Liberal Scholars Include Tax Increases and Benefit Cuts to Reform Plan

December 15, 2003

At a Brookings Institution briefing on December 10, two top scholars laid out a plan to preserve the current Social Security structure by gradually imposing tax increases and benefit reductions. Supporters of individual accounts have maintained all along that, absent structural changes to the system, the only other options are increases in payroll taxes and benefit cuts.

At the briefing, "Saving Social Security: Which Way to Reform?" Orszag said that both he and Diamond believed that the basic structure of Social Security must be saved, both from its impending financial crisis and from the reform advocates that propose allowing individuals the option to divert a portion of payroll taxes to individual accounts, otherwise known as "carve outs."

Orszag and Diamond's plan rules out the option to use individual accounts and general revenue transfers as a means to avoid the program's serious long-term deficits. On the other hand, it does not rely completely on benefit cuts or completely on tax increases, but a combination of the two. "Our plan restores balance to Social Security by combining benefit reductions and revenue increases rather than relying solely on either," said Orszag.

Through a series of gradual modifications, Orszag and Diamond's plan addresses what they claim are Social Security's three problem areas—life expectancy increases, earnings inequality, and paying for the "legacy debt" caused by earlier generations receiving benefits larger than their contributions warranted.

The authors note that "improving life expectancy raises Social Security's cost" and thus propose a balance approach with "roughly half the life expectancy adjustment occurring through changes to benefits and the rest through changes to payroll taxes." The employee share of the payroll tax is projected to gradually increase from 6.2 percent in 2005 to 7.1 percent in 2055. The benefit reductions for today's average-earning workers will be the following: 45-year-old, .06 percent; 35-year-old, 4.5 percent; 25-year- old, 8.6 percent.

To correct earnings inequity resulting from recent wage growth among high-earning workers, Orszag and Diamond propose to gradually raise the maximum taxable earnings base until the share of untaxed earnings is about 13 percent. Additionally, for lifetime earnings that fall in the top tier of the benefit formula (above $44,000 in 2003) the plan calls for benefits of 10 cents per additional dollar of earnings, reduced from 15 cents per dollar under the current structure.

Orszag and Diamond propose the following measures to fill the "legacy gap":

• "Introduce mandatory Social Security coverage for newly hired state and local government workers.



• "Impose a universal legacy charge on future workers and beneficiaries, roughly half in the form of benefit reductions for all beneficiaries becoming eligible in or after 2023, and the rest in the form of very modest increases in the payroll tax from 2023 onward … This universal legacy charge gradually increases over time, so as to help stabilize the ratio of the legacy debt to taxable payroll.



• "Impose a legacy tax on earnings above the maximum taxable earnings base. The legacy tax above the maximum taxable earnings base starts at 3 percent and gradually rises along with the charge for everyone described [above] reaching 3.5 percent by 2080."

While this plan does not require any general revenue transfers, Orszag and Diamond rely on current trust fund balances that are widely regarded as an accounting measure to pay future benefits. After 2018, the Social Security will have to redeem those IOUs from the Treasury putting the same pressure on the unified budget. Diamond instead argued that the IOUs held in the trust fund were "meaningful."

Maya MacGuineas, co-director of the Retirement Security Program at the New America Foundation and executive director of the Committee for a Responsible Federal Budget, praised the plan for its honest approach. MacGuineas said, "Trust funds are not an effective way of pre-funding a system if they lead to higher consumption than would otherwise occur, thereby obligating younger workers to not only fund the trust funds, but to also fund the extra expenditures by the government."

MacGuineas also came out in favor of individual accounts. "I do think they can play a crucial role," she said.

For more information, see director of the Cato Institute's Project on Social Security Choice Michael Tanner's study, "No Second Best: The Unappetizing Alternatives to Social Security Choice."

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