Solving Social Security's problems

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As the debate over Social Security reform heated up over the holidays, a major dispute between the advocates of change and the defenders of the status quo involved the estimates of the program's total unfunded liabilities by the Social Security trustees. Traditionally, the trustees confined their unfunded-liability estimate to the next 75 years. In the 2004 report, the trustees reported that the present value of Social Security's unfunded obligation through 2078 was $3.7 trillion. But because Social Security will not disappear in 2079, the trustees endeavored to estimate its financial situation "through the infinite horizon." Demonstrating that Social Security's problems under current law actually worsen after 2078, the trustees reported an extremely long-term unfunded liability of $10.4 trillion. For a while, the battle over reform centered on which of the two figures ($3.7 trillion or $10.4 trillion in unfunded obligations) was most appropriate.

Then, following the New Year's Day holiday, Peter Wehner, President Bush's director of strategic initiatives, issued a "not for attribution" memo detailing the White House's current thoughts on Social Security reform. Two days later, the Wall Street Journal published the memo on its Web site.

Clearly, the most salient comment in Mr. Wehner's three-page memo was this observation: "We simply cannot solve the Social Security problem with Personal Retirement Accounts [PRAs] alone. If the goal is permanent solvency and sustainability -- as we believe it should be -- then [PRAs], for all their virtues, are insufficient to that task."

Mr. Wehner referred to a widely circulated proposal, "wage indexation," which earlier found prominence in Plan #2 detailed in the December 2001 report of the President's Commission to Strengthen Social Security. Under current law, the formula determining first-year Social Security benefits is based on trend changes in wages, which historically have risen faster than prices. Thus, based on current law and projected rising real (i.e., inflation-adjusted) wages, the Congressional Budget Office (CBO) estimates that the scheduled initial annual benefit for the median-wage-earner born in 1990 will be $23,300 (expressed in 2004 dollars). That is 56 percent higher than the scheduled initial benefit ($14,900) of the median wage earner born in 1940 and retiring this year. However, current law also requires that once the trust fund assets fall to zero, benefits must be reduced to the level that can be financed by contemporaneous Social Security tax revenues. Based on the CBO's expectation that fund assets will be exhausted in 2052, the initial benefit of the worker born in 1990 would fall from its scheduled level of $23,300 to $18,100.

Now, in addition to permitting workers to divert 4 percentage points of the combined employer-employee Social Security tax of 12.4 percent to PRAs (up to $1,000 per year), Plan #2 would also change the indexation of the initial benefit from wages to prices. The effect would be to reduce the level of the initial benefit for the median-wage-earner born in 1990 to $14,500. (Trust-fund-financed benefits would account for $9,700, and PRAs would contribute $4,800.)

Essentially echoing the CBO's analysis, which found that merely instituting PRAs does not by itself solve Social Security's financing problem, Mr. Wehner declared in his memo: "If we borrow $1-2 trillion to cover transition costs for [PRAs] and make no changes in wage indexing, we will have borrowed trillions and will still confront more than $10 trillion in unfunded liabilities."

Thus, arguing over the two unfunded-liability figures ($3.7 trillion over 75 years or $10.4 trillion for all time) seems to have missed the elephant in the room. What Mr. Wehner's memo has contributed to the debate is the crucial acknowledgement that the White House and the CBO (the nonpartisan budget scorekeeper advising Congress) agree that PRAs are insufficient to the task at hand.