Thinking Ahead On Retirement Security

One of the principal fiscal and policy challenges facing the nation is the aging of the population. Social Security faces significant funding shortfalls – and Medicare even larger – while traditional defined benefit pensions are disappearing and 401(k) plans face many challenges in taking their place. Through both the Clinton and Bush administrations policy responses to the retirement of the Baby Boomers have been discussed and debated – but very few policies have been implemented.

Over the past 10 years, the dominant view on the right toward Social Security has been so-called “privatization, ” meaning the partial or full replacement of the current pay-as-you-go, defined benefit pension program with a pre-funded, defined contribution plan based upon personal retirement accounts. Republicans also almost universally opposed any increase in Social Security taxes – the 12.4 percent rate paid, or in the $106,800 maximum wage upon which taxes are paid. This was a very attractive package, seemingly offering something for everyone and something for nothing.

During most of these 10 years the personal accounts movement has been on the offensive, such that alternate approaches have been mostly defined in terms of what they would not do – no personal accounts, no benefit cuts – rather than what they would. Some on the left have been proactive, proposing increases in “cap” on payroll taxes, transfers of income tax revenues to Social Security, or investment of the Social Security trust fund in stocks. Others have been in denial, claiming that the Social Security problem is simply a function of pessimistic economic forecasts and will largely fix itself over time.

President Clinton attempted to fix Social Security in the late 1990s, through a combination of transfers of projected income tax surpluses and investment of the Social Security trust fund in equities. Due to Republican opposition and Clinton’s extracurricular troubles, the Clinton plan went nowhere.

The Social Security debate truly came to a head in 2005, when a newly re-elected President Bush attempted to push through a reform that would fix Social Security’s deficits by reducing benefits for high earners and introduce personal retirement accounts “carved out” of the existing 12.4 percent payroll tax. Most Democrats, by contrast, would address solvency by increasing taxes. Personal accounts would be established, if at all, as “add ons” funded with additional contributions.

On taxes, Bush had a point: Social Security taxes have already risen from two percent in 1935 to 12.4 percent today. Increased payroll taxes would hurt jobs, slow the economy and absorb revenues needed for Medicare reform. Moreover, individuals can easily substitute for lower Social Security benefits by saving more on their own.

But on personal accounts the Democrats had a point: while accounts would be a better “lock box” than the Social Security trust fund, personal accounts funded out of the existing payroll tax only make the Social Security deficit larger. Carve out accounts would entail large “transition costs,” which under the Bush approach would be almost entirely borrowed, and for account holders would require even larger reductions in traditional defined benefits at retirement. Both the borrowing and the reductions in traditional benefits, along with a healthy dose of demagoguery on the Democratic side of the debate spelled defeat: the Bush reform plan didn’t even come up for a vote in Congress.

Given all this, where do we go from here? The key questions I ask myself are first, what would Social Security’s retirement program have to look like if everyone did what they should, meaning, save an appropriate share of their income for retirement; and second, how do we get everyone to do what they should?

The answer to the first question is that, assuming everyone saved for retirement, Social Security could focus its resources on those too poor to provide a decent retirement income for themselves even if they had saved regularly. Beyond that, there isn’t a strong reason to levy more taxes on higher income Americans in order to provide higher Social Security benefits for higher income Americans – they can handle that stuff pretty well on their own. This is particularly important given how tax revenues will be squeezed in coming years.

But how do we get people to save for retirement? It’s hard to get people to do something they don’t want to do. Even if we encourage or require universal participation in 401(k) plans or other non-Social Security retirement accounts – an idea with merit – folks who really don’t want to save can just save less elsewhere or increase their borrowing. There will be people who do that.

But universal participation in retirement savings accounts has one merit: even if people choose to save less in other accounts or to borrow more elsewhere, we have at least some assurance that in one area federal policy has become very involved in – retirement – the typical person will have enough to at least get by. That’s important, since the alternatives are to bail out retirees on an ad hoc basis, which only further discourages personal saving.

There’s a long road ahead on retirement policy and many possible outcomes, and I’ll have more to say on this and other issues in days ahead. President Obama has some very able staff on the issue – Jason Furman at the National Economic Council and Peter Orszag and Jeffrey Liebman at OMB. Obama spoke recently of taking on Social Security reform, and it’s hard to imagine his “fiscal responsibility summit” in February not bringing up the issue. Let’s hope that the Obama administration learns from the experiences of Clinton and Bush.