The Washington Post

Monday, July 17, 2000

Bush's All-Gain, No-Pain Retirement Plan

By Martin Feldstein

George W. Bush has proposed a plan to protect the future of Social Security by allowing individuals to invest a small portion of their payroll taxes in Personal Retirement Accounts. Without such a reform, actuaries warn that the nation will have to choose between a big cut in Social Security benefits or a major increase in taxes.

With no change in the 12.4 percent payroll tax, the aging population eventually will require a painful 30 percent cut in benefits relative to the levels projected in current law. Maintaining the projected benefits would require raising the tax rate to 19 percent. For a couple in which the husband and wife each earns $30,000, that would be a tax increase of nearly $4,000 a year.

The Bush proposal for Personal Retirement Accounts avoids that painful choice because the return on the stocks and bonds in Personal Retirement Accounts would be substantially higher than the low return earned in the existing Social Security system.

Vice President Al Gore has argued incorrectly that Bush's plan would lead to lower retirement incomes, especially for the poor. The opposite is true. A system that combines traditional Social Security with Personal Retirement Accounts that are financed with about one-sixth of payroll tax payments- about 2 percent of earnings- can make future retirement incomes even higher than they are projected to be in current law and can be helpful to low-income groups for which the Social Security program is often a bad deal.

The attempt of the Bush critics to scare voters relies on a flawed study for the New Century Foundation that asserts that a Bush plan would cause future retirement incomes to be 20 percent lower than the levels projected in current law. But although that study analyzes a plan that resembles the Bush proposal, the plan differs in critical ways that lead to predictions of poor performance. When those errors are corrected, that finding is reversed, and future retirement incomes exceed projected levels.

The first correction is to recognize that the Personal Retirement Accounts raise national saving, leading to a larger capital stock and therefore greater profits. A significant portion of the extra profits would go automatically to the Treasury as higher corporate tax payments. Transferring that extra tax revenue to the Social Security Trust Fund would help to maintain both the level of future benefits and the solvency of the trust fund.

The second correction is allowing the trust fund to borrow when it does not have enough assets to pay benefits. Although the increase in baby boomer retirees will cause the trust fund to run out of money under any plan, the infusion of corporate tax revenue and the growing size of Personal Retirement Account annuities in a Bush plan eventually would bring the trust fund back to a healthy positive balance.

The New Century Foundation study incorrectly assumes that benefits would be cut sharply when the trust fund runs dry. In fact, no such benefit cut is needed if the trust fund borrows temporarily to bridge its funding gap. Because of the higher return on Personal Retirement Account balances, the needed borrowing by the trust fund eventually would be fully repaid with interest.

Critics of the Bush proposal also argue that Personal Retirement Accounts are risky because the funds are invested in stocks and bonds. But although investment returns are volatile, the return over a lifetime is almost certain to exceed the low return implicit in the traditional pay-as-you-go program. While staying with an unreformed system would make a benefit cut almost certain, the retirement incomes provided by the mixed system proposed by Gov. Bush would almost certainly exceed the benefits projected in current law.

Making Personal Retirement Accounts part of Social Security can be particularly helpful to divorced women and other groups ill served by the current Social Security system. Now, a woman who is divorced after fewer than 10 years of marriage gets no retirement benefits based on her former husbands earnings. Since the average duration of marriages that end in divorce is fewer than 10 years, poverty in old age is high among divorced women. An individual account system can avoid such poverty by requiring a couple to share the combined value of their accounts at the time of divorce.

A Bush-type plan would help low- and middle-income persons by eliminating an increase in the payroll tax rate. No other policy can do as much to protect the consumption of the future aged and to raise the after-tax incomes of average Americans in the decades ahead.

Martin Feldstein, an economics professor at Harvard, chaired the Council of Economic Advisers under President Reagan and is an adviser to the Bush campaign.