by Robert Eisner

Some of the Results

Benefits to Retirees

With an actual rate of return of 8 percent on the indexed fund investments, those making the mean contribution over their working lives would enjoy substantial additional pension benefits. Members of the 1963 cohort, the first to contribute for the full thirty years, beginning with the mean contribution of $706 in 1998, would be credited with mean supplementary fund balances of $124,699 in 2027. In 2028, their first year of retirement, they would receive supplements to their Social Security checks of $10,170, or $4,848 in 1998 dollars, as shown in Table 5.1 on page 26. This would add almost exactly one-third to the OASDI projection of mean benefits of $14,497 for those with "average earnings."¹ The supplementary benefits would carry annual cost-of-living adjustments of 2.5 percent over the next nineteen years, bringing the current-dollar amount to $16,258 in 2047. Benefits for older cohorts, who do not have the opportunity to contribute for the full thirty years, will be less (unless they make up for it with contributions of more than 3.1 percent). Investors in the indexed funds may indeed earn more or less than an 8 percent return, as illustrated in Table 5.1.

The mean figure of $706 for initial contributions used in the calculations hides, of course, a wide variation among contributors. Lower-income workers would be likely to contribute much less, many not at all. Since the three-tiered benefit calculations in the current Social Security system offer much higher "replacement ratios," or benefits relative to previous earnings, for those with low incomes, the supplementary program would redress the balance to an extent. Its benefits would be exactly proportionate to contributions. But the basic social insurance and favoring of low-income workers built into the mandatory contributions of current Social Security would be fully maintained.

In the aggregate, the additional benefits will of course start low for new retirees but will rise continuously as more cohorts retire and as successive cohorts have been contributing for longer and longer periods. The OASDI intermediate-cost projections put benefits ("outgo") in 2025 at 6.27 percent of GDP. The supplementary benefits in that year would come to 1.22 percent of GDP, as shown in Table 5.2, and would thus be adding 19.45 percent to the projected benefits under the current program. At equilibrium in 2047 the supplementary benefits will have mounted to 2.47 percent of GDP. Benefits paid by OASDI, according to the intermediate forecast, will be 6.5 percent of GDP at that time.²

Once in full flower, then, the supplementary program would be raising Social Security payments to beneficiaries by about 38 percent. If mean supplementary contributions came instead to 6.2 percent, equal to the amount currently paid by employees alone, total Social Security payouts would increase by more than three-quarters. Net gains in total retirement income will be less, however, to the extent that the investments via Social Security prove substitutes for other money set aside for retirement.

The amount of real benefits to retirees is affected by both the rate of price inflation and the rate of increase of real wages. In Table 5.3, I compare the effects of different rates of inflation on the (pessimistic) assumption that real wages grow at the 0.9 percent per annum pace projected by the OASDI trustees. Note that slower price inflation increases real benefits while faster inflation reduces them. My assumption is that benefits remain actuarially fair. The need to make higher cost-of-living adjustments after retirement thus necessitates a reduction in real benefits. For those contributing for the full thirty years, benefits in 1998 dollars of $4,567, with my originally assumed inflation rate of 2.5 percent, are reduced to $3,539 if the OASDI projection of a 3.5 percent inflation rate in the future turns out to be correct. Real benefits would be raised to $5,066 if the current 2.1 percent cost-of-living adjustment for 1998 were repeated indefinitely into the future. The reduction in real benefits associated with greater rates of inflation could be avoided if the Social Security system-in effect, the U.S. Treasury-were to undertake to finance whatever cost-of-living adjustment is indicated by the consumer price index, as it does with current benefits. My proposal might well be modified to encompass this.

The reduction in real benefits accompanying greater inflation rates in my simulations follows as well, however, from the assumption that nominal rates of return are not affected. This implies that real rates of return are reduced proportionately by higher rates of inflation. It would seem more reasonable to assume that over the long run real rates of return are not affected by inflation. This would mean that if a 3.5 percent inflation rate is assumed, for example, instead of 2.5 percent, it would be appropriate to expect a nominal stock index return of 9.05 percent³ instead of 8 percent and have the Treasury credit fund balances at 9.05 percent for investment in Treasury securities. Such a nominal rate of return is of course still far below what has been enjoyed on average in the stockmarket in recent years.⁴

As shown in Table 5.3, crediting the higher rate of return would restore the real benefits lost to inflation. The Treasury might, alternatively, each year adjust the rate of interest credited to the funds by the difference between the actual rate of inflation and the 2.5 percent that I have assumed in my main simulations.

It must also be noted in Table 5.3, however, that the faster rate of growth of real wages of 1.425 percent assumed in Table 5.1 generates higher real benefits. These would be $4,848 for those contributing for thirty years as against the $4,567 for the slower real wage growth of 0.9 percent and the same 2.5 percent rate of inflation.

Other Consequences: The Trust Fund

Improved Social Security retirement benefits are the most significant result of the supplementary contributions. Implementation of this proposal will have other, salutary effects on the various (real or more typically imagined) problems popularly perceived with regard to the Social Security Trust Funds, the federal budget deficit, the federal debt held by the public, and national saving. These effects are largely matters of accounting, of doubtful or nonexistent consequence. But since so many would base policy on these bookkeeping measures, they are worth noting.

These other, broad-scale implications will depend upon the rate of growth of aggregate contributions. This, in turn, will depend upon the growth in the nominal wage base for each cohort and on the rate of increase in cohort size. With my initial assumptions of a 3.96 percent per annum increase in wage base within each cohort and a 1 percent per annum increase in cohort size, aggregate contributions expand by 5 percent per year. Assume that GDP grows at this same 5 percent rate.

As shown in Table 5.2, which is built on these assumptions, fund assets immediately begin growing. By the year 2002 they will have added $689 billion to Social Security assets, equivalent to some 6.6 percent of GDP (Appendix Table A1 on pages 45-47 provides projections for all of the years from 1998 to 2058 and for 2070 and 2075). By the critical year 2029, when the intermediate-cost projection would have the OASDI combined assets on current policies exhausted, the supplementary accounts would have put $16,290 billion, or 41.6 percent of GDP, into the coffers. When equilibrium is reached in 2047, the additional fund assets of $43,450 billion will constitute 46.1 percent of GDP, and they will continue to grow in step with GDP thereafter.

What does this do to the overall shortage in the OASDI Trust Funds? The current intermediate-cost forecast for 2047 is a negative $36,605 billion. The additional assets from the supplementary contributions and the return on them will turn that negative figure to a positive $6,845 billion. The year 2052 would, however, be the last year of "solvency," even with the supplementary contributions added in. The total assets by that year would have fallen to minus $55,086 billion plus $55,455 billion supplementary, or $369 billion. In 2053 the total will have turned to a negative $2,527 billion.

For those concerned with the matter of trust fund assets, it is worth noting that, without any other corrective measure, these supplementary contributions averaging 3.1 percent of taxable wages would have put off the day of reckoning twenty-three years, from 2029 to 2052. And if supplementary contributions came to 7.3768 percent of wages, the funds would remain solvent until 2075, the end of the period of long-run forecasts.

How can larger contributions add so much to OASDI assets when they must be used to pay out increased benefits? The explanation is simple. The contributions come first while the payouts come later. There is a fifty-year transition period, until all those making the supplementary contributions are matched by those receiving benefits. Until 2047, then, it is clear that OASDI assets deriving from the supplementary contribution program will be mounting.

What may not be so obvious, though, is that even after 2047, for the indefinite future those assets will keep increasing, actually at the rate of increase of taxable payrolls. This increase occurs despite the fact that retirement annuities are actuarially fair-the individual gets back exactly what he or she has put in plus the 8 percent annual return. In the aggregate, the funds keep growing because in a growing population and expanding economy current benefits are tied to the lesser per person prior contributions of less numerous cohorts. There are more current contributors per cohort in each year than there are beneficiaries, and they are earning more, thanks to the increase in nominal wages. Only in the event that cohort size stopped growing, and in the more unlikely event that the average nominal wage base per worker stopped increasing, would the fund balances stop growing.⁵

The Federal Budget

As for the overall federal budget, as it is currently reported, the initial effect of indexed fund investment will be to increase the deficit-or reduce the surplus. These results, however, will quickly be reversed as the funds swell. The deficit rises at first because the tax-deductible supplementary contributions will go not to the Treasury but to buy the indexed stock and bond fund securities. Owing to the loss of tax receipts, with contributions of 3.1 percent of taxable payrolls the deficit will be increased by $16.4 billion or 0.19 percent of GDP in 1998. This deficit will soon be wiped out, though, as balances accumulate, assuming the returns on the indexed funds are actually 8 percent.⁶ The initially very small new benefits paid out will add to the deficit but will be compensated for in minor part by the taxes paid on these benefits. By 2000 the additional income from the securities investments will be sufficient to compensate for the losses to the Treasury, and the net effect on the budget will be approximately nil.

Thereafter, the contributions to reducing the budget deficit or increasing the surplus rise rapidly. In 2002, with $48 billion in income from the investments, the net effect on the budget is $21 billion on the positive side of the ledger, or 0.20 percent of GDP. In 2010 it is $145 billion or 0.94 percent of GDP. In 2025, when the net impact on income tax payments has just turned positive, since taxable current benefits begin to exceed tax-deductible current contributions, the budget deficit is reduced or surplus increased by $555 billion or 1.72 percent of GDP.⁷ While benefit payments as a percentage of GDP continue to increase, the deficit reduction or surplus enhancement as a percentage of GDP begins to fall from its maximum of 1.73 percent attained in 2026. It reaches an equilibrium value of 1.38 percent in 2047, and the dollar amount of that deficit reduction or surplus increase, then $1,304 billion, continues to grow at the 5 percent rate assumed for the growth in taxable payrolls.

To the extent that the Treasury collects the cash dividends or interest payments earned on the indexed funds, in effect borrowing from the trust funds as it does currently, it reduces its borrowing from the public. This then keeps down the most significant measure of the federal debt, that held by the public, currently some $3.8 trillion.

All of these effects on deficits and debt may indeed seem strange. One must start, however, from the strange ways in which federal government accounts are reckoned. Washington's measures are often arbitrary and not infrequently foolish. Sales of assets are netted against outlays and hence reduce the deficit.⁸ When a government agency buys financial assets, such as those related to failed savings and loan institutions a few years ago, that increases the deficit; when the financial assets are sold, the deficit is reduced. Most relevant here, the addition to explicit debt enlarges the deficit while the implicit or "contingent" debt of future Social Security commitments is not counted. Hence, if government increased mandatory contributions in the form of payroll taxes and simultaneously legislated increases in future benefits, that would reduce the deficit because the increased obligation toward future benefits would not be counted. To take the position, as in this paper, that the increased voluntary contributions and the returns that accumulate on them should be considered as reducing the deficit is thus consistent with current accounting practice.

One could go the other way and view current mandatory payroll "contributions" not as taxes but as forced loans to the Treasury that will be paid back eventually in annuities.⁹ If so, the conventional measure of the current deficit would be vastly increased.

In any event, my supplementary contributions and benefits would appear to offer no fundamental difference in terms of budgetary impact from the current, mandatory contributions. It is true that the benefits are more sharply defined as relating precisely to contributions, but, as with the current system, these benefits are not written in stone. Annuities might be altered on the basis of changes in life expectancy or even changes in administrative costs if Congress decided to take those into account.

National Saving

And what about the much-watched though also defective measures of "national saving"? The conventional tally adds together private saving-the sum of personal saving and the undistributed profits that constitute corporate saving-and public saving, taken as the sum of federal, state, and local budget surpluses. National saving in turn is identical, except for (recently sizable) "statistical discrepancies" in measurement, to the sum of gross private domestic investment and net foreign investment.¹⁰ To the extent that the increased contributions to Social Security are not a substitute for other saving or investment and hence actually reduce individual consumption, they increase private saving.

How much such diversion from other saving outlets there will be, as opposed to new saving by individuals, is hard to determine. Households' and nonprofit organizations' direct holdings of corporate equity at the end of the second quarter of 1997 came to almost $5.4 trillion,¹¹ some of which might well be sold in order to make additional contributions to Social Security. And pension funds currently have more than $5 trillion in assets,¹² with new contributions running at a rate of some $250 billion per year.¹³ IRAs had $1 trillion in assets and 401(k)s had $650 billion at the end of 1995.¹⁴ Average contributions for the 23 million-plus participants in 401(k) plans in 1993 were almost exactly $3,000.¹⁵ Yet calculations from a Health and Retirement Survey database indicate that 44 percent of the population have made no arrangement whatsoever for retirement saving. The percentages of Americans without such provision were put at about 64 percent for those with incomes less than $20,000 and 51 percent for those with incomes between $20,000 and $30,000.¹⁶

It has been estimated that close to 30 percent of married households are not saving adequately for retirement, and the median shortfall in retirement wealth is $22,480, which could be met by saving 0.52 percent of annual earnings.¹⁷ The measure of adequacy, however, is tied to a level of income that was enjoyed prior to retirement. Many may aspire to live more than "adequately" in their final years.

My assumption that the total of voluntary contributions would amount to 3.1 percent of taxable payroll implies an aggregate of $103.85 billion in 1998. In view of what has just been discussed, this total, which translates initially as mean individual voluntary contributions of $706, does not appear unreasonable. To the extent that the actual figures were to turn out lower-or higher-my aggregate projections would be altered proportionately, but the thrust of the results would not be changed.¹⁸

Studies of the extent to which the introduction of 401(k)s and IRAs brought in new saving rather than a shifting of existing assets have produced disparate results. I will apply the principle of "equal ignorance" with regard to my proposed new Social Security vehicle. I will suggest that the supplementary contributions may come half from new saving and half from diversion from other methods of saving.

All this, I must caution, relates to individual efforts to save. These efforts may not in the end yield increased national saving. Household cuts in consumption may cause businesses to cut back production and reduce, rather than raise, their capital expenditures or investment as well. There would then be an associated fall in national income and saving. The advocates of increased private saving generally ignore or downplay this "Keynesian" concern, however, and may welcome the supplementary contributions as likely to increase private saving. The reduction in federal deficits, unless it is matched by increases in deficits or decreases in surpluses at the state and local level,¹⁹ will by definition increase public saving, as conventionally measured. The ultimate effect on national saving and investment will depend on the balance of changes in public and private investment.²⁰

Investment in Treasury Securities

All of the results above hold for supplementary contributions to investment in Treasury securities except those for the budget balance. To the extent that supplementary contributors use the option of investing in Treasury securities, the effects on the measured federal deficit or surplus will be somewhat different. With identical rates of return, retirement benefits will be the same regardless of the type of investment. The effects on the OASDI balances will also be the same, but the effects on the budgetary position and the Treasury debt held by the public will, because of the curiosities of federal accounting, be different.

The reason for this is that contributions used to buy Treasury securities to be held by the OASDI will, in accordance with Treasury accounting, be viewed (properly) as Treasury revenues, trimming the deficit. Debt held by the public will be correspondingly reduced since the Treasury will not have to borrow from the public amounts equal to the securities it sells to the OASDI. This will also entail savings in net interest paid by the Treasury.

OASDI purchase of indexed stock or bond funds with the supplementary contributions, on the other hand, aside from the tax deductions provided, will initially have no impact on any measured deficit or debt held by the public. However, the returns from these investments, while credited to the individual participant accounts, to the extent they are in cash or converted to cash, will flow into the Treasury and hence affect budgetary balance.

The impact on the federal budget of the two kinds of investment will be different in the fifty-year transition period, until there is a full set of those contributing all of their working lives and receiving full benefits in their retirement years. They will also be different, however, in the growing economy that I assume will prevail in the long run after equilibrium is attained fifty years hence.

Investing in Treasury obligations would immediately, in 1998, change the budget balance by $87 billion, or 1 percent of projected GDP. This is the sum of the contributions of $104 billion minus the forgone income taxes of $21 billion, plus the interest saving to the Treasury of $4 billion on the average amount of reduced borrowing from the public, calculated at a 6.5 percent long-term rate of interest. In equilibrium, beginning in 2047, the contribution to surplus or to reduction in the deficit will be 1.96 percent of GDP, as shown in Table 6.1 (page 38). These figures compare with 1.39 percent of GDP and 0.76 percent for investment returns in the securities markets that were, respectively, 8 percent and 6.5 percent.