Reforming Social Security

THE DEBATE OVER THE FUTURE of Social Security is really a debate about two connected issues that are of fundamental importance to Americans. The first issue concerns how we should make commitments to future retirees when today’s promises mean huge costs to our children and grandchildren. While some want to ignore this question, the responsible approach is to require Congress to present Americans with an honest picture of liabilities and to take prudent action now. The second issue is how to modernize a program that is giving steadily worse returns to workers and does nothing to help them save for retirement. Creating personal retirement accounts within Social Security is crucial to modernizing the system and to getting the system’s long-term finances back on track. 9


The promised benefits of current retirees and those close to retirement should not be reduced. The government has a moral contract with those who currently receive Social Security retirement benefits, as well as with those who are currently close to retirement. These workers no longer have the ability to adjust their retirement planning.

Personal retirement accounts would improve the rate of return on a worker’s retirement contributions and provide at least an adequate minimum retirement income. Workers, especially those who are younger or have lower income, should be allowed to increase the poor rate of return offered by today’s Social Security by investing a portion of their payroll taxes into a personal retirement account. In addition, retirees must be able to count on at least a reasonable and predictable minimum level of monthly income, regardless of what happens in the investment markets.

Americans should be able to use Social Security to build a nest egg for the future. Workers should be able to use Social Security to build a cash nest egg that can be used to increase their retirement income or to build a better economic future for their families. This must be a priority in establishing a system of Social Security personal retirement accounts.

Workers should be allowed to fund their Social Security personal retirement accounts by allocating some of their existing payroll tax dollars to them. Congress should allow Americans to direct a portion of the taxes that they currently pay for Social Security retirement benefits into personal retirement accounts. Workers should not be required to pay twice for the same benefits— once through existing payroll taxes and again through additional taxes or contributions.

Participation in new personal retirement accounts should be voluntary. No one should be forced into a system of personal retirement accounts. Instead, workers must be allowed to choose between today’s Social Security and one that offers personal retirement accounts.

Any Social Security reform plan should reduce the current system’s unfunded liabilities. rue Social Security reform will reduce Social Security’s huge unfunded liabilities by more than the “transition” cost needed to finance benefits for retirees during the reform. Like paying points to obtain a better mortgage, Social Security reform should lead to a net reduction in liabilities.


Create Social Security personal retirement accounts that workers would own and could use to build nest eggs for retirement. The Administration and Congress need to give a high priority to the rapid passage of real Social Security reform that allows workers to invest a part of their payroll taxes in personal retirement accounts. The new system should include carefully controlled basic investment options available through a low-cost central management and should include a default account if the worker fails to make an alternate choice.

However, a reform effort should focus on more than solving Social Security’s impending fiscal crisis. It should give an equal weight to allowing workers of all income levels to build a nest egg that retirees can use to improve retirement income, meet unforeseen emergencies, or leave to their families as part of their estate. True Social Security reform should also reduce the massive benefits promised to future generations that today’s system will be unable to pay.

Improve the information that workers receive about Social Security. Workers need better information about the state of Social Security’s finances and the level of benefits that they can realistically expect to receive. The existing annual Social Security statement should clearly and simply explain the system’s coming fiscal problems and include a measure of the worker’s rate of return on his or her payroll taxes.

In addition, an improved annual statement would provide a clear discussion of the true nature of the Social Security trust fund and what sacrifices will be required to repay the bonds that it contains. It should also include estimates of what monthly benefit amounts the worker can expect once the system’s trust fund has been depleted.

In the future, Social Security needs to develop a combined statement that includes projected benefits from both Social Security and any occupational or other pension plan in which the worker participates. This combined statement would both provide a better picture of a worker’s projected total retirement income and serve as an incentive to increase retirement savings.

Encourage better financial education and improve the regulatory climate for defined-contribution pension plans. Employers and school districts should be encouraged to offer simple, practical financial education to current workers and to school students so that they can better handle retirement and other investment plans. However, these programs should not be federally mandated or financed.

In addition, defined-contribution pension plans need to be simplified to make it easier for workers to make the right decisions for their future. Congress and regulators should make it easier for plans to include an appropriate default fund that workers’ money would go into if they fail to designate another investment. To boost participation, workers should automatically be enrolled in pension plans unless they explicitly choose not to participate.

The Administration also needs to encourage the development of low-cost, flexible annuities that can be used upon retirement to pay for all or part of a worker’s retirement benefits. Workers also need more accurate and understandable information about the financial status of any plan to which they currently belong. In addition, the Administration and Congress need to encourage the development of “hybrid” pension plans with some of the characteristics of both defined-benefit and defined-contribution plans. This should facilitate the conversion of existing defined-benefit plans to this model to reduce taxpayer liability and provide workers with a more secure retirement future as current defined-benefit retirement systems continue to fail.

Federal budget rules that have the unintended effect of making Social Security personal retirement accounts a huge expense to the federal government should be changed. In addition, the federal accounting system needs to reflect the cost of Social Security and other entitlement benefits that have already been earned in all longer-term financial statements.

As an example, current federal budget rules would treat money that goes into a personal retirement account as an expenditure, artificially increasing the size of federal spending despite the fact that the accounts would greatly reduce future benefit payments. Similarly, federal accounting practices fail to show either Social Security or Medicare benefits that workers have already earned but that will not be paid until some time in the future. Both budgetary rules and the federal accounting system need to reflect any reduction in Social Security’s unfunded obligations that would result from entitlement reform.

Reform the long-term benefits structure of Social Security to reduce the unfunded liabilities imposed on future generations and to focus available funds on the most needy. Social Security’s benefit formula needs to be revised to reduce the cost that future generations will have to pay to honor benefit promises made today.

Among other adjustments, past earnings should be more realistically weighted by indexing them to inflation rather than to wage growth. Other benefit formula changes may also be necessary. At the same time, lower-income workers who have worked a full career must be able to receive at least a certain minimum monthly benefit.

David C. John is Research Fellow in Social Security and Financial Institutions in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation. This article is reprinted from The Heritage Foundation’s Mandate for Leadership.