Under the DeMint bill, individual accounts would be established for individuals born in 1950 or later.   The total amount of contributions to individual accounts in a year would be equal to the cash surplus of tax revenues for the year after the costs of paying benefits.  In effect each worker would have the portion of his or her payroll taxes that are not needed to pay current benefits deposited in an individual account.  The contributions to the worker’s PRA would be automatically invested in marketable Treasury bonds through a Treasury bond index fund (modeled on the Federal Thrift Savings Plan’s G Fund).   Two years after the accounts are fully operational the Social Security Personal Account Board would begin allowing workers to diversify their holdings.

Upon retirement there would be an offset to the retired worker benefit based on the amount of payroll taxes contributed to individual accounts instead of the current system adjusted to reflect the realized yield on the Treasury Bond fund minus 30 basis points for administrative costs.  For workers who die before retirement, the account balance would be transferred to the account of the surviving spouse and the offset would apply as well.  If there is no surviving spouse then the account is left to the workers estate.

Under the Senate version, excess payroll taxes would be immediately deposited into an individual account.  These funds would not be available for the trust fund to invest in Treasury bills and would not be credited to the trust fund.  Every dollar of payroll taxes not needed to pay current benefits would be saved in an individual account instead of the trust fund.

By contrast, the companion bill introduced in the House of Representatives payroll taxes would first be credited to the Social Security trust fund and lent to the general in exchange for Treasury bills before being transferred to an individual account.  Each dollar of surplus payroll taxes would creates two liabilities -- one to the trust fund and one to an account -- that will be reflected in the national debt. This approach is very similar to the double-counting approach proposed by the Clinton administration in 1997. 

Because many details of the House legislation remain unclear, the remainder of this analysis will discuss the Senate legislation introduced by Senator DeMint.

Individual Accounts as the Ultimate Social Security Lockbox

In the past, Social Security's surpluses have been credited the program's trust funds. The funds are invested in government Treasuries - in effect the government is lending money to itself promising to repay itself later.  These efforts to save money in the trust fund to meet future benefit promises have failed to work in an economic sense, because Congress has used the money in the trust funds to pay for deficits in the rest of the budget.  While the promise to repay the money may be there, the money has already been spent, so the government will have to raise taxes, cut other spending or issue new debt when the trust fund needs the money.

Legislators from both parties have promised to stop spending Social Security surpluses several times, but except for one brief exception in the late 1990s those promises have been broken as quickly as they were made.  After more than two decades of building up balances in the Social Security trust fund, we have little to show for it other than a handful of Social Security promises with no feasible plan for how to pay for them.

The DeMint bill would take a different approach by saving any Social Security surpluses in individual-owned accounts so they could not be spent on other areas of government.  Individual accounts provide a more effective method to save current payroll taxes to pay future retirement benefits than trust funds. They - not government trust funds - are the only real "lockbox" where politicians don't hold the key. Individual accounts ensure that current payroll taxes are truly saved for future retirement benefits instead of being spent on other government programs by taking them entirely off the federal ledger. 

Increasing Transparency Of The Budget Process

The Social Security system began running sizeable annual surpluses following the 1983 reforms.  At the same time the federal budget was beginning to run substantial operating deficits.   Many observers have argued the existence of trust fund surpluses to mask the full size of the unified budget deficit reduced has allowed Congress and the administration to tolerate larger on-budget deficits than they otherwise would have and reduced the pressure for serious deficit reduction. Research conducted by University of Pennsylvania Professor Kent Smetters suggests that the existence of Social Security surpluses may have resulted in greater deficit spending outside of Social Security than would have otherwise been the case

The goal of the legislation is to remove payroll tax surpluses from the Federal ledger and budget calculations.  Although it remains unclear exactly how CBO would score the accounts in the bill, if the accounts are considered privately owned deposits into the accounts would be treated as an outlay.  As a result, the surplus in annual payroll taxes would be cancelled out by the outlays into accounts.  This will fulfill the goal of fiscal conservatives in both parties to provide a more accurate display of the budget deficit without using the Social Security surplus to mask the true size of the deficit.

Enactment of the DeMint bill could have a salutary effect on the budget process if removing the Social Security surpluses from the budget debate and exposing the true size of the deficit resulted in a change in budgetary behavior.  However, this will only have a practical impact if enactment of the bill would have to make a difference in the budget debate. 

The day after the President signs the bill, the unified deficit for fiscal year 2010 would increase from roughly $260 billion under current projections to approximately $390 billion.  Would the ever-moving target for achieving the goal of reducing the deficit in half be adjusted to reflect the higher unified deficit totals?  Would policymakers be more reluctant to enact new tax cuts or increased spending if the costs of that legislation would be added to a deficit of $390 billion instead of a $260 billion deficit? The real world impact of this legislation depends in large part on the answer to that question.

Impact On Prospects For Comprehensive Reforms Addressing Long Term Solvency Of Social Security

Creating a mechanism to ensure that savings from changes to restore solvency are saved for Social Security and not used to mask the size of the deficit may make it easier to approve reforms to increase revenues and reduce costs in Social Security.  For example, Republican members may be more comfortable voting for legislation increasing Social Security revenues if those revenues were saved in accounts and not used to finance other spending.  Similarly, it could be easier for Democrats to vote for changes in benefits if the savings from those changes were not used to mask the costs of another round of tax cuts.

As Centrists.Org Chairman Maya MacGuineas observed in a recent op-ed in the Christian Science Monitor, “Individual investment accounts don't answer the question of what changes need to be made to put Social Security’s finances in order, but they do ensure that any changes made to Social Security’s finances will go to strengthen the systems finances instead of being used for other purposes.”

Unlike other account-only free lunch plans introduced in the past, this proposal does not claim to restore solvency and the authors of the plan acknowledge that further reforms are necessary.  The sponsors of the bill stressed that further reforms would be necessary to restore solvency, and the legislation begins with a Sense of Congress finding that comprehensive reforms to fix Social Security permanently and provide for repayment of any general revenue transfers.

By contrast, House bill would create the appearance of improving solvency without actually doing anything.  The bill would improve trust fund solvency on paper by claiming to use payroll tax surpluses to provide advance funding through individual accounts to reduce future liabilities, while continuing to use these surpluses to achieve advance funding on paper through the trust fund by the exact same amount as current law.  It is easy to get an increase in solvency on paper if one dollar of surplus payroll taxes can be saved on paper twice.

Do Individual Accounts “Take Money Away From Social Security?”

Individual accounts are often described as taking money away from the Social Security system. In reality, they represent a different approach to saving current payroll taxes to fund future retirement income.  The total assets of the system would remain the essentially same in an accounting sense, but a portion of the system’s assets held by the government trust funds in Government IOUs would be replaced by individually owned accounts.  

For example, according to Table 1a of the memo describing the impact of the bill prepared by the Social Security Administration Office of the Actuary, by 2020 there would be balances of $2.655 trillion (in constant 2005 dollars) in the trust fund and $1.082 trillion in individual accounts (assuming account portfolios are not diversified to achieve higher returns) for total system assets of $3.555 trillion, compared to a projected trust fund balance of $3.584 trillion under current law.

The reduction in system assets is a result of administrative costs and “leakage” of funds from accounts left to an estate when a worker dies before retirement the new costs to create and administer the accounts.  This loss would be more than offset if preventing the Social Security surplus from being used to mask the size of the deficit resulted in a change in budgetary behavior.

Impact On Trust Fund Balances And System Cash Flow

Because the annual cash-flow surpluses would be redirected to the individual accounts, the trust funds would not run annual cash surpluses as under current law.  Except for the interest on cash surpluses already collected to date, Social Security would stop accumulating trust fund balances, which reflect a growing liability on the Treasury.

The plan would make transfers from general revenues to maintain trust fund solvency long enough so that full scheduled benefits would be payable until 2041. The estimated present value of these transfers is $422 billion.  These transfers are needed primarily because of the timing difference between when costs are incurred for individual account contributions and the savings that are realized from the benefit offset when workers retire.  The bill contains a Sense of Congress provision that all general revenue transfers should be repaid as part of comprehensive Social security reform. The savings from the benefit offset in the bill offset most, but not all, of the general revenue transfers in the bill.

Although annual cash flow would be worse than current law from 2006 through 2016 as a result of depositing funds in individual accounts, the system’s annual finances would be improved from 2017 through 2080 as benefit offsets reduce costs.  For the period 2005 through 2079 as a whole, the amount of general revenues that would be needed to cover trust fund deficits would be $5.8 trillion under the proposal compared to $5.7 trillion under current law.  The size of Social Security’s unfunded obligation for the long-range period is decreased from $4.0 trillion in present value under current law to $3.7 trillion under the DeMint bill.

Impact On The Total National Debt

Although the debt held by the public would increase considerably under the bill, to total debt subject to the limit will be virtually unchanged in the near term because debt that would have been held by the trust fund would be held by individual accounts instead.  There will be more publicly held debt and less intergovernmental debt, because the money that would be borrowed from the Social Security trust fund under current law would be replaced by money borrowed from the public, primarily the individual accounts. The usual rules about why publicly held debt is more significant from an economic sense wouldn’t apply because the government would not have to find a new source of borrowing from private markets to replace the money currently borrowed from the Social Security trust fund.

By contrast, the companion bill introduced in the House of Representatives would result is a substantial increase in the total national debt by double counting payroll tax surpluses.  Payroll taxes would first be credited to the Social Security trust fund and lent to the general in exchange for Treasury bills before being transferred to an individual account.  Each dollar of surplus payroll taxes would creates two liabilities -- one to the trust fund and one to an account -- that will be reflected in the national debt. This approach is very similar the double-counting approach proposed by Clinton in 1997, which was widely criticized by Republicans and centrist Democrats. The key difference is that the funds are credited to an account after being credited to the trust fund instead of being credited to the trust fund for a second time.

Conclusion

Although this proposal would not address the issue of Social Security solvency, it could have an impact on the budget debate and the prospects for comprehensive Social Security reform legislation.  Whether this impact is positive or negative depends on how it would influence future legislative actions.  The approach introduced in the Senate is more likely to have a positive impact on both the budget and Social Security debate than the House version.


Links:
Memo to Senator Chuck Jim DeMint from Stephen C. Goss, Chief Actuary and Alice H. Wade, Deputy Chief Actuary, "Estimated Financial Effects of a proposal to Finance Individual Accounts with the OASDI Cash surplus"

Legislative Text of S. ___, The Stop the Raid on Social Security Act of 2002 (Introduced in the Senate June 23, 2005).

Centrists.Org  Issue Summary: Social Security Reform

CentristPolicyNetwork.Org  Op-Ed by Maya MacGuineas: Individual Accounts As Part Of Social Security Reform From A Fiscally Responsible Perspective (March 30, 2005)

Centrists.Org  2005 Social Security Trustees Report Reaffirms the Need for Action on Social Security Reform  (March 23, 2005)

Centrists.Org  Reality Check on Social Security Reform: Personal Accounts Do Not Provide a Painless Solution (March 11, 2005)