances, including both the cash flow effect in column 6 and the additional interest on the accumulated debt indicated in column 8.
As noted above, these projections do not reflect any potential change from reductions in the growth of Federal spending or from possible net increases in corporate taxes due to the individual account investments that are intended to occur as a result of implementation of this plan. The cumulative amounts of transfers to the Trust Funds associated with these intended effects are presented in columns 9 and 10. If these transfers were fully offset by corresponding increases in corporate tax revenue or reductions in Federal spending, then the projected change in the debt held by the public under this plan (column 7) would be reduced by these amounts.
Cash Flow to the General Fund of the Treasury
Table 1c provides estimates of the net cash flow from the OASDI Trust Funds to the General Fund of the Treasury. Revenue paid by the Treasury to the Trust Funds for the redemption of the special-issue Treasury obligations held by the Trust Funds is included here as a negative cash flow to the General Fund. Specified transfers from the General Fund under the plan also are shown as negative cash flow.
Values in Table 1c are shown as a percent of taxable payroll, in current dollars, in present value dollars as of 1/1/2003, and in constant 2003 dollars (discounted to 2003 with the projected growth in the CPI). For comparison purposes, net cash flow is also shown for a theoretical Social Security program where transfers from the General Fund of the Treasury to the OASDI Trust Funds are assumed to occur as needed to assure full payment of scheduled benefits in 2042 and later.
Development of Transfers under the Plan
Table 1d provides estimates of the amounts of the specified transfers under the plan in present value discounted to January 1, 2003. Columns 1, 2, and 3 develop the specified transfer based on the intended reduction in the growth in Federal spending. Column 1 provides the projected GDP under the Trustees intermediate assumptions. Column 2 provides what GDP would be if it grew 1 percent slower in each of the years 2005 through 2012. Column 3 provides 20 percent of the difference between columns 1 and 2, or the specified amount of transfer. Column 4 provides the estimated amount of annual transfers related to corporate tax on Individual Account investments. Column 5 provides the estimated reverse transfers, which are determined to offset the transfers in columns 3 and 4 when they are no longer needed. Column 6 provides the cumulative amount of net transfers from columns 3, 4, and 5 through the end of the year. Finally, the values in columns 7, 8, and 9 provide the annual net transfer amounts for the three mechanisms combined.
Components of Cash Flow to the General Fund of the Treasury
In Table 1e, total net cash flow from the trust funds to the general fund is shown in two components. The first is the cash flow due to the net amounts of the specified transfers to the trust funds under this proposal. The amounts of the specified transfers are detailed in columns (3), (4), and (5) of table 1d provided earlier. Under the specifications of the proposal, net specified transfers to the trust funds are expected to occur in years 2005 through 2057.
The second component is the residual amount of cash flow due to the trust funds net purchase (or redemption) of assets held in the form of special-issue Treasury Securities. Net purchases of Treasury securities are projected to change to net redemptions starting in 2005, under the proposal. Net redemptions are projected to continue through 2029. For 2030 and later, net redemptions of Treasury securities held be the trust funds are projected to be zero, consistent with the targeted zero OASDI annual cash-flow under the proposal.
Tables 2, 2a, 2b, 2c, 2d, and 2e provide an analysis of the implications of realizing actual real yields on individual account assets that are equal to the assumed average real yield on long-term Treasury bonds, or 3 percent. This may be viewed as either illustrating the case where the average real yield on equities and corporate bonds is no higher than on government bonds, or illustrating the effect of assuming risk-adjusted returns on equities and corporate bonds. In either case, the "expected" yield on annuitized assets is assumed to match the actual yield, on average. It should be noted that while average real yields for equities have been at or below average bond yields for periods of a decade or so, the likelihood of having such a low average yield for a period of several decades seems extremely low.
Table 2 indicates that net General Fund transfers would be needed longer, throughout the 75-year projection period. This is largely due to the fact that, with the assumed low yield on individual account assets, the cost of providing the guarantee is far higher-see table 2b column 3. The low yield also results in lower projected transfers based on corporate tax on IA investments-see table 2a column 2. As a result, the specified transfer based on a formula related to potential reductions in growth in total Federal spending is increased by extending reductions for the formula for years 2005 through 2016, or 4 years longer than under the assumptions of tables 1. Thus, with the low yield assumed on individual account assets, reverse transfers do not reach the point of fully offsetting transfers based on slowed growth in Federal spending and corporate tax on account investments by 2078 (see table 2a) and it is not possible to reduce the payroll tax rate within this period.
Only one sensitivity example is provided because the financial status of the OASDI Trust Funds under the plan is relatively insensitive to individual account returns. Even the very low average returns in tables 2 require only a 4 year extension of the period of annual increases for specified transfers.
It must be noted that the uncertainties associated with equity investments, bond yields, and mortality improvement, as well as with a number of additional variables mean that actual experience could vary from the illustrations provided in Tables 1 and 2. In any case, the plan would provide for adequate financing for the OASDI program through the provisions described above.
List of Attached Tables
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