The Brookings Institution, Washington, D.C. www.brookings.edu

Saving Social Security

Peter R. OrszagDirector, Retirement Security Project

Joseph A. Pechman Senior Fellow, Brookings

January 13, 2005

The Brookings Institution, Washington, D.C. www.brookings.edu

Social Security’s role• Social Security is intended to provide core layer

of financial security during particular times of need:

1. Retirement2. Disability3. Death of a family wage earner

• Not designed to be sufficient by itself:1. Recommended “replacement rate” at retirement:

70 percent2. SS replacement rate at age 62 (most common age for

claiming benefits) for medium earners: 32 percent

3. Average retirement benefit: <$1,000/month

The Brookings Institution, Washington, D.C. www.brookings.edu

For the bottom tier of financial security, several beneficial attributes

• Benefits protected against:1. stock market collapses2. inflation3. risk of outliving assets

• Benefit formula is progressive:1. Higher replacement rate for lower than higher earners2. Protects against career not turning out well

• Benefits provided to family members. Some examples:1. Children of workers who die2. Surviving spouses3. Spouses of disabled workers

The Brookings Institution, Washington, D.C. www.brookings.edu

Individual Accounts: An Overview

• Individual accounts, such as 401(k)s and IRAs, provide critical supplements to Social Security – and several common-sense reforms would substantially raise saving in them

• But individual accounts don’t make sense as part of the core tier

The Brookings Institution, Washington, D.C. www.brookings.edu

Make It Easier To Save:The Automatic 401(k)

35

1913

8675 80

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60

80

100

Females Hispanic Under$20,000 inearnings

Par

tici

pat

ion

rat

eOpt-in Opt-out

Source: Madrian and Shea

The Brookings Institution, Washington, D.C. www.brookings.edu

But accounts don’t make sense within Social Security

• As pension system moves toward individuals bearing more risks, individual accounts in Social Security make even less sense

• Individual account system may respond to political pressure for:• early withdrawals• no annuitizationwhich would undermine retirement security

• Significant financing issues

The Brookings Institution, Washington, D.C. www.brookings.edu

Addressing the long-term deficit in Social Security

The Brookings Institution, Washington, D.C. www.brookings.edu

Projected Social Security deficit: 0.7% of GDP

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Tax Revenue

The Brookings Institution, Washington, D.C. www.brookings.edu

Social Security is not the main problem….

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2078

Social Security Medicare Medicaid

The Brookings Institution, Washington, D.C. www.brookings.edu

Diamond and Orszag, Saving Social Security

• Restore long-term sustainable solvency• Do not destroy program in order to save it • No accounting gimmicks or magic

asterisks• No general revenue transfers, no ignoring

risks of stocks

• Combine benefit reductions and revenue increases, rather than relying solely on either• Follow precedent of 1983 Greenspan reforms

The Brookings Institution, Washington, D.C. www.brookings.edu

A Progressive Reform• Protect most vulnerable: disabled

workers, young surviving children, lifetime low earners, widows

• Average earners: modest sacrifices

• Higher earners: somewhat larger role in reaching long-term balance

-- differential earnings growth, life expectancy increases

The Brookings Institution, Washington, D.C. www.brookings.edu

Bottom line: Benefits for medium earners

• Benefit reductions less substantial for lower earners and more substantial for higher earners.

• Real benefit levels continue to increase from one generation to the next because of ongoing productivity growth.

Age in 2004

Percentage change in benefits from those

under current benefit formula

Inflation-adjusted benefit at full benefit age relative to

55-year-old in 200455 0.0% 100%45 -0.6% 110%35 -4.5% 118%25 -8.6% 125%

The Brookings Institution, Washington, D.C. www.brookings.edu

Bottom line: Payroll tax rate

• If 2045 increase implemented this year, $35,000 earner would pay extra $37 per month in combined employer-employee taxes

• For 25-year-old average earner, present value of additional lifetime tax is 0.3 percent of career wages

Employee rate

Combined employer-

employee rate

Note: Combined rate needed to finance

benefits under current benefit formula

2005 6.2% 12.4% 12.4%2015 6.2% 12.5% 12.4%2025 6.4% 12.7% 12.4%2035 6.6% 13.2% 12.4%2045 6.8% 13.7% 17.0%2055 7.1% 14.2% 17.7%

The Brookings Institution, Washington, D.C. www.brookings.edu

Conclusions• Individual accounts do not make sense as

part of Social Security• Social Security is like a car with a flat tire.

Let’s fix the flat tire, not replace the car.• Exciting new evidence on ways to boost

saving on top of Social Security for low- and moderate-income households• Retirement Security Project, funded by Pew

Charitable Trusts