Reforming Social Security Won’t Be Easy

The big theme of President Bush’s plan to partially privatize Social Security – ownership – has made a good sound bite. But there is a mouthful of details Congress would have to digest before it could enact the proposal.

Already, possibilities leaked and floated from the White House, such as reducing guaranteed benefits and borrowing $2 trillion to fund “transition costs,” have not gone down smoothly, even among some Republicans.

Among the big issues Congress would have to confront in partially privatizing Social Security:

Budgetary impact

If a portion of the payroll taxes now used to fund Social Security checks is diverted to private accounts, overall federal deficits would increase sharply. That is because Congress annually uses the surpluses Social Security generates from payroll taxes for other government spending (and replaces what it takes with government IOUs in the form of non-marketable Treasury securities).

Diverting between 2 percent and 4 percent of payroll taxes to private accounts would mean as much as a $200 billion annual hit to Social Security’s funding. That would more than wipe out the annual surplus – the excess of payroll tax money coming in vs. the amount going out as benefits – Social Security has contributed in recent years to the federal budget.

For example, if such a change were made in fiscal year 2006 , the government’s deficit would jump to a projected $498 billion rather than the $298 billion that the Congressional Budget Office is forecasting with the inclusion of Social Security’s projected surplus.

Bush administration officials have suggested that the government might have to borrow $2 trillion to cover these “transition costs,” further adding to the public debt.


Coping with private accounts could mean headaches for employers, particularly small ones.

Some early discussions on establishing and administrating private accounts have envisioned a complex system in which many different investment managers would be designated to oversee private accounts and employers would be required to direct payroll taxes to them, much as they direct savings to 401(k) plans.

Simpler systems are under discussion, but they pose their own problems. For example, under one scenario, the diverted payroll taxes would be sent quarterly to the Internal Revenue Service, as they are now. Those funds probably would accumulate for a full year until W-2s show Social Security how much should be credited to each individual. Such an approach could undercut investment returns because beneficiaries probably would receive interest at short-term Treasury rates while the funds were being held.

Another widely discussed simplification measure would require all beneficiaries to invest with a single investment manager, such as the federal Thrift Savings Plan, which manages a savings program for federal government workers. The investment choices under that plan are limited to five mutual funds _ fewer than sophisticated investors might want but still enough to confuse people who have never had to make choices.

Restriction to a single plan also could disappoint Wall Street fund managers hoping to win accounts and the management fees that come with them. Critics have said the costs of multiple private fund managers, whose annual fees typically amount to 1 percent of the assets they oversee, would amount to 10 times what it costs to administer the Federal Thrift Savings plan and even more compared with Social Security’s historical costs. Even a simplified system could require enlistment of thousands of new government employees to handle paperwork and public contact needed under partial privatization.

Disability and survivor benefits

In addition to retirement income, Social Security provides benefits to workers who become disabled before retirement and to dependents and spouses of workers or retirees who die. Together, those receiving either disability benefits or death benefits account for 37 percent of all Social Security beneficiaries.

Although President Bush has said he does not want to disrupt that coverage, the White House has not yet said how future benefits would be calculated or whether private accounts would automatically go to spouses of deceased beneficiaries or become part of their estates.

Income security

Even champions of the president’s “ownership society” ideology don’t want to risk the possibility of future retirees becoming wards of the state, either because their private accounts did not grow enough to offset expected cuts in Social Security’s guaranteed benefits or because they tapped their savings as soon as they could and spent it.

Most analysts expect the White House or Congress to avert that possibility by requiring retirees to use enough of their savings to purchase annuities – together with guaranteed benefits from the traditional Social Security program – to provide an income equal to what the government defines as “poverty level.”

As a result, many if not most low-income people might be required to turn their entire private accounts into annuities, undercutting the notion of ownership of assets that can be passed on to heirs. Critics suggest even middle-income people whose private accounts did not provide expected returns might be forced to use much of their savings for annuities.

Income Redistribution

Formulas used to calculate traditional Social Security benefits ensure that lower-income people receive disproportionately higher paybacks, as a percentage of pre-retirement income, from the program than higher-income people. It is not yet known whether or how a partially privatized system would maintain that practice.

One idea that has been discussed might shift more of low-wage workers’ payroll taxes into private accounts, helping them build more savings. Another possibility would be to continue setting Social Security benefits that are not privatized at higher percentages of pre-retirement earnings for lower-income workers than for higher-income workers.