Brookings: Topics - Social Security Administration

Money Illusion, the Chained CPI, and the Benefits of Inflation

Isabel V. Sawhill — Wed, 17 Apr 2013 00:00:00 -0400

Economists have long recognized the fact that money illusion plays a role in how people behave. Money illusion is the tendency to evaluate the merits of a transaction based on nominal rather than real values.

In an interesting chapter by Eldar Shafir, Peter Diamond, and Amos Tversky in the path-breaking book, Choices, Values, and Frames, these authors reports on a number of experiments where, when presented with various choices, respondents behave in a way that suggests they are influenced by nominal and not just real values.

Keynes recognized that this was one reason why wages are “sticky” – that is, hard to reduce even when prices are actually falling. If prices are falling and nominal wages are reduced, workers are no worse off than before, but they will still resist any cut in their nominal wage because a loss in dollar terms is still hard to bear.

This tendency of behavior to be influenced by money illusion goes well beyond the reaction of employees to wage gains and losses. In the investment arena, a higher rate of inflation leads people to be less fearful about losing money since they tend to evaluate the losses in nominal terms. As a result, when inflation is higher, they tend to undertake more risky investments and end up earning more money by allocating a higher fraction of their portfolio to riskier assets.

Money illusion has played a role in the huge fuss being made about the proposal to change the inflation index for Social Security to the chained CPI. No one seems to realize that under the existing formula, seniors have been getting what could be characterized as an unwarranted adjustment in their benefits measured in real rather than nominal terms. The upward bias in the current inflation adjustment is well known to economists but not to the general public. The public believes that moving to a chained CPI is the equivalent of a benefit cut. A more accurate way of looking at it is as a corrective to what has been a small but automatic increase in real benefits for many years.

An economist reading the literature on money illusion and observing people’s behavior is likely to wring her hands over what seems like irrational behavior on the part of most people. The CPI brouhaha is a nice example. But clouds of irrationality do have a few silver linings.

First, in an inflationary environment, it is easier to reallocate resources from one area to another without lowering the morale of workers or the holders of capital. These reallocations are needed to spur the growth and efficiency of the market.

Second, government budgets often contain tax or benefit program formulas that are not indexed for inflation. Up until the 1980s, for example, income tax thresholds were not indexed with the result that as inflation increased people’s nominal incomes they were automatically moved into higher tax brackets and revenues flowed into the Treasury without anyone complaining very much. A more up-to-date example is setting a nominal threshold for paying an income-tested Medicare premium. If this is not adjusted for inflation, more and more people over time will be drawn into the system. The current thresholds are $85,000 of modified adjusted gross income for single tax filers and $170,000 for joint filers. While this encompasses a very small fraction of all Medicare enrollees now, it will cover far more beneficiaries a decade or two from now, thereby enhancing the solvency of the Medicare system. For better or worse, money illusion is a politician’s best friend.

Finally, there seem to be constant worries that the buildup of assets on the Fed’s balance sheet will lead to inflation. Granted unwinding their holdings could be tricky, but it’s time we stopped worrying so much about small amounts of inflation. Serious inflation is nowhere in sight and will not occur as long as the economy is operating so far below its potential. In addition, for some of the reasons cited above, a little more inflation would not be such a terrible thing.

Authors

Isabel V. Sawhill

Publication: Yahoo! Finance

Image Source: © Brendan McDermid / Reuters

An Evidence-Based Path to Disability Insurance Reform

Jeffrey B. Liebman and Jack A. Smalligan — Tue, 26 Feb 2013 08:00:00 -0500

In this policy proposal — part of The Hamilton Project's 15 Ways to Rethink the Federal Budget — Jeffrey Liebman and Jack Smalligan propose a path to improve our disability insurance system, through demonstration projects and administrative changes, that could potentially increase employment and economic engagement among workers with disabilities and provide more rapid and reliable resolution of disability insurance claims for those who cannot work.

IMPACT

Deficit Reduction (10-year): $10billion to $20 billion

Broader Benefits: Potential to increase employment and economic engagement of workers with disabilities and provide more rapid and reliable resolution of disability insurance claims for those who cannot work. Results of pilots would inform broader reforms of the disability insurance system, leading to additional longer-term benefits.

INTRODUCTION

Disability insurance is the leading edge of the demographic tsunami that is starting to flood U.S. social insurance programs. Americans who are between the ages of fifty and sixty-five are four times more likely than those between the ages of twenty and forty-nine to be receiving disability insurance benefits. For the past decade, the same baby boomers who are just beginning to create fiscal challenges for Medicare and Social Security have been in their peak years of disability insurance receipt. Spending on disability benefits through the federal Disability Insurance (DI) and Supplemental Security Insurance (SSI) programs has increased from 0.7 percent of GDP in 1980 to 1.2 percent of GDP in 2013. Spending on Medicare and Medicaid benefits for DI and SSI recipients is also slightly more than 1 percent of GDP.
The good news is that spending on disability cash benefits appears to have peaked. With baby boomers transitioning off disability benefits and onto Social Security retirement benefits, and with the next cohorts slightly smaller than the baby boomers, the Congressional Budget Office (CBO) projects that spending on DI will fall by 0.1 percent of GDP between now and 2022 (CBO 2012).

But even though the fiscal burden of disability insurance is not expected to worsen, the program is in significant need of reform. This policy note summarizes the conclusions of a year-long research project designed to establish an evidence-based path to disability insurance reform. Our complete findings are available in Liebman and Smalligan (2013). The project was motivated by the observation that, while a consensus is emerging that changes are needed to the U.S. disability insurance system, there is no agreement around any specific reforms, nor does there appear to be a path in place that will lead to such agreement. Moreover, in most cases we lack the evidentiary base necessary to judge whether specific reforms would do more good than harm.

We therefore recommend a path that identifies promising reforms that are administratively realistic, pilots them or otherwise acquires the evidence necessary to judge their merits, and then rolls them out more broadly if proven benefits are established.

Two immediate steps are needed to start down this path. First, Congress should authorize three demonstration projects centered around early intervention. The key to reducing disability insurance costs is to intervene as early as possible to assist individuals in remaining at work. Waiting until after an individual has been approved for benefits is too late. Second, Congress should give the new Social Security commissioner the tools necessary to improve the disability determination system. Most important, funding for state disability determination services should be placed on the mandatory, rather than the discretionary, side of the budget. This will allow the Social Security Administration (SSA) to make investments in administrative capacity that will reduce spending on benefits—for example, by reducing the backlog of continuing disability reviews.

Like reforms to other social insurance programs, these changes will have a relatively small budget impact over the next ten years, but have the potential to produce much larger savings in later years. A package with these two reforms could save $10 billion to $20 billion over the coming decade, mostly through more thorough initial reviews. If the early intervention pilots are successful and taken to scale, annual savings of as much as 0.1 percent of GDP would be possible. ^[1].

^[1] We reach this estimate by assuming that roughly one-third of DI recipients are potentially able to be targeted for employment services and that the services enable one-third of that one-third to work rather than receive benefits. Net of the cost of the employment services, the savings would be around 0.1 percent of GDP.

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Authors

Jeffrey B. Liebman
Jack A. Smalligan

Publication: The Hamilton Project

Image Source: Keith Brofsky

Comments on the 50th Anniversary Celebration of the Special Committee on Aging

Henry J. Aaron — Thu, 08 Dec 2011 00:00:00 -0500

Mr. Chairman, Ranking Member, Senator Corker, Members of the Committee:

It is a pleasure and an honor to be able to share in this celebration with you today. This committee has observed, influenced, and helped to shape a transformation in the whole meaning of growing old in the United States—a change for the better. A scrim of forgetfulness shields us from the rather ugly reality of growing old in the America of just a few generations past. Let us draw back that curtain to examine what growing old meant for the generations born in 1860, 1890, 1930, and 1960. And let us also consider what aging will hold for younger Americans.

The 1860 cohort was born in a nation that still treated slavery as a constitutional right. A quarter of those born in 1860 died before turning age 20, half before reaching age 65. Living conditions and public sanitation were appalling by today’s standards: few houses had indoor plumbing, and few cities had municipal water and sewer systems. Surgery was uncommon and dangerous because surgical technique was primitive and anesthesia was dangerous. Inoculations were uncommon. Childhood diseases winnowed the young. Pneumonia was known as the "widow’s friend."

By current standards, the 1860 cohort was a nation of educational dropouts, although the United States led the world in mass education. Out of every hundred students who started primary school, 70 finished, 12 completed high school, and 3 graduated from college. Economic growth was rapid but uneven. The U.S. economy underwent thirteen economic contractions between 1885 and 1925. Many were catastrophic by modern standards.

Women gave birth to an average of more than five children. The backbreaking job of caring for children, husbands, brothers, sisters, and parents in a world without washing machines, vacuum cleaners, refrigerators, or dishwashers was borne, typically by women, until death and lightened only as family members died or moved away. Once married, few white women worked outside the home. Those who worked for pay almost invariably performed menial tasks. Many women, especially African American women, were domestics. Old age was not a passage to a "new mode of living," but a continuation of what life had been when one was young.

Three-quarters of men born in 1860 and still alive at age 65 continued to work for pay until death, disability, or economic catastrophe intervened. Such a catastrophe–the Great Depression–did intervene when the 1860 cohort was sixty-nine years old. By 1932, a quarter of the work force was unemployed. The elderly were more likely than the young to lose their jobs and less likely to find new ones. Protracted unemployment, bank failures, plunging stock prices, and collapsing real-estate values destroyed the savings of those in the middle and working classes who had scrimped and saved for retirement. Private charities were overwhelmed. Public charity dried up as state and municipal tax collections plummeted. Only a few Civil War veterans and their widows received small pensions; otherwise, private pensions were rare.

The first Social Security check was not paid until the 1860 cohort reached age 80, and few were eligible for benefits. For the one-third of the 1860 cohort who survived to their sixty-ninth birthdays, the final years were generally grim.

America’s 1890 cohort also lived through boom and bust. World War I ended a recession. With peace came another recession. Unemployment reached 12 percent. The 1920s brought boom, except on the farm. The year 1929 ushered in twelve years that blighted what should have been this cohort’s prime earning years. Too old to fight in World War II, the men of the 1890 cohort worked to support their sons at the front. Women left home for the paid labor force. Freed from traditional jobs as secretaries, teachers, social workers, and nurses, they become machinists and assembly-line operatives.

Like its forebears, the 1890 cohort suffered high rates of infant mortality. Although this cohort benefitted from steady, if undramatic, improvements in health and education, more than one-third of 20-year-old women and two-fifths of 20-year-old men did not live to see their sixty-fifth birthdays. Eighty percent of unmarried elderly women and half of unmarried elderly men had been widowed. Four-fifths of this cohort finished primary school. One-fourth graduated from high school, but only one in 20 earned a college degree.

When this cohort reached age sixty-five in the mid-1950s, fewer than half had health insurance. Coverage was often uncertain because insurers could raise premiums sharply or refuse to renew coverage of those whose health had begun to deteriorate. Because health expenses of the elderly were less than one-tenth of what they are today (even when adjusted for inflation), medical outlays were a threat only for the minority who became seriously ill. But in one of the most striking social changes of the late twentieth century, a spell in a nursing home became common. By the late 1970s, roughly a quarter of the 1890 cohort survivors were residing in nursing homes.

Congress passed the Social Security Act of 1935, subsequently increasing benefits and extending coverage in 1939 and again in 1950. Because of these liberalizations, members of the 1890 cohort received benefits far greater than the earmarked payroll taxes they and their employers had paid. Still, benefits were modest–only about 32 percent of taxable earnings of full-time covered workers. And since roughly half of U.S. jobs were not covered until the 1950 legislation broadened coverage, many members of the 1890 cohort did not receive benefits at all. Furthermore, private pensions covered only about a quarter of members of the 1890 cohort. Even workers who were covered typically received meager benefits because most had not worked long enough under these plans to have earned meaningful benefits. With insufficient income to retire, two-thirds of surviving men from the 1890 cohort were still working at age 65, nearly half at age 70, and 30 percent at age 75. More than one-third had incomes below official poverty thresholds.

The 2.6 million American children born in 1930 enjoyed advantages unavailable to previous generations. Nearly all finished primary school. Seven in ten graduated from high school. Partly because of the G.I. Bill for Korean War veterans, one man in five and one woman in nine graduated from college. Women no longer automatically withdrew from the labor force after marriage. Those who did often reentered when still young. Just over one-third worked outside the home when they were age 30, but three-fifths did at age 50, and two-fifths still worked for pay at age 60.

If the educational achievements of the 1930 cohort were striking, the economic advances were breathtaking. Between the end ofWorld War II and the mid-1970s, output per person more than doubled. At the start of their working lives, members of the 1930 cohort earned hourly wages three times higher than members of the 1890 cohort had earned in their first jobs. By the time the 1930 cohort turned age 65, their average earnings had risen by another one-third.

Post–World War II recessions, though numerous, were shallow during the 20th century compared with the economic paroxysms of earlier eras. Furthermore, unemployment compensation, also created by the Social Security Act of 1935, cushioned the shock for those who did lose jobs–for up to six months in normal times and even longer during recessions. Higher incomes, medical advances, and improved working conditions combined to boost life expectancy for the 1930 cohort. Two-thirds of men and over three-quarters of women born in 1930 lived to celebrate their sixty-fifth birthdays. Four-fifths of 65-year-old men and three-fifths of 65-year-old women still lived with a spouse.

As they approached retirement age in the mid-1990s, members of the 1930 cohort had options and resources few of their parents had enjoyed. Most had assets that provided substantial financial security. Social Security benefits, averaging $8,500 a year for individuals and $12,000 for couples, were fully protected against erosion by inflation. One-third of the 1930 cohort received private pensions, although the amounts were modest–a median of less than $7,000 a year. Further, more than four in five members of the 1930 cohort owned their own homes at retirement. Most had benefitted from the postwar real-estate boom that tripled the real value of owner-occupied housing between 1950 and 1995. The 1930 cohort also had better protection against medical costs than ever before. Medicare, enacted in 1965, provided basic health insurance coverage for the elderly and the disabled while eight in ten also had supplementary coverage. Increasingly workers retired years before they died. One-third of men in the 1930 cohort stopped working before age 62, two-thirds before age 65. Average living standards approximated those of younger adults. Averages, however, concealed large disparities: only 4.3 percent of elderly couples were poor in 1996, compared to 18 percent of elderly single men, 20 percent of elderly single women, and 36 percent of elderly single African-American women. Whatever the future holds for the final years of the 1930 cohort, its circumstances represent a revolutionary improvement over the experiences of their predecessors.

America’s 1960 cohort was better educated than any of its forebears. Only one in eight dropped out of high school. Half attended college and nearly one-fourth earned a bachelor’s degree. The fraction of the 1960 cohort with post-baccalaureate education matched the share of the 1860 cohort who had completed high school. But not all advanced at the same pace. African Americans were only two-thirds as likely as whites to earn a college degree, and barely half of Hispanics completed high school. Even if the earnings of men with little education grew more slowly than their parents’ pay had, the 1960 cohort earned more on their first jobs than their parents had three decades earlier. The jobs filled by members of the 1960 cohort also required less brawn and more brain than had jobs in the past. Three-fifths of men and 90 percent of women in the 1960 cohort worked in white-collar or service-sector jobs. Still, roughly one quarter of men and a small but growing fraction of women worked as craftsmen, mechanics, miners, machine operators, laborers, truck drivers, or in other physically strenuous jobs that become increasing difficult to perform as one ages. Women were better educated, worked more hours, stayed in the labor force with fewer interruptions, and earned much more than women had previously. As a result, more will be entitled to their own private pensions and to Social Security based on their earnings rather than their husbands’.

Members of the 1960 cohort told pollsters that they hoped to retire earlier than have past generations. Despite these stated intentions, however, men began to retire later, starting in the mid- 1990s and this trend has continued. One reason may have been that they had not done enough to prepare economically for retirement. By 2000, only 31 percent of those born between 1954 and 1964 had nonhousing assets worth more than $100,000, and 49 percent had accumulated less than $50,000, a sum that would support an annuity of less than $4,000 a year. In their failure to save, the 1960 cohort differ little from their forebears, who began to save, if at all, only in their 40sand 50s. For a long time, it looked like members of the 1960 cohort would have more sizeable pensions than previous generations. But that hope was undercut by the drop in stock-market values and the loss of equity in owner-occupied houses in the last decade. Furthermore, there is no way for anyone of any age to convert liquid assets into annuities fully protected against inflation and market risks, in the same way that Social Security benefits are protected. And Social Security benefits are in process of being lowered relative to earnings, a delayed effect of amendments enacted in 1983. For that reason, more than previous cohorts, members of the 1960 cohort will also confront the possibility that they will outlive their assets. One-fifth of men who reach age 65 are projected to be alive at age 90, and half of women alive at age 65 are expected to live past their eighty-seventh birthdays.

The prospects for younger age cohorts are more troubling. The past record of more-or-less continuous growth of income and improvement in educational achievement is in jeopardy. Earnings of men have fallen for about four decades. High-school completion rates are falling. Male college attendance and completion rates are falling. An encouraging bright spot is the continued increase in female college attendance and completion rates. More women than men now hold college degrees and the gap is widening—in part because female attendance rates continue to rise, but also because male attendance rates are stagnant or falling.

An additional source of concern is the projected increase in the budgetary cost of Medicare. These rising costs have led to proposals to replace the defined benefits provided by those programs with cash vouchers tied to indexes that have grown less rapidly than health care costs. The combination of stagnant wages, reduced replacement rates under Social Security, increased financial market volatility, and the threat that health care costs will be shifted to the elderly raise serious concerns about the financial security of the elderly. For a variety of reasons—private calculations and shifts in public policy—workers are likely to elect to work until older ages in the future than in the past. This trend will simultaneously lighten the burden of supporting a growing elderly population and boost national output.

Furthermore, there is no sign that scientific advance is ending. Progress in medical science, in particular, holds out the promise that people will live to longer, function well until older ages, and die with less pain than in the past. Out side medicine, advances in technology hold the promise of higher incomes. In brief, we hold in our own hands the capacity to do for our children and grandchildren what our forbears did for us—promote improved education, prevent illness from becoming financial calamity, encourage hard work, and recognize that the improving living standards and security that each of us seeks requires not only individual effort but also collective cooperation and mutual support.

Authors

Henry J. Aaron

Publication: Senate Special Committee on Aging

Image Source: Â© Rebecca Cook / Reuters

Social Security Reconsidered

Henry J. Aaron — Thu, 16 Jun 2011 13:36:00 -0400

Social Security is currently much in the news because it faces a projected funding gap, because of overall budget deficits, and because of doubts in some quarters about its design. Minor adjustments are sufficient to close the funding gap. Benefit cuts, even if considered desirable, would not help close the overall budget gap in a timely way. Some adjustments in Social Security benefits and financing are desirable, but large scale changes would be disruptive and would not well serve the program’s basic purposes — to provide assured, basic income to retirees, the disabled, and survivors — unless they more or less replicated the current program.

Social Security assures people basic income in defined contingencies, providing a floor to undergird private saving. The program has been remarkably successful in performing these functions. Of families age 65 or over, 64 percent received half or more of their income and 22 percent received all of it from Social Security in 2008. In public opinion polls, Social Security consistently ranks as the most popular government program. Nonetheless, the size and structure of Social Security now generate intense public interest for three reasons:

The Social Security Trust Funds face a projected long-term funding gap. If the trust fund is exhausted and revenues are less than benefits at that time, financial rules would require benefit cuts. A financially-driven benefit cut has never happened before, but it is projected to occur in 2037 (Board of Trustees, 2010). If nothing were done before then and the projections do not prove to be unduly pessimistic, it would be necessary in 2037 either to cut benefits by approximately 24 percent or, to sustain benefits, raise earmarked revenues 32 percent.¹ Alternatively, action could be taken earlier to raise earmarked taxes, cut promised benefits, or boost the investment yield on accumulated Social Security reserves.
Independently of the trust fund gap, federal spending is expected to exceed total revenues by progressively larger amounts. Eventually, large continued budget deficits would threaten the stability of the U.S. economy. Because Social Security spending and earmarked revenues are large - accounting for 20 percent of federal government spending and 29 percent of federal revenues in 2010 - many believe that measures to lower projected Trust Fund gaps could help close future budget deficits.²
Finally, elected officials and analysts continue to disagree on whether Social Security could be structured to better achieve the objectives of social insurance - to assure basic income to retirees, the disabled, and dependent survivors of early decedents. The disagreements extend to both the design and the size of the program. Social Security was designed three-quarters of a century ago for a nation that was different in many respects from modern America. Changing circumstances might require revisions in the ways people cope with retirement, disability, or the death of a bread-winner. In addition, ideological divisions - over the extent to which, if at all, the government should use its sovereign authority to impose taxes in order to pay for pensions - that date from the creation of the program persist to this day.

I shall take up each of these issues in turn. On the first question, all of the projected funding gap facing the Social Security Trust Funds - and more - results from the payment of benefits to people who qualified for benefits early in the life of the program.³ How to service the debt incurred because of payments made to people, most of whom are dead or retired, goes to the heart of the way the financing of Social Security is framed in the public mind.

The Social Security actuaries project that Social Security spending, as a share of GDP, will rise 1.2 percent between 2010-2030, but will then fall by 0.2 percent between 2030-2050 as baby-boomers die and are replaced by smaller age cohorts and because the share of total compensation subject to tax is projected to continue to fall. The Congressional Budget Office (CBO) (2009) anticipates that the share of GDP devoted to Social Security will increase a bit more - 1.8 percent - between 2010-2030 and then fall back to 1.5 percent of GDP between 2010-2050. In both cases, Social Security accounts for a negligible share of the total projected increase in federal spending.⁴

More importantly, if the ratio of debt to GDP is to be stabilized before it reaches levels widely regarded as dangerous, budget deficits must be reined in long before 2030. Because Social Security accounts for one fifth of non-interest government spending, various study commissions have proposed that benefits be cut (National Research Council and National Academy of Public Administration, 2010; National Commission on Fiscal Responsibility and Reform, 2010; Bipartisan Policy Center, 2010). For reasons to be described below, however, cutbacks in Social Security benefits are unlikely to kick in fast enough to help materially in stabilizing the debt/GDP ratio.

The third question concerns whether a pension program designed in the Great Depression remains well suited to the 21st century United States. My conclusion is that wholesale change is undesirable but that various adjustments should be made. Indeed, increases in various risks that people commonly face have heightened the importance of the assured basic income that Social Security provides. It is certainly possible through the exercise of enormous ingenuity to conceive of alternative arrangements that would reproduce many of the benefits generated by Social Security. The transition to such arrangements would be laborious and costly. In the end, such a shift would produce few if any demonstrable benefits. In particular, current proposals to replace some or all of the current Social Security system with individually owned private accounts have not been shown to advance any legitimate national objective. Specifically, private accounts are neither necessary for, nor sufficient to, promote increased pension saving.

Footnotes

1. In practice, benefit payments are delayed rather than cut.
2. Officially, Social Security spending and revenues are “off-budget,” along with operations of the Postal Service. In practice, all reports of budget balance merge these off-budget accounts with so-called “onbudget” government operations.
3. Perhaps the most dramatic example is that of the first Social Security beneficiary, who paid $49.50 in payroll tax (including her employer’s tax payment) and received benefits totaling $22,888.92. See “Research Note #3: Details of Ida May Fuller’s Payroll Tax Contributions.” Social Security Online, http://ssa.gov/history/idapayroll.html.
4. Technically, Social Security should not be included in future projected deficits after 2037 because law prohibits benefit payments from exceeding current earmarked revenues after Trust Fund balances have been exhausted. However, the Gramm-Rudman-Hollings legislation enacted in 1985 instructs the CBO to ignore this requirement. Consequently, CBO projects Social Security spending exceeding earmarked revenues, so that its long-term budget projections show deficits that are larger than actually authorized under current law.

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Authors

Henry J. Aaron

Publication: National Tax Journal

Image Source: Â© Shannon Stapleton / Reuters

Supporting Work: A Proposal for Modernizing the U.S. Disability Insurance System

David H. Autor and Mark Duggan — Fri, 03 Dec 2010 16:46:00 -0500

Introduction and Summary —

A wealthy, compassionate nation should have a fair and efficient disability insurance program that protects workers and their families from poverty and loss of medical care in the event of work-limiting disability. In the United States, the Social Security Disability Insurance (SSDI) program has played this role since its inception in 1956. Currently providing disability insurance to 152 million nonelderly Americans and paying monthly disability insurance benefits to 8.1 million workers with disabilities, the program has become a crucial piece of the U.S. safety net. Without this protection, the country would be substantially worse off.

However, SSDI is ineffective in assisting workers with disabilities to reach their employment potential or maintain economic self-sufficiency. Instead, the program provides strong incentives to applicants and beneficiaries to remain permanently out of the labor force, and it provides no incentive to employers to implement cost-effective accommodations that enable employees with work limitations to remain on the job. Consequently, too many work-capable individuals involuntarily exit the labor force and apply for, and often receive, SSDI.

When Congress created SSDI in 1956, disability and employability were viewed as mutually exclusive states. As a result, the 1956 law defines disability as the “inability to engage in a substantial gainful activity in the U.S. economy”—in other words, the inability to work. The SSDI program still uses this definition, providing income support and medical benefits exclusively to workers who are out of the labor force and cannot be expected to work in the future, as determined by the Social Security Administration (SSA).

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Authors

David H. Autor
Mark Duggan

Publication: The Hamilton Project and the Center for American Progress

Cut Social Security Benefits, but Do It Fairly

Robert C. Pozen — Sat, 21 Aug 2010 00:00:00 -0400

This piece by Brookings Nonresident Senior Fellow Robert Pozen was featured in the New York Times as one of a collection of recommendations of specific fixes that could be part of a comprehensive reform package for Social Security.

How do we maintain Social Security in the fairest way? Consider progressive indexing, which would preserve benefits for the bottom third of wage earners who rely on the program for almost all of their retirement income, but recalculate the benefits of higher-paid workers who have other sources of retirement income — including 401(k)s and IRAs — that are tax-subsidized by the federal government.

To calculate initial benefits at retirement, Social Security currently takes workers’ average career earnings and increases them by the rate at which average wages rose during their careers, a mechanism called wage indexing. Once workers start receiving benefits, they are increased annually by the amount that consumer prices rose in the prior year, called price indexing.

Under progressive indexing, by contrast, the initial benefits of the top earners would be calculated by price indexing, while the initial benefits for the bottom third would still be calculated by wage indexing (a grace period would be put in place for workers within three years of retirement). The initial benefits for the middle third would be calculated by a blend of price and wage indexing.

Progressive indexing would reduce the long-term Social Security deficit from $4.7 trillion to between $1.2 trillion and $1.7 trillion, depending on the design of the middle-income blend. Why? Because over the span of a worker’s career, wages tend to rise about 1 percent faster than prices.

In short, progressive indexing would preserve Social Security benefits for the neediest workers while allowing the benefits of other future retirees to grow at the rate of consumer prices or higher.

Authors

Robert C. Pozen

Publication: The New York Times

The Right Reason for Saving Social Security

Alice M. Rivlin — Wed, 21 Jul 2010 16:08:00 -0400

As a member of the President's Commission on Fiscal Responsibility and Reform, which is charged with producing a bipartisan plan to rein in future budget deficits, I get to hear the favorite deficit reduction schemes of friends, acquaintances and strangers. A surprising number lead with Social Security. Some begin, “The first thing is to raise the retirement age in Social Security, which would fix a big part of the problem, right?” (Wrong). Others are afraid the Commission will recommend cutting the benefits of elderly widows living on the edge of subsistence (absurdly unlikely). Many insist that Social Security, because of its separate funding, plays no part in projected federal deficits (also wrong), and therefore should be exempt from the deficit-cutting exercise. As usual, the real story is more complex.

The right reason for saving Social Security is to reassure all Americans that this hugely successful program is solidly funded and will be there for the millions who depend on it when they need it. That such action will make a modest contribution to reducing long run deficits is a serendipitous by-product, not the central motivation. The reason for acting now rather than later is simply that the sooner we act the less drastic adjustments we have to make. These adjustments can involve revenue increases, future benefit reductions (including retirement age changes), or some of each. They need not be large if they are done soon and they need not have a significant effect on those currently retired or close to retirement.

Here is a quick refresher on how Social Security works. Workers and their employers pay Social Security taxes on their wages (up to a limit of $106,800 increased annually for inflation) during their working lives and are entitled to benefits when they retire, become disabled or die leaving survivors. These payments are credited to a fund from which the benefits are paid.

Since the last reforms in 1983 Social Security has run a cash surplus. More money was coming into the fund in payroll tax collections than was needed to pay current beneficiaries. The excess was invested in special Treasury bonds that pay interest. However, with the retirement of the baby boomers and increasing longevity driving up benefit payments, as well as high unemployment reducing payroll tax collections and swelling disability rolls, that cash surplus is fast disappearing. Looking forward, current tax collections will not be enough to fund all benefits; so part of the benefits will have to be paid from the accumulated interest or from cashing in the Treasury bonds. By about 2037, on current calculations, the accumulated interest will be used up and the bonds will all be cashed. Payroll tax collections will still be coming in, of course, but will only be sufficient to pay about three quarters of the benefits due. If nothing is done before 2037, benefits will have to be cut immediately by a quarter (and more thereafter) or the government will have to find the money elsewhere to make up the difference. The system won’t “go belly-up,” as some scare-mongers allege, but it will require dramatic adjustment either in benefits, revenues or both.

If no crisis is projected in the Social Security fund itself for 27 years, why should Social Security be part of the current deficit discussion? I see at least three reasons. First, this is the best time to put Social Security on a sound sustainable track. The only better time would be last year or any year before that. Workers need to know that Social Security will be there when they need it so that they can make other retirement plans on top of a secure base. People who will reach retirement age in 2037 aren’t faceless “future generations.” They are our younger colleagues in the workforce whose payroll taxes are deducted from every pay check – and most of them have been paying those taxes for at least a decade already. They deserve to know that they are contributing to a robust system, one with benefits that they can count on in their retirement planning. Polls indicate that many of them do not believe they will ever collect any benefits.

Moreover, the sooner we act, the smaller the adjustments need be, whether they are benefit reductions, tax increases or some of each, because small changes cumulate over time. We have already waited too long. We should fix Social Security now to avoid more painful changes later.

Second, fixing Social Security now would not only reassure future retirees. It would build confidence both at home and abroad that our political system can still function to solve important problems. It is true, as we keep telling ourselves, that the United States is not Greece. But our public debt is on a dangerous trajectory with no end in sight. World markets have a tendency to plunge rapidly when confidence erodes. Unless we demonstrate an ability to get our house in order we risk a Greek-type debacle at some point. Legislating future Social Security adjustments now is particularly attractive as a signal to the markets because there are essentially no adverse implications for our current recession-ridden economy. We have to fix it sometime, so show we can do it now?

Third, the interaction of an aging population with rising health care spending is the reason federal spending is projected to rise faster than the economy can grow over the foreseeable future. Spending for Social Security alone is projected to rise from about 4.8 percent of Gross Domestic Product (GDP) in 2010 to about 6.2 percent by 2035, when most of the boomers will have retired. That is not a trivial increase in spending, even though spending for Medicare is projected to rise considerably faster—from 3.6 percent of GDP in 2010 to 5.9 percent in 2035 even if we are very successful in cutting the growth of medical costs. Tax increases can be part of the solution, but we cannot raise taxes continuously to offset the growth in spending without eventually damaging the economy, and we can’t afford to keep borrowing increasing amounts, so we have to find ways to keep total federal spending from growing significantly faster than the GDP.

The fact that programs for seniors are driving projected spending increases doesn’t mean they should bear the brunt of the cuts (surely an aging democracy will spend relatively more on older people than a younger one). But neither should programs for the aging be immune. In particular, do we want to allow rapid growth in programs supporting seniors (including Social Security) to drive out spending for education or scientific research or improving infrastructure that might contribute more to future economic growth? Strong growth will ease the economic burden of an aging population, and weak growth will compound it. Fixing Social Security in the context of broader deficit reduction allows us to debate those competing priorities. Those who believe that slowing federal spending growth is necessary to curb future deficits, but want to exempt programs for the aged, need to say why, for example, it is more important to continue increasing benefits for upper-income retirees than to nourish low-income children.

If a higher retirement age will be part of a package of Social Security Reforms, it needs to be phased in slowly and carefully. The age at which retirees can draw full benefits has been rising gradually under a law passed after the 1983 reforms. It now stands at 66 and is already scheduled to rise to 67 in the future. However, workers can choose to retire as early as 62, on reduced benefits—benefits calculated to give them the same total amount as they would have gotten if they had retired at the normal age. At least 40 percent of workers retire as early as they can (age 62) and only a few continue working to the full retirement age (66) or later. In other words, most workers choose to take lower benefits than they could obtain by working longer—some because they want to retire and can afford to forego the larger benefits and some because they cannot work any longer and need the money right away.

Raising the retirement age is a way of reducing benefits across the board. Those who favor increasing the normal retirement age beyond 67 emphasize the fact that people live considerably longer than they did when Social Security was created and seniors are more active than they used to be. This fortunate development means that many people can continue working productively longer than their parents did. The problem is that increases in longevity and health have been concentrated among people with higher earnings and more education. Many jobs take a heavy toll on the human body, or require being on one’s feet for long hours at a stretch. The fact that so many people opt for early retirement at lower benefits suggests that many have lost their jobs or simply can’t work longer.

Increasing the age of full retirement in the future (to, say, 68, or 69) without changing the early retirement rules would mean even lower monthly checks for those retiring at 62 or even 65. Some would stay in the labor force longer, but those unable to do so would just have less money to live on. Those whose checks were reduced most would likely be those who had low earnings over their working lives and accumulated few assets. Raising the early retirement age (i.e., saying no one could collect even reduced benefits before, say, age 64), would mitigate these reductions in monthly checks—and would likely keep more workers at their jobs longer--but it would be even harder on people in their early 60s with physically demanding jobs and no other options.

A package of Social Security reforms that includes raising the age of full retirement or the early retirement age or both should include measures to assist those who physically can’t do their current jobs and create new kinds of jobs for older workers. The cost of these measures would reduce the savings from increasing the retirement age. Hence, the benefits of increasing the retirement age could be more difficult to achieve and even further in the future than proponents suggest. Alternative benefit reductions, especially those reducing future increases at the top end of the income distribution, should also be considered, along with measures to augment revenues, such as accelerating the increases in the limit on earnings subject to the payroll tax.

Opponents of including Social Security in a deficit reduction plan, sometimes point out that Social Security has been running surpluses for decades. Investing those surpluses in Treasury bonds meant the government was borrowing from Social Security to fund other spending. Now that the time has come to redeem those bonds, they say, Social Security should not be “punished” by having to share in the reduction of future deficits. But putting Social Security on a sound fiscal footing is not “punishing” the system or its beneficiaries. The bonds held by Social Security are obligations of the United States and will be paid. But current and future workers need to know that Social Security will be there for them, and the way to reassure them is to act now to adjust the future benefits, revenues or both. Immediate action is best for Social Security. That such action will also modestly reduce long run deficits and show the world that our political system is not totally gridlocked is just icing on the cake.

Authors

Alice M. Rivlin

Image Source: © Rebecca Cook / Reuters

Social Security and Medicare Solvency

Henry J. Aaron — Thu, 14 May 2009 12:00:00 -0400

The latest report on the solvency of the Social Security and Medicare trust funds reveals that these entitlement programs will likely run out of money sooner than expected. Senior Fellow Henry Aaron assesses the future of these two programs.

Transcript

"I think the Social Security trust funds report should be interpreted as worse news than last year, but actually better than the news that has been on the average for about the last 15 years. The Actuary's projections have been pretty much constant over that period. The system has enough money until sometime late in the 2030s or early 2040s. It does face a long term deficit, and the sooner we deal with that problem the better, but there is really no cause for hand ringing that the sky is falling. There is a steady warning that it is time for Congress to face this problem and deal with it. Furthermore it’s a relatively easy problem to deal with. Small adjustments in revenues or in benefits would be sufficient to put the system on a steady financial course for the indefinite future."

"...In the case of Medicare the prospects as indicated by the trust funds reports this week are far more serious than in the case of Social Security. There are smaller reserves for hospital insurance, so the system is projected to exhaust those reserves much sooner. Furthermore, costs are projected to increase not only because the baby boomers are going to retire, which also affects Social Security, but in addition because the per capita costs of health care spending are growing faster than incomes, and that means you got a double whammy. Big changes are going to be necessary, probably mostly on the revenue side, but some in the form of economies and expenditures, in order to assure that the Medicare system is in balance. The key point here is that in order to do those things with in Medicare the changes almost certainly will have to be and should be embedded in overall health system reform. That is the reason my view why President Obama and leading administration spokespersons have been emphasizing that health reform is budget reform for the federal government."

Video

Shore Up Social Security and Medicare Now

High Priority Poverty Reduction Strategies for the Next Decade

Rebecca M. Blank — Sun, 31 Aug 2008 12:00:00 -0400

INTRODUCTION

In the midst of America’s riches, too many families still struggle for economic survival. The poor in American cut across all groups, but are disproportionately represented by single mothers and their children, by persons of color, by immigrants, by less-skilled individuals, or by those with physical or mental disabilities. Many working poor and near-poor families face problems with low wages or unstable jobs. This paper outlines three strategic areas where policy and research attention should focus over the next decade. These are areas where we need to understand more about the problems and the possible strategies that can help increase income, alleviate economic suffering, or improve children’s long-term opportunities. Throughout this paper, I use the word ‘policy’ in a broad sense, to refer to public actions that can be taken by state, local or national government, or to the actions of community-based or religious organizations.

I choose to focus on three areas that are defined by the type of anti-poverty strategies that they encompass. In each of these areas, there are important cross-cutting issues that deal with race, ethnicity or citizenship, gender, disability, or age-specific concerns. This paper is too brief to discuss how these particular subgroups are affected in each policy area, but such an analysis would be important for a more complete policy discussion. While this paper focuses on the issue of poverty, I should also note that action in these strategic areas would substantially benefit both poor and near-poor families. With the poverty line at $20,400 for a family of four, many near-poor families also struggle to make ends meet.

In all of the areas identified below, there are multiple groups working on various agendas, from educational reform to tax reform. Mott will want to focus on a selected set of issues where they can leverage their resources in the most effective way. For each topic, I suggest a few specific policy issues that I think are highly important and where grant-making activities within the Pathways Out of Poverty group at Mott could help advance the agenda.

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Additional Papers presented at the Poverty Reduction Strategies for the Next Decade event:

Poverty Reduction Strategies for the U.S. »
by Mary Jo Bane

Poverty and Philanthropy: Strategies for Change »
by Gordon Berlin

A Plan for Reducing Poverty »
by Ron Haskins

Three Policy Options for Reducing Poverty in the U.S. »
by Wade F. Horn

Policies To Require and Enable Less-Educated Noncustodial Parents To Work And Provide Financial Support For Their Children. »
by Ronald B. Mincy

The Next Time Around: Some Thoughts on Poverty Policy in the Next Administration »
by Katherine S. Newman

Reducing Poverty Four Key Policy Areas that Need More Policy and Foundation Attention »
by Sharon Parrott

Growing Together: New Poverty Policy for New Times »
by Manuel Pastor

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Authors

Rebecca M. Blank

Publication: Charles Stewart Mott Foundation Project

Bridging the Social Security Divide: Lessons From Abroad

R. Kent Weaver — Thu, 19 Jun 2008 16:13:05 -0400

Executive Summary

Efforts by President George W. Bush to promote major reforms in the Social Security retirement program have not led to policy change, but rather to increased polarization between the two parties. And the longer we wait to address Social Security’s long-term funding problem, the bigger and more painful the changes will need to be.

But despite the current political stalemate, Social Security is a solvable problem. To be financially and politically stable, a future Social Security system will likely need several components, including a version of the current Social Security-defined benefit that becomes somewhat less generous over time; and a new universal, mandatory retirement savings component in low-cost individual accounts that is financed by Social Security payroll tax increases; and a reasonable minimum benefit for those with low lifetime earnings. Diversification of trust fund investments and new legislative mechanisms to facilitate early action as trust fund problems emerge would also be useful components of a Social Security reform package. Lessons from other countries point to common-sense ways to address these issues.

A new approach to Social Security reform also requires a different process of policy formulation and adoption. As a first step, the president and congressional leaders should agree on an overall mandate for a commission named through a bipartisan nominating process designed to generate a group that is likely to focus on practical, consensus-building solutions. Special procedures in each house of Congress would provide expedited consideration of the commission’s reform package and alternatives, while providing incentives for constructive congressional engagement in the reform process.

Policy Brief #166

Over the past three decades, population aging has led to profound changes in the public pension systems of most advanced industrial countries. Many countries have experienced multiple rounds of reform. The United States is an outlier: our main public pension program, Social Security, has remained virtually unchanged for a quarter century.

The last seven years have been particularly unproductive for Social Security reform. In 2001, President George W. Bush established a Social Security reform commission with a mandate to propose partial individual account opt-outs for Social Security. The commission’s final report, issued in the run-up to the 2002 midterm election, identified several alternatives but made no clear recommendation. It was roundly ignored by Congress. After his 2004 re-election, President Bush tried to put Social Security reform back on the agenda and failed to generate any enthusiasm among either politicians or the citizenry.

When Social Security has made it to the U.S. agenda, the outcome has been a hardening of positions and rhetoric rather a willingness to compromise. That is a pity for several reasons. First, with a long term shortfall in contributions relative to expected benefits of about 2 percent of payroll, Social Security is a solvable problem. Second, the longer we wait to address Social Security’s long-term funding problem, the bigger and more painful the changes will need to be. As the Pensions Commission in the United Kingdom recently pointed out, an aging population means that society’s only long-term options are later retirement, lower retiree benefits, devoting more tax resources to retirement income security, or increased savings. Third, delaying a Social Security fix diverts attention from health care financing, which is a much more difficult issue politically and economically.

The public pension reform experiences of other wealthy countries provide the United States with a panoply of potential reform options. The major problem in reforming Social Security is a political one. Finding a long-term solution to Social Security’s funding woes—indeed, having any outcome other than stalemate—requires liberals and conservatives to both put aside positions that are most unacceptable to those on the other side of the ideological divide and to accept some proposals from the other side with which they may strongly disagree.

What sorts of positions need to be put aside? Conservatives must drop efforts to “carve out” some portion of current Social Security payroll taxes to finance individual accounts, which liberals believe will undermine the current Social Security system as the core of U.S. retirement income policy. Liberals must recognize that conservatives will accept neither putting any more payroll tax resources into the current Social Security program nor injecting significant general revenues into the current Social Security program, except perhaps for very narrow, carefully delimited purposes.

As difficult as this is, it is the easy part: liberals and conservatives must also agree on a common overall vision for the future of the retirement income system in the United States including some provisions, backed by their opponents, that they strongly oppose. What might that vision look like? To be financially and politically stable over the long term, a future Social Security system will likely need to have several components, including a version of the current Social Security-defined benefit that becomes somewhat less generous over time; a new universal, mandatory retirement savings component in low-cost individual accounts; and an improved minimum benefit for those with low lifetime earnings. Future arguments should concern the relative size of those components rather than whether they should exist at all.

Two major substantive trade-offs are almost certain to be required in a comprehensive Social Security reform package. Conservatives will have to accept increased payroll taxes. They must further accept that the current Social Security-defined benefit will remain the biggest component of the retirement income system. In exchange, liberals will have to accept that all of those additional payroll taxes will go into a new system of low-cost individual accounts. Liberals will also have to accept cuts over time in Social Security’s guaranteed benefit. No agreement is likely to be reached unless both sides set as an objective that combined Social Security-defined benefit and mandatory savings will in the future replace something close to the same percentage of a retiree’s former earnings as the current Social Security system alone does now, and that it not lead to an increase in senior poverty among the most vulnerable groups of seniors.

In addition to a set of reform proposals that can address both fiscal and income security concerns, adapting Social Security for the new century requires: (1) a reform process that encourages compromise and protects politicians from their own predilection to cast blame rather than solve problems, and (2) a willingness on the part of politicians to compromise. The experience of other wealthy countries with aging populations suggests that a workable reform process can be created if politicians are willing to sacrifice some policy control over policy formulation, but it is unrealistic (and undesirable) to expect that they give up complete control. Once again, pragmatic compromise is needed.

Elements of a Reform Package

If the two sides of the ideological and partisan divide on Social Security are willing to work toward an agreement, rather than just bash each other for fun and political profit, a balanced reform package could be built from some or all of the following components:

Payroll Tax Increases and Individual Accounts: A key component of a reform package is likely to be an increase in the Social Security payroll tax of between 2 and 2.5 percent of earnings (split between employers and employees). All of the new contributions would go into individual accounts that would be mandatory for all workers, but no existing payroll taxes would be diverted to individual accounts. Workers would choose from a modest range of index fund options managed by private sector fund managers. Those managers would be selected in a competitive bidding process, as with the Thrift Savings Plan for federal workers. The Social Security Administration would manage the collection and flow of money from individual accounts into those funds and switches among fund managers in order to further lower administrative costs. At retirement, individuals could choose between annuitizing the funds in their individual accounts to guarantee a steady income stream or drawing the funds down by a set schedule. Lump-sum withdrawals would not be permitted.

Gradual Reductions in Defined Benefits: The initial Social Security-defined benefit would be reduced for future cohorts of retirees over time as the new individual accounts are phased in. Replacement rates will be set so that the combined “old” Social Security benefits and new mandatory savings accounts will roughly equal current benefits, given moderate estimates on rate of return for the mandatory savings component. Given the progressive nature of the current Social Security benefit formula, some changes in the Social Security benefit formula or injection of general revenues to finance benefits of low earners would be required. Workers would also need to receive better information about how working longer can lead to higher benefits, and about the increased risk posed by having their Social Security benefits depend partially upon the performance of individual investment accounts.

Alarm Bells and Fail Safes: Another potentially useful element of a Social Security reform package would be an "alarm bell" mechanism to focus attention and debate on future Social Security trust fund imbalances if they arise. One option would be a special procedure triggered by a finding of the Social Security actuaries in the trustee’s annual report that the Social Security trust fund was likely to be exhausted within thirty years.

When this alarm bell is triggered, the president would be required to make a report to Congress within a specified amount of time proposing specific legislative steps to address that shortfall. Each house of Congress would then be given a window of time to consider the president’s recommendations under special rules limiting debate and prohibiting amendments. This procedural vote would require a special majority of 60 percent of members voting in each chamber. Final approval of the president’s plan would require a normal majority vote in each chamber. The procedural vote hurdle would hopefully encourage the president to submit a plan that could win broad support.

Stronger “fail-safe” mechanisms—for example, automatically putting in place a combination of automatic tax increases and benefit cuts in specified proportions if the alarm bell is triggered and the president’s reform package fails to win approval—could also be employed. Sweden, Canada and Germany all have enacted various forms of fail-safe mechanisms that vary in their balance between benefit reductions and payroll tax increases. Sweden’s automatic balancing mechanism, which operates entirely on the benefit side, fully adjusts for adverse trends in demography and economic growth. But congressional and interest group resistance to adopting such a stringent fail safe would undoubtedly be very high, making it unlikely to win adoption.

Improvement of Minimum Benefits: Despite major progress over the past 40 years, the U.S. has one of the highest rates of relative senior poverty among the advanced industrial countries. Poverty is especially serious among elderly widows. Many privatization proposals could make this very vulnerable group even worse off.

To address this problem, Congress should include in a Social Security reform package a more generous minimum benefit for retirees who have worked (or whose spouse has worked) long careers at low wages in the United States. This benefit should be paid for out of general revenues. The current safety net income program for the elderly, Supplemental Security Income, serves very few people because its benefit levels are low and its assets tests are extraordinarily stringent.

International experience suggests that it is almost impossible to eliminate poverty among the aged without increased reliance on some form of means-tested program. In Canada, close to 40 percent of seniors receive the Guaranteed Income Supplement, which has moderate income tests, no assets tests, and streamlined re-application procedures designed to reduce stigma and increase take-up among those who are eligible. Using this approach, Canada has virtually eliminated senior poverty at a modest cost. Both Sweden and Germany included improved safety net pensions in their recent pension reform packages. To reduce costs, this new minimum benefit should not confer automatic eligibility for Medicaid, which would raise program costs substantially, but SSI-qualified seniors receiving the new benefit could still get Medicaid.

Help for Families with Young Children: Another potential component of a reform package, pioneered in many European countries, is a requirement that government make contributions to Social Security and mandatory savings accounts on behalf of a custodial parent of very young children who is out of the labor force or has only minimal labor force participation during his or her children's first years of life. These contributions would be paid at (or topped up to) a flat rate, perhaps 60 percent of average earnings, and paid for out of general revenues. This benefit would disproportionately aid women, who are still much more likely than men to spend prolonged periods either outside the paid labor force or in part-time paid work because they bear a disproportionate share of the burden as caregivers to children and elderly parents. Making modest contributions on behalf of caregivers—at least for very young children—would recognize the social value of their work and help even out the balance of incentives in current government policies, which social conservatives have argued currently favor mothers going into the labor force rather than staying home with their children.

Diversification of Trust Fund Investments: Currently, Social Security trust fund surpluses are invested only in U.S. Treasury securities. Canada, New Zealand, Norway and Sweden all invest part of the public pension funds in equity, corporate bonds and other assets through independent entities in order to gain higher returns. These funds are clearly charged with maximizing fund assets for retirees rather than social investment criteria. The U.S. should consider doing the same thing. As in other countries, these funds should have a strict legislative mandate to maximize return for retirees. The U.S. could use multiple funds of limited size with heavy reliance on private fund managers, to prevent any disruption of capital markets. This approach not only would increase returns on Social Security contributions, it would ease the cash flow transition expected to occur in 2017 as Social Security shifts from serving as a source of financing for the federal government to being a drain on government revenues.

A Process and Timetable for Reform

Social Security reform can only succeed if it is built on a process that involves both Democrats and Republicans, and both the president and Congressional leaders. Equally important, both sides must be constrained from pinning the blame on the other for painful elements of a reform package. Given the political sensitivity of benefit cuts, retirement age increases, payroll tax increases, partial privatization and other reform proposals, an ever-present fear of blame-generating attacks from the other party gives politicians an incentive to criticize proposals from the other party without offering their own alternatives (as Democrats did in 2005), as well as incentives to play to your political bases by being intransigent in policy positions. These political risks make the prospects for stalemate very high.

Several countries with pension funding problems much more severe than the U.S. have found ways to insulate their pension reform process from such pressures leading to stalemate, although the steps taken have understandably reflected individual national political environments. In Sweden, a multi-party negotiating group appointed by a conservative coalition government in the early 1990s succeeded in large part because it was made up of politicians who were committed to reform and to working together and who resisted taking intransigent policy stands. Representatives of two small parties who rejected reform dropped off the working group. The parties remaining on the working group were committed to finding a solution that compromised on key issues, such as the inclusion of individual accounts, and defended their proposal against opposition from interest groups. In the U.K., a recent independent commission built public awareness of the need for pension reform in preliminary reports before issuing its final reform recommendations.

These national experiences suggest several lessons for design of a reform process in the U.S.. First, a partisan process, or a process that appears to give an advantage to one party, must be avoided. Second, a direct interest group role should be avoided. Finally, the government should take time to inform the public rather than try to push a reform package through quickly.

In the round of reform that culminated in the 1983 Social Security reform package, the president and congressional leaders shared responsibility for appointing members of a bipartisan commission. Enactment of that package was aided by two factors. First, doing nothing was not an option: unless a package was passed within a few months, there would not be enough money to pay promised benefits. Second, one of the most difficult changes, an increase in the standard retirement age added by Congress to the commission’s original package, did not need to go into effect immediately; it was delayed almost two decades into the future. Neither of the conditions that facilitated passage of the 1983 reform package exist today: there is no immediate funding crisis to force immediate action, and making a major dent in the long-term Social Security deficit will require phasing in changes sooner rather than later.

Given the absence of an immediate action-forcing mechanism and the need to phase in some painful changes in Social Security fairly quickly, what sort of reform process might work in the United States? One possibility is the procedure used to close military bases and ratify presidentially-negotiated trade agreements: Congress is presented with a package on which it must vote either up or down (with no option to add amendments) by a specified deadline. These procedures prevent bold reform packages from suffering “the death of a thousand cuts.” However, it is unlikely that Congress would limit its authority so severely on an issue that is as politically contentious and has such high political stakes as Social Security.

In the absence of up-or-down fast track authority, what sort of process has the best prospects for facilitating agreement leading to bold and relatively rapid policy change? One possibility is to have a four-step process of policy formulation and adoption that is partially insulated from political pressures, but gives politicians incentives to engage constructively in Social Security reform.

As a first stage, the president and congressional leaders of both parties should agree on a very general overall mandate for a reform commission. Unlike the 2001 president’s commission, the mandate for the new commission should not require members to sign on to endorse a particular substantive direction for reform. On the contrary, they should commit themselves to consider all reasonable alternatives. Second, members of the commission should not be named directly by politicians, but rather by a seven-person nominating body with two appointments by the president, one each by the House speaker, the Senate majority leader and the House and Senate minority leaders, and a chair jointly agreed to by the president and House Speaker and minority leader. The nominating body should be instructed to choose a seven-member commission that includes members with a combination of substantive Social Security expertise and general political and economic expertise. The slate of seven commission members, including the chair, would require the approval of six of seven members of the nominating body. This process should generate a body that is likely to focus on practical, consensus-building solutions.

Third, the commission would be charged with writing two reports. The first, to be published within eight months, would lay out the seriousness of the Social Security financing problem for the public and discuss the major options for change with their social and financial implications. After this report, the commissioners would hold a series of public hearings and publish a second report containing a specific legislative proposal within six months. After conversion to specific legislative language, that proposal would proceed to the fourth stage: debate followed by votes under special procedures in both the House Ways and Means and Senate Finance committees and on the floor of the House and Senate. In these committees, an initial vote would pit the commission’s proposal against an alternative posed by the committee’s ranking minority member, followed by the winner of that vote against an alternative proposed by the committee chair. The bill approved by the committee (if it approved one of the alternatives) would then go to the chamber floor, where after debate the ranking minority member and the committee chair would once again have sequential opportunities to pose alternatives, followed by an up-or-down vote on the winner of that competition. If bills passed by the two chambers differed, the normal conference committee process would be used to try to reconcile them. If a reform package was passed by Congress and signed by the president, it would become law. If no package won enactment, the commission could try again with another proposal within six months that would follow the same congressional ratification process, after which point it would go out of existence. Even if this process failed, it would force congressional leaders to come to grips with Social Security, generating both concrete reform proposals and a momentum for reform.

Willingness to Compromise

None of the specific reform proposals outlined above, individually or collectively, is a panacea for Social Security’s problems. Nor is the proposed reform process. But if politicians truly want to solve Social Security’s funding problems rather than score political points and pander to their political base, it should be possible to assemble and enact a balanced reform package that has elements appealing to both sides of the ideological divide, using reform processes that encourage consensus and minimize blame-generating.

Seeking a middle-of-the-road solution for Social Security is not easy. Texas politician Jim Hightower once wrote a book titled There’s Nothing in the Middle of the Road but Yellow Stripes and Dead Armadillos. That has certainly has been true of the recent debates on Social Security. If it remains true, it will be to the detriment of future generations of workers and retirees, and to the shame of today’s politicians. Social Security is a solvable problem, but only if policymakers exhibit both political courage and willingness to compromise.

R. Kent Weaver is a Senior Fellow in Governance Studies at the Brookings Institution and a Professor of Public Policy and Government at Georgetown University. He is the author of the forthcoming book Reforming Social Security: Lessons from Abroad.

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R. Kent Weaver

Tackle Social Security First

John W. Kingdon and Alice M. Rivlin — Tue, 17 Jun 2008 14:16:07 -0400

The next president and new Congress face a daunting set of challenges come January 2009: Iraq war, troubled economy, global climate change, looming government debt, taxes, health care reform and rebuilding infrastructure, all vying for immediate attention. Such a long "to do" list presents two possible tactics: tackle the hardest problem first or get the easy ones out of the way. We prefer the latter and would start with Social Security.

With the large baby boom generation retiring and Americans living longer, the ratio of workers to Social Security beneficiaries is falling fast. Quite soon the payroll taxes coming into the Social Security system will be inadequate to pay all the benefits promised to retirees. Restoring the system's solvency is crucial to almost everyone's retirement security. The longer we put off setting Social Security on a firm footing, the more expensive the fix will be - indeed, we have waited too long already.

Fixing the Social Security program is relatively simple - far less complex than reforming health care. It requires choosing a combination of revenue increases and benefit reductions, but relatively small changes will do the trick. Emotions run high on which combination is best, but the list of options is short, and political compromise is clearly within reach.

Dealing with Social Security would build rebuild confidence in our elected leaders and give both Democrats and Republicans a legitimate chance to take credit for solving a major national problem. The new president would achieve a major objective, and congressional leaders would score a win as well. That accomplishment would build the momentum and relationships needed for tackling more difficult national problems that require pragmatic cooperation across party and ideological lines.

Of course, everyone has to compromise to accomplish a comprehensive Social Security reform. Republicans have to give up diverting existing revenues into private accounts. But they can preserve private accounts on top of Social Security and strengthen incentives for individual retirement savings without going to "privatization."

Democrats have to accept future benefit cuts, but they need not be drastic and can spare current retirees and lower-income beneficiaries. The package could include future gradual increases in the retirement age and concentrate benefit cuts on higher income people.

As part of the compromise, both parties must agree to revenue increases, but they, too, can be modest and can spare low-income individuals. For example, the cap on income subject to social security tax can be raised in gradual steps.

We know that nothing as politically charged as Social Security can be fixed easily. But saving Social Security is crucial and requires bipartisan agreement. It must be done sometime, and the sooner the better. Let's show that government can function, by solving the Social Security problem early in 2009.

Authors

John W. Kingdon
Alice M. Rivlin

Publication: The News & Observer (Raleigh)

Taking Back our Fiscal Future

Tue, 01 Apr 2008 12:00:00 -0400

The authors of this paper are longtime federal budget and policy experts who have been drawn together by a deep concern about the nation’s long-term fiscal outlook.

Our group covers the ideological spectrum. We are affiliated with a diverse set of organizations. We have been meeting informally for over a year, under the auspices of The Brookings Institution and The Heritage Foundation, to define the dimensions and consequences of the looming federal budget problem, examine alternative solutions, and reach agreement on what should be done. Despite our diverse philosophies and political leanings, we have found solid common ground. We agree that:

Unsustainable deficits in the federal budget threaten the health and vigor of the American economy.
The first step toward establishing budget responsibility is to reform the budget decision process so that the major drivers of escalating deficits—Social Security, Medicare, and Medicaid—are no longer on autopilot.

More specifically, we recommend that:

Congress and the president enact explicit long-term budgets for Medicare, Medicaid, and Social Security that are sustainable, set limits on automatic spending growth, and reduce the relatively favorable budgetary treatment of these programs compared with other types of expenditures.
The programs be reviewed on a regular schedule by the Social Security and Medicare Trustees or the Congressional Budget Office to determine whether they will remain within budgeted amounts.
Significant long-term deviations from budgeted amounts trigger automatic adjustments in benefits, premiums, provider payments, or other revenues. These adjustments could only be over-ridden by an explicit vote of Congress and acceptance by the president.

We provide examples of specific policies that might be adopted to bring the programs in line with their long-term budgets but believe that the first action needed to restore long-term fiscal balance is a change in the way budget decisions are made.

The remainder of this paper describes why we think this change is so important and what the next steps should be.

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Publication: The Brookings Institution and the Heritage Foundation

How To Take Back Our Fiscal Future

Mon, 31 Mar 2008 10:30:00 -0400

Event Information

March 31, 2008
10:30 AM - 12:00 PM EDT

First Amendment Lounge
The National Press Club
529 14th St. NW
Washington, DC 20045

Unsustainable deficits in the federal budget threaten the health and vigor of the American economy. When the next president and Congress take office in January 2009, they will face one crucial question that has been almost absent from the current election campaign: how to close the enormous gap between projected federal spending and revenues.

At this public event, some of the nation’s top economists and budget policy experts presented a new paper arguing that the first step toward establishing budget responsibility is to reform the budget decision process so that Social Security, Medicare, and Medicaid—the major drivers of escalating deficits—are no longer on auto-pilot. Organized by the Brookings Institution and the Heritage Foundation, the diverse group included experts affiliated with many different organizations who have found solid common ground. Authors of the paper include Joseph Antos, Robert Bixby, Stuart Butler, Paul Cullinan, Alison Fraser, William Galston, Ron Haskins, Julia Isaacs, Maya MacGuineas, Will Marshall, Pietro Nivola, Rudolph Penner, Robert Reischauer, Alice Rivlin, Isabel Sawhill, and Eugene Steuerle.

Following a summary of the paper by three former Congressional Budget Office directors, the panel took questions from the audience.

Transcript

Transcript (.pdf)

Event Materials

Participants

Panelists

Stuart Butler

Vice President, Domestic and Economic Policy Studies, The Heritage Foundation

Rudolph Penner

Senior Fellow, The Urban Institute

Robert Reischauer

President, The Urban Institute

Why the 2005 Social Security Initiative Failed, and What it Means for the Future

William A. Galston — Fri, 21 Sep 2007 00:00:00 -0400

Following his successful 2004 reelection campaign, President George W. Bush designated fundamental Social Security reform as his top domestic priority. This was anything but an impulsive decision. As early as his 1978 congressional race, he had suggested that the Social Security System could not be sustained unless individuals were allowed to invest the payroll tax themselves. Overriding theoubts of some political advisors, he raised the issue while announcing his first presidential race, declaring that "We should trust Americans by giving them the option of investing part of their Social Security contributions in private accounts."

Toward the end of a first term dominated by international terrorism, President Bush renewed this call in his 2004 State of the Union address: "Younger workers should have the opportunity to build a nest egg by saving part of their Social Security taxes in a personal retirement account. We should make the Social Security system a source of ownership for the American people." He mentioned the issue repeatedly during the 2004 campaign and was able to argue that his reelection represented a mandate to move forward on what he called personal accounts (and his adversaries called partial privatization).

Within days after the election, President Bush made it clear that he did not intend to play it safe on Social Security reform and other controversial issues. In a post-election press conference, he asserted, "I earned capital in this campaign, political capital, and now I intend to spend it." He was as good as his word. By mid-January of 2005, the White House had launched a huge initiative, directed by Karl Rove and Ken Mehlman, to mobilize public opinion and build public support for Social Security reform and other key presidential proposals.

The President followed up two weeks later, placing a lengthy discussion of Social Security at the heart of his 2005 State of the Union address. After citing the fiscal and demographic pressures moving the system toward eventual bankruptcy, he listed some basic principles and then reached the nub of the matter: "As we fix Social Security, we also have the responsibility to make the system a better deal for younger workers. And the best way to reach that goal is through voluntary personal retirement accounts." This approach, the President argued, would offer younger workers a "better deal": The rate of return would be higher than in the traditional system; the accumulation could be passed on to children and grandchildren; and "best of all, the money in this account is yours, and the government can never take it away."

Having invested so much political capital in this issue, President Bush embarked on the first of what proved to be a long series of tours crammed with events at which he pitched his plan to the people. It soon became apparent that it would be a tough sell. Within weeks, observers noticed that the more the President talked about Social Security, the more support for his plan declined. According to the Gallup organization, public disapproval of President Bush's handling of Social Security rose by 16 points from 48 to 64 percent--between his State of the Union address and June.

By early summer the initiative was on life support, with congressional Democrats uniformly opposed and Republicans in disarray.After Hurricane Katrina inundated what remained of the President's support, congressional leaders quietly pulled the plug. By October, even the President had to acknowledge that his effort had failed.

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Authors

William A. Galston

Publication: NYU John Brademas Center

Taming the Deficit: Forge a Grand Compromise for a Sustainable Future

Bill Frenzel, Charles Stenholm, G. William Hoagland and Isabel V. Sawhill — Wed, 28 Feb 2007 00:00:00 -0500

Deficits do matter. Projections show risks to the economy, an extra "debt tax" on every taxpayer, and highlight the weakened ability of the federal government to invest in the future or respond to unforeseen emergencies. Cutting fraud, waste, and abuse, curbing earmarks, raising taxes on the very wealthy, or streamlining the staffing of the federal government is simply not enough to solve the problem.

Recommendations
The next President should not be expected to immediately provide detailed blueprints for reducing the deficit. However, all candidates can and should do the following:

state unequivocally that deficits do matter
commit to restore fiscal balance over a reasonable time period, such as five years, and to put the nation on a sustainable fiscal course by reforming entitlements as soon as possible
pledge to work in a bipartisan way to achieve this objective
put all issues and options on the table: entitlements, revenues, defense, and all other spending categories
outline the spending cuts and revenue increases needed to achieve short-term fiscal objectives and the changes needed in Social Security and Medicare to maintain long-term fiscal discipline
be candid with the American people about the nature and magnitude of the challenge, acknowledging that the problem cannot be solved simply by cutting fraud, waste, and abuse, curbing earmarks, raising taxes on the very wealthy, or streamlining government
propose reforms to the budget process without assuming that these alone will be sufficient to restore fiscal balance

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Opportunity 08 aims to help 2008 presidential candidates and the public focus on critical issues facing the nation, presenting policy ideas on a wide array of domestic and foreign policy questions. The project is committed to providing both independent policy solutions and background material on issues of concern to voters.

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Authors

Bill Frenzel
Charles Stenholm
G. William Hoagland
Isabel V. Sawhill

Publication: Opportunity 08

Saving Social Security

Peter A. Diamond and Peter R. Orszag — Tue, 01 Mar 2005 00:00:00 -0500

For almost 70 years, Social Security has provided retirees with a basic level of income that is protected against inflation, financial market fluctuations and the risk of outliving one's assets. It protects against other risks as well, such as disability or the death of a family wage earner. In addition, through its progressive structure, Social Security provides some protection against one's career not turning out well. Social Security plays a critical role in providing financial security during retirement: It provides the majority of income for two-thirds of elderly beneficiaries, and all income for 20 percent of elderly beneficiaries.

Over the next 75 years, Social Security costs are projected to rise by about 2.5 percent of Gross Domestic Product (GDP), while revenues are projected to decline slightly as a share of GDP. Social Security's long-term financial health can be restored through either minor adjustments or major surgery. In our view, major surgery is neither warranted nor desirable—sustainable solvency and improved social insurance can be accomplished by a progressive reform that combines modest benefit reductions and revenue increases (as presented in more detail in Diamond and Orszag, 2004).

We begin by describing some benefit improvements for vulnerable groups for which there appears to be wide support, including from the President's Commission to Strengthen Social Security (2001) appointed by President Bush. We then discuss our proposed benefit and tax changes to close the underlying Social Security deficit and finance these important social insurance improvements. We also examine plans that replace part of Social Security with individual accounts, explaining why, in our view, such a course would not represent sound policy.

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Authors

Peter A. Diamond
Peter R. Orszag

Publication: Journal of Economic Perspectives