Not All Social Security Reforms Are Equal

May 30, 2001
Danny Devine
(202) 775-6308
devine@ebri.org, EBRI

WASHINGTON, DC—What is the probability of Social Security reforms being successful? A new comparative analysis by the nonpartisan Employee Benefit Research Institute (EBRI) shows that the answer depends greatly on how the analysis is conducted and the assumptions concerning equity returns and administrative costs for individual account proposals.

According to results from SSASIM published in the May EBRI Notes, sharply different results are obtained when analyzing different reform scenarios in both static ("deterministic") and random ("stochastic") modes over the 75-year period used to test for actuarial balance of the Social Security system. Stochastic projections are significant because they allow for the variability that occurs in real-life economic situations (unlike deterministic projections), especially when equity investments are involved.

For instance, when allowing the model to account for variable outcomes, the EBRI report finds:

  • "Traditional" reforms (raising taxes or cutting benefits) appear to have a relatively low probability of "solving" the program's projected actuarial imbalance in the near term or in the long term, because of the variation in key economic and demographic variables that is likely to occur over the 75-year evaluation period. This variation is not reflected when the model is run in deterministic mode, as the Social Security Office of the Actuary does when making projections.

  • By comparison, a Social Security reform with individual accounts-similar to that advanced in the last Congress by Reps. Bill Archer (R-TX) and Clay Shaw (R-FL)-has a significantly higher chance of achieving actuarial balance, if administrative costs are low and equities produce their historical rate of return. Not surprisingly, those chances fall sharply if administrative costs in an individual-account Social Security system are high and equity returns are low.

"This report illustrates the impact of both equity returns and administrative costs on a reform proposal using individual accounts, relative to the uncertainties surrounding traditional reforms," said EBRI President and CEO Dallas Salisbury. "This report also demonstrates the importance of stochastic projections, as even raising taxes or cutting benefits have a relatively low probability of covering the projected costs of the Social Security program when random events are factored into the calculations, compared with using fixed projections."

Although President Bush has not endorsed any specific way to add individual accounts to Social Security, he is firmly committed to the concept, and has a established a Social Security commission to study proposals to reform the system. The Archer/Shaw proposal would establish mandatory individual accounts for each eligible worker, financed by tax credits from general revenue equal to 2 percent of the worker's Old-Age Survivors and Disability Insurance (OASDI) taxable earnings for each year. Sixty percent of the account balances would be invested in stock index funds, with the remaining 40 percent invested in corporate bonds.

The May 2001 issue of EBRI Notes compares an Archer/Shaw-type reform, with four traditional Social Security reform options that would:

  • Increase taxes only to maintain current benefits.

  • Cut OASI benefits in order to allow current-law taxes to completely fund the new (lower) benefits.

  • Include a mix of benefit cuts and tax increases and continue to increase the normal retirement age from 65 to 67 for those turning 62 in 2011, and subsequently index it to longevity.

  • Immediately (2001) increase the OASI payroll tax rate by 2 percentage points.

The model results show that the probability of achieving actuarial balance for the Archer/Shaw-type reform is 79 percent under the most favorable assumptions on equity returns and administrative costs, 49 percent under mid-level assumptions, and 23 percent under the least favorable assumptions. Under the least favorable assumptions it has a probability of achieving actuarial balance similar to that of the traditional reform options.

EBRI Notes is a monthly periodical providing up-to-date information on a variety of employee benefit topics. Members of the press may request complimentary copies of EBRI Notes no. 5, which features "Social Security: Not All Reform Approaches Are Equal," from Alicia Willis at (202) 775-9132. Reporters may also obtain an executive summary of the article at www.ebri.org/ebripubs.htm Full-text copies of the article are available online by contacting Danny Devine (202) 775-6308, e-mail: devine@ebri.org for the "press only" password. Others may purchase printed copies for $25 prepaid or pdf for $7.50 prepaid by calling (202) 775-9132.

EBRI is a private, nonprofit, public policy research organization based in Washington, DC. Founded in 1978, its mission is to contribute to, to encourage, and to enhance the development of sound employee benefit programs and sound public policy through objective research and education. EBRI does not lobby and does not take positions on legislative proposals.

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