Ideas for Privatizing Social Security

Ideas for Privatizing Social Security

96-504 EPW
CRS Report for Congress
Received through the CRS Web
Ideas for Privatizing Social Security
Updated April 6, 1998
David Koitz
Specialist in Social Legislation
Education and Public Welfare Division
Congressional Research Service ˜ The Library of Congress

ABSTRACT
There has been considerable interest recently in privatizing Social Security. The ideas
are wide-ranging: from adoption of a totally-revamped system of personal retirement
accounts, similar to an approach taken by Chile in 1983, to permitting optional earmarking
of a portion of existing payroll taxes for personal savings. This report summarizes the
proposals that have emerged and the issues surrounding them.

Ideas for Privatizing Social Security
Summary
There has been considerable interest recently in privatizing Social Security.
Although dormant for many years, the idea is not really new. It dates back to the
system’s inception 60 years ago when Congress rejected amendments to delete “old
age benefits” from the Social Security Act of 1935 and to exempt workers from the
system if their employers provided more generous pensions. The renewed interest
is wide-ranging: from adoption of a totally-revamped system of personal retirement
accounts, similar to an approach taken by Chile in 1983, to permitting optional
earmarking of a portion of existing payroll taxes for personal savings, to using federal
budget surpluses to create them. Others suggest that additional payroll withholding
be required, over and above today’s payroll taxes, for personal savings. Still others
suggest that the government should invest the Social Security trust funds in stocks
and bonds instead of federal securities.
Many privatization advocates feel that with expenditures approaching $400
billion a year, Social Security has gotten too big. They argue that it is outmoded, that
the public is skeptical about its future, and that there would be more economic
growth if people saved and invested privately instead. Some take issue with the
system’s social features, which they contend are inappropriate for a retirement
program that workers pay for. They argue for an approach that aligns benefits more
closely with what people pay. Still others feel that the system cannot survive for
long, as evidenced by Congress’ repeatedly having to address its long-run deficits,
and that a more “reliable” means of retirement savings must be adopted.
The system’s supporters contend that it is not “broken” and that moderate fixes
will solve its problems. They fear that privatization would erode the social purposes
of the system and tilt it in favor of highly paid workers, and argue that features such
as inflation adjustments and the system’s disability and survivor benefits are not
easily replicated in private plans. They stress that the risks inherent in personal
investing are high and may leave many people who made unwise or unlucky choices
with inadequate retirement income. They further contend that to the extent that
privatization requires foregoing taxes, federal budget deficits would be larger, there
may not be enough revenue to finance existing benefits, and drastic benefit cuts may
be needed to restore long-run solvency.

Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Range of Ideas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Philosophic Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The “Transition” Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Early Ideas for Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Chilean Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Ideas Emerging from the 1996 Social Security Advisory Council . . . . . . . . 4
Current Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Related CRS Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Ideas for Privatizing Social Security
Introduction
The Range of Ideas
There has been considerable
interest recently in privatizing
The range of ideas—
Social Security. Although dormant
Wholesale reform—replace the existing program
for many years, the idea is not
with a Chilean-like system of personal investment
really new. It dates back to the
accounts.
system’s inception 60 years ago
when Congress rejected
Adopt a two-tiered system composed of a flat-rate
amendments to delete “old age
basic benefit supplemented by a personal savings
account.
benefits” from the Social Security
Act of 1935 and to exempt workers
Earmark one or more percentage points of the
from the system if their employers
existing payroll tax rate for deposit in personal
provided more generous pensions.
savings accounts.
The renewed interest is wide-
Mandate additional payroll withholding (over and
ranging: from adoption of a
above existing payroll taxes) for deposit in
totally-revamped system of
personal savings accounts.
personal retirement accounts,
similar to an approach taken by
Use federal budget surpluses to fund personal
Chile in 1983, to permitting
savings accounts.
optional earmarking of a portion of
Create an investment board to invest Social
existing payroll taxes for personal
Security trust funds in stocks and bonds.
savings, to using federal budget
surpluses to create them. Others
suggest that additional payroll
withholding be required, over and
above today’s payroll taxes, for personal savings. Still others suggest that the
government should invest the Social Security trust funds in stocks and bonds instead
of federal securities.
Philosophic Debate
The debate about privatizing Social Security actually dates back to the system’s
inception in 1935, when both the House and Senate considered amendments to
delete the “old-age benefits” title from the original Social Security Act. The Senate
adopted an amendment by Senator Clark that would have exempted workers from the
program if their employers provided more generous pensions on their own.
However, in the conference with the House that followed, the Clark amendment
proved to be among the hardest issues to resolve, and was dropped. A subsequent
attempt was made to restore it in the House, but it too was defeated. Since then,

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Social Security has evolved as a totally federal system. Federal taxes are levied to
finance its benefits; its surpluses are invested in federal securities; and federal
employees administer it. Moreover, while designed as a pension that workers pay
for, it is very different from a traditional pension system. In particular, it has features
designed to meet social goals: it is mandatory to assure that workers have at least a
basic pension income, and it has provisions intended to meet anti-poverty goals such
as benefit rules that favor low-wage workers.
For some privatization advocates, it is an ideological issue. They feel that with
Social Security expenditures approaching $400 billion a year, the government’s role
has gotten too big. For others, the issue is the apparent lack of confidence the public
has about the system. They argue that too many workers do not believe it can survive
in its current form, and that a more “reliable” means of savings must be adopted. For
still others, it is an economic issue. They contend that the economy would grow
faster if people saved and invested privately instead. Finally, there are those who
believe the current system is inequitable because it has too many social features.
They feel that a worker’s retirement benefits should be more closely aligned with
what he or she pays for them, and that society’s “social” needs should be dealt with
through means-tested programs that explicitly measure whether people are in need.
The system’s supporters contend that it is not “broken.” While acknowledging
that a long-range financing deficit exists, they point out that it only represents 14%
of the average cost of the system. They argue that moderate fixes would eliminate
it. They fear that significant privatization would tilt the system in favor of highly
paid workers who already have substantial means to supplement Social Security.
They argue that features such as inflation adjustments and the system’s disability and
survivor benefits may not be easily replicated in private plans. They stress that the
“risks” inherent in personal investing are high and may leave many people who made
unwise or unlucky investment choices with inadequate retirement income. Finally,
they contend that to the extent that privatization requires foregoing existing taxes, the
federal budget will be harder to balance, there may not be enough revenue to finance
future Social Security benefits, and drastic benefit cuts may be needed to restore
long-run solvency.
The “Transition” Problem
The practical issue with privatizing Social Security is determining how to shift
from the current system to a new one, and in particular, how to finance the transition
from one to the other. Some 44 million people now receive an aggregate 40% of
their income from Social Security. Although there are surplus Social Security taxes
flowing into the government, the system is still basically pay-as-you-go. If workers
were told to put their taxes into private savings plans instead, the question arises of
how the government would continue to finance the current system. The cash surplus
today (the excess of current revenues to the system over payments from it) is only
about $40-45 billion a year. To put this in perspective, foregoing taxes equal to 2%
of payroll would result in an annual revenue loss of $70 billion. Even if people were
required to take reductions in their eventual Social Security benefits, those reductions
would not amount to much until way off in the future and therefore would not slow
the system’s outgo for many years. However, the revenue loss would be immediate.

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A decade’s worth of foregoing 2 percentage points of the payroll taxes would result
in $1.1 trillion in lost receipts and interest.
Even if it were accepted that the Social Security system could forego these
receipts, there would still be the questions of “if” and “how” the government should
make up for the revenue loss. Excess Social Security taxes now flow into the
Treasury. If the federal budget were running a deficit, the Treasury would receive
less revenue and need to borrow more from the public. All that would occur is that
money would flow into the Nation’s financial markets through worker deposits in
personal accounts, only to be borrowed back by the government. If borrowing from
the public were not an option, the issue for policymakers is what revenue increases
and/or spending cuts should be made to cover the revenue loss. If the federal budget
were running a surplus, the question is whether this is the way it should be used (with
spending increases and tax cuts being the alternatives).
Early Ideas for Reform
The seeds for today’s debate probably date back to the mid 1970s when it
became apparent that changing economic and demographic circumstances would
strain the financial condition of the existing system. Although there was little
congressional interest then in wholesale reform, a new wave of privatizing ideas
began to emerge. One proposal, designed and circulated on the Hill in the early
1980s by the Insurance Company of North America, would have permitted workers
to contribute up to $6,000 a year to an IRA or some similar plan and then take an
immediate income tax deduction for the contribution. For each $1,000 workers
deposited in their accounts, 0.5% of their eventual Social Security benefits would be
forfeited. Workers who made the maximum $6,000 contribution for 33-1/3 years
would forfeit all their benefits.
A similar plan, authored by Peter Ferrara and promoted by the CATO Institute
in the mid-1980s, would have given workers an income tax credit of up to 20% of
their Social Security taxes for equivalent deposits in what he called “super IRAs.”
Upon retirement, the worker’s Social Security benefits would be reduced by an
amount related to some proportion of the lifetime Social Security taxes that had been
refunded through the credits.
Another plan devised by former Council of Economic Advisers chairman,
Michael Boskin, and promoted by the National Federation of Independent Business,
would not have privatized any part of the program per se, but transformed it into two-
tiers with the second tier fashioned after a traditional annuity plan. He proposed that
the government administer it. Representative Archer offered this proposal in a House
Ways and Means Committee markup on the 1983 Social Security Amendments, but
it was defeated.
In recent years a number of Members have come forward with other ideas. In
1986, Representative Gingrich developed a plan to eliminate the payroll tax and have
workers under age 40 contribute to IRAs instead. Older workers were to be
grandfathered under the old system and a new retirement trust fund was to be created
to raise the income of all seniors above the poverty level. A value added tax was to
be levied to provide the needed revenues.

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In the 102 and 103
nd
rd Congresses, Representative Porter introduced bills to
privatize Social Security surpluses by mandating that 2 percentage points of the
12.4% Social Security tax be deposited in IRA-type accounts. Initially, these
proposals were viewed as an alternative to a Social Security tax cut idea offered by
Senator Moynihan in 1990. Although not specified in his bills, Representative Porter
envisioned an eventual reduction in Social Security benefits in recognition that
people would be saving through these IRAs. Former Senator Symms introduced a
similar proposal.
The Chilean Model
The Chilean system represents another model. In 1981, Chile engaged in a
sweeping reform of its Social Security system. Private retirement accounts managed
by pension fund companies were established to replace much of the government-run
system. Beginning in 1983, new labor force entrants were brought into the new
system and existing workers were given strong inducements to join through an 18%
mandatory salary increase and so-called recognition bonds that reflected the accrued
value of the benefits they earned under the old system. Employers were relieved of
any payroll taxes. Workers were required to make at least a 10% of pay contribution
toward retirement and 3.3% for survivor and disability protection. The government
regulates the investment companies and requires a minimum investment return. It
also runs the old system for those who remain in it and guarantees a minimum benefit
under the new one. Some 90% of the workforce is under the new system. Many
analysts attribute a considerable portion of the economic growth that Chile
experienced over the past decade to the new system. In part, Chile’s reform was
aided by the presence of a military government, existence of a substantial budget
surplus, and a high degree of public dissatisfaction with the old system.
Ideas Emerging from the 1996 Social Security Advisory Council
A range of ideas was proposed in January 1997 by three different factions of a
13-member legislatively-mandated Social Security Advisory panel. It was charged
with examining various ways to restore the system to a sound financial footing. One
faction suggested revamping Social Security into a two tiered system — the first
would provide flat-rate benefits based solely on years of covered employment and
the second would be a private savings account, similar to an IRA, into which 5
percentage points of the existing Social Security tax would be deposited. The plan
called for a 1.52 percentage point payroll tax increase and $2 trillion in public
borrowing to help defray the “transition” costs of maintaining the existing system for
those already in or nearing retirement. A second faction proposed a new mandatory
payroll deduction of 1.6 percentage points on top of existing Social Security taxes to
finance personal retirement accounts, similar to 401(K) plans. The assets that would
build up in these accounts would be expected to compensate for the cuts in Social
Security benefits needed to restore the system to long-range solvency. A third faction
suggested that Congress consider creating an investment board, similar to the federal
employees’ thrift investment board. This board would invest part of the Social
Security trust funds in the financial markets, perhaps through stock and bond “index
funds” rather than the direct purchase of stocks and bonds. All three factions of the
Advisory Council proposed other measures that in conjunction with their

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“privatization” proposals would restore the Social Security system to long-run
solvency.
Current Proposals
One of the most significant policy question with creating private accounts is
how to fund them. Thus far, three generic approaches have been suggested: (1)
carve out a portion of existing Social Security taxes, (2) withhold more from
workers’ earnings, or (3) use projected budget surpluses.
The “carve out” approach: Currently, 12.4% of a worker’s first $68,400 in
annual earnings is paid in taxes by employees and employers (6.2% by each) to
finance the Social Security system.1 In recent years, the most prominent approach
suggested to setting up private accounts would require or allow workers to use part
of these taxes to do so. Such an approach is incorporated in one of three alternative
plans proffered by the 1994-1996 Advisory Council on Social Security.2 Its sponsors
proposed that 5% of pay be carved out of the current Social Security tax rate for the
creation of so-called “Personal Security Accounts” or PSAs.3
The carve out approach also is reflected in a number of bills introduced in the
105th Congress, including, S. 321 (introduced by Senator Gregg), calling for a
mandatory 1% of pay set aside, and H.R. 2782 (introduced by Representative
Sanford), which is similar to S. 321. A voluntary approach is reflected in H.R. 2929
(introduced by Representative Porter), calling for a 10% carve out (5% for employee
and employer, each) for those electing to switch from the existing Social Security
system to new individually-based accounts. A similar voluntary approach, calling for
an 8% carve out (4% for employee and employer, each), is reflected in H.R. 27684
1 More than 90% of workers have earnings below this annual threshold ($68,400 in 1998);
thus, most workers pay the Social Security tax on all of their earnings. Another 2.9% tax
rate (1.45% on employee and employer, each) is levied on all earnings (i.e., there is no
annual maximum) to help finance the Medicare Hospital Insurance (HI) trust fund. The total
Social Security and Medicare tax rate that the vast majority of workers and employers pay
on all their earnings is 15.3%.
2 The council was a legislatively-mandated body whose primary purpose was to make
recommendations to resolve Social Security’s long-range financing problem. Its report was
issued in January 1997.
3 Supported by 5 of the 13 members of the council, this plan (sometimes referred to as the
Schieber/Weaver plan, named for two of its authors, Sylvester Schieber and Carolyn
Weaver) also would have increased FICA taxes on workers by 1.52% of pay for 72 years.
Hence, it represented a combination of a “carve out” and “add on” approach — on balance
the net carve out from the two was to be about 3.5% of pay. The plan also envisioned
converting the traditional government-run program into a flat-rate benefit system as well as
making other changes to restore the program’s long-run solvency. The authors contended
that the combination of benefits from the new private accounts (the PSAs) and the scaled
down government system would equal or possibly exceed the benefits payable from the
current Social Security system (i.e., assuming the current system were able to pay the
benefits prescribed under the benefit rules of current law).
4 It also provides for additional voluntary contributions—i.e., an “add on” above the 8%
(continued...)

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(also introduced by Representative Sanford). Yet another approach is
5
reflected in
S. 1792 (introduced by Senator Moynihan) that, among numerous other changes it
would make to Social Security directly, would allow workers and employers to each
have a 1 percentage point Social Security tax cut. If the worker used it to create an
individual retirement savings account, his or her employer would have to match it.
Obviously, if it is projected that the taxes that finance the system are insufficient
to pay for future promised benefits, earmarking some of them for the buildup of
private accounts would make this problem worse.6 It would mean that to restore the
system to solvency future tax increases would have to be larger or benefits cut
deeper. Some proposals address this issue by asking workers to forego or forfeit a
part of their Social Security benefits in exchange for the option to build private
accounts — the premise being the larger the amount of taxes that they forego, the
greater the forfeiture. In effect, the burden of reduction is placed on those who have
made the greatest use of the carve out. The goal of these proposals is not to make the
current system’s problems worse, but to replace it. With these measures, the key
financing question is one of timing. The larger the amount of foregone tax revenues,
especially in the near term, the less money there is to meet current expenditures. The
commitments to people currently receiving benefits or nearing retirement would have
to be met, so to some extent the amount of the potential tax carve out is constrained,
at least in the early years of such a proposal, by the need to keep the existing system
going.
Withholding more from earnings — the “add on” approach: Some have
suggested that instead of carving out existing taxes, today’s workers could be asked
to set aside an “additional” part of their incomes to build private accounts. One
faction of the recent advisory council suggested that an additional 1.6% of pay be
mandatorily set aside. A similar, but voluntary, approach is reflected in H.R. 1611
7
(introduced by Representative Petri), which would permit anyone eligible for a
“deductible IRA” under current law to make a contribution to a new personal “Social
4 (...continued)
required of those who switch.
5 Similar “carve out” measures introduced in the 104 Congress include bills by Senator
th
s
Kerrey, Simpson, and Robb (S. 824 and 825), and Representatives Porter (H.R. 2953),
Thomas (H.R. 2971), and Nick Smith (H.R. 3758).

6 Under the Social Security trustees’ 1997 intermediate forecast, the Social Security system
is projected to have an average 75-year deficit equal to 2.23% of taxable payroll under
current law. This amount is equal to about 14% of the average cost of the system over the
period. In terms of today’s taxable payroll, this would be equal to $75 billion per year.
7 This “add on” was included as part of the so-called “Individual Accounts” or IA plan,
sponsored by the Advisory Council Chairman Edward Gramlich and member Marc
Twinney. The plan included other measures to raise the income of the Social Security
system and reduce its expenditures. As with the PSA plan, the intent was to give recipients
the approximate combined benefits from a constrained Social Security program and
individual accounts as they would have received under current Social Security benefit
computation rules.

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Security investment account.” The motives here are not to replace the existin
8
g
system, but to offset some of the benefit reductions that may have to be put in place
to restore solvency with accumulations of private assets.
Earmarking budget surpluses: Yet another possibility would be to have the
government use surplus federal revenues — assuming unified budget surpluses
eventually arise — to make deposits in new individual accounts. This approach
would envision neither a tax carve out nor a new form of withholding, but would be
contingent upon budget surpluses arising and not being used for numerous other
politically popular purposes (i.e., new spending initiatives or lower taxes). Such an
approach is partly reflected in H.R. 3082 (introduced by Representative Nick Smith),
under which the Secretary of the Treasury would allocate one-third of any annual
budget surplus to personal retirement accounts established for workers covered by
Social Security (each worker would receive a “pro-rata” share of the surplus).
9
A
related proposal, introduced by Representative Kasich, H.R. 3456, would dedicate
budget surpluses for the creation of “Social Security Plus accounts” for Social
Security taxpayers who had annual earnings of $2,800 or more (the amount deposited
would be based on a worker’s earnings). Similar proposals have been suggested by
Senator Roth and Speaker of the House Gingrich. Support for the Roth proposal was
reflected in passage on April 1, 1998 (by a vote of 51-49) of a Sense of the Senate
resolution on H. Con. Res. 86 calling for Senate passage of such a measure this year.
Investing the Social Security trust funds in the stock market — Representative
Solomon has proposed yet another variant — creation of a Social Security investment
board with authority to invest surplus Social Security funds in stock and bonds as
well as government securities (H.R. 336 in the 105 Congress, H.R. 164 and 491 in
th
the 104 Congress, and H.R. 2152 in the 103
th
rd Congress). This approach, also
reflected in a third Advisory Council proposal, would not create new personal
savings accounts but would attempt to use equity investments to bolster the return of
the Social Security trust funds.
Related CRS Products
Report 95-839, Social Security: The Chilean Example, by Geoffrey Kollmann.
Report 97-990, Social Security in the United Kingdom: A Model for Reform? by
Geoffrey Kollmann.
Report 94-593, Social Security Taxes: Where Do Surplus Taxes Go and How Are
They Used? by David Koitz.
8 This bill also includes a provision prescribing that $1,000 be transferred from the general
fund of the Treasury to each “Social Security investment account” established pursuant to
the bill (presumably to be financed by the sale of “federal assets” to be recommended by the
President).

9 Among numerous other measures to constrain the long-run cost of Social Security, the bill
also would permit additional voluntary contributions, carved out of workers’ social security
taxes, up to $2,000 a year. In turn, they would receive lower Social Security benefits in
recognition of the amounts they accumulate in these new private accounts.

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Report 91-129, Social Security: Investing the Surplus, by Geoffrey Kollmann.
Report 87-14, An Analysis of a Proposal to Authorize “Super IRAs” as an
Alternative to Social Security Benefits, by David Koitz.