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How Should We Save America’s Social Security System? Structural Changes

How Should We Save America’s Social Security System? Structural Changes. By Nicholas Maliska and Maurits Pot. Background. Created by FDR in 1935 to provide old age insurance Has reduced elderly poverty rates from 35 percent in 1960 to 10 percent in 1995

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How Should We Save America’s Social Security System? Structural Changes

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  1. How Should We Save America’s Social Security System? Structural Changes By Nicholas Maliska and Maurits Pot

  2. Background • Created by FDR in 1935 to provide old age insurance • Has reduced elderly poverty rates from 35 percent in 1960 to 10 percent in 1995 • But, demographic transition to an older population • Ratio of workers to retirees has decreased from 16.5 in 1950 2.31 now  2.17 by 2030 • Initial benefits are based on earnings and have increased over time

  3. Solvency Problem • Retiring baby boomers, improved life expectancies, and declining fertility will lead to funding shortfall • U.S. Government expected to start borrowing in 2017 to finance benefits • At current rate, trust fund expected to be depleted by 2037 • Present value of projected benefits far exceeds present value of revenue

  4. National Savings Account • Invest the Trust Fund in a portfolio of stocks and bonds to gain higher returns • Problem: collective investment of this magnitude is subject to political interference • Interest Groups could push for investment in favored industries or sectors at the expense of the beneficiaries.

  5. Personal Investment-based Accounts • Funded by 1.5% individual contribution and conditional 1.5% matching payroll tax contribution • Invested in diversified equity and bond mutual funds • Individuals select personal investment manager from approved list • Investments are tax deferrable • Would likely be part of a Two-tiered/mixed system that maintained PAYGO (60%)

  6. Benefits • Minimize economic inefficiencies • Labor market distortions prevented by avoiding pay-roll tax increase and no change in deadweight loss. • Increase present value of all future consumption • Recipients take responsibility for retirement benefit growth and options

  7. Problems • Transition costs: requires an increase in national saving during the transition from PAYGO to personal accounts • One generation would have to pay double • Increase risk by investing in market, which puts goal of program at higher risk • Administrative costs could range from .3 to .8 percent of assets and would reduce higher returns

  8. Summary • Social Security will run a deficit by 2017 and Trust Fund will be exhausted by 2037 • Can increase payroll tax or reduce benefits to restore long-term solvency OR • Structural reform: Mixed system with personal accounts • Benefits: higher returns could increase benefits • Problems: Transition costs, increased risk, and administrative costs

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