The Feldstein Social Security Plan
by Robert Greenstein, Wendell Primus, and Kilolo Kijakazi
Introduction and Overview Table of Contents
Increasing attention is being paid to a Social Security I. Introduction and Overview
proposal developed by Martin Feldstein, a Harvard II. How the Feldstein Proposal
economist and former chairman of the Council of Works
Economic Advisers under President Reagan. The III. Weaknesses of the Plan
Feldstein plan is generally presented as a painless IV. Conclusion
way to restore Social Security solvency without any
reductions in the level of benefits the current benefit structure promises, with no tax increases, and, in fact, with almost all retirees receiving greater
retirement income than under current law. When something appears too good to be true, it usually is. This adage holds for the Feldstein proposal.
While proponents of the plan claim it would restore long-term Social Security solvency with no pain, analyses of the plan — including analyses by the
Congressional Budget Office and the Office of the Chief Actuary at the Social
show otherwise. The Social Security system faces Security Administration —
insolvency because the system has promised more in benefits than it will collect in revenues. The Feldstein plan promises more in retirement benefits
than current law would provide but collects no more revenue to cover the added costs. The Feldstein plan would devote much of the surplus projected in the unified budget to finance the increases the plan would provide in retirement benefits. These surpluses, however, are uncertain in magnitude, are not expected to last for more than about two decades, and have other claims on them. When the surpluses wane, major new financing would have to be found. That would entail cutting other parts of the federal government heavily, imposing large tax increases, or borrowing substantial sums and swelling the already-large budget deficits that CBO forecasts will return when the baby boom generation has retired. The Social Security actuaries project that in the absence of budget cuts or tax increases to pay for the plan, the Feldstein
proposal would reduce budget surpluses and then increase deficits by $6.4
(1)trillion over the next 25 years.
The Feldstein plan essentially poses as a "free lunch" entailing no tough choices. This appearance, however, is deceptive. The plan leaves a gaping hole in financing that future Congresses would have to address. The plan is reminiscent in this respect of the feature of the first Reagan budget that David Stockman called a "magic asterisk." And because large reductions in other programs ultimately would be needed unless taxes were raised substantially or deficits allowed to mount, the plan would place programs funded through general revenues at a significant disadvantage and likely lead to some
sacrifice of the needs of younger generations to finance increased benefits for the elderly.
Furthermore, by soaking up much of the surpluses and likely leading to large budget cuts when surpluses dissipate, the plan also would make it harder to rescue Medicare. Medicare's financing hole is so large (much larger than Social Security's) that it is highly unlikely Medicare solvency can be restored without a combination of major, and controversial, program reforms and
additional resources. The Feldstein plan would make it more difficult to find such resources.
Moreover, the increased retirement benefits the plan would provide would accrue disproportionately to the affluent. Retirement income would rise much more, both in dollar terms and in percentage terms, for the elderly who are most well-off than for those with modest incomes. Cutting other government benefits or raising taxes to finance increases in retirement benefits that go disproportionately to the affluent elderly is a formula for exacerbating disparities in income in the United States, which already are at their widest point since the end of World War II and exceed the disparities in any other western industrialized nation.
Of particular concern, the Social Security component of the Feldstein plan is likely to prove politically unsustainable over time. The plan provides federal financing for the establishment of individual accounts and reduces Social Security benefits $3 for each $4 in income that a retiree receives from his or her account. As a result, when the plan is fully mature and workers entering the labor force today are reaching retirement age, many middle- and upper-income retirees would receive most or all of their retirement income from their private accounts and little or none from Social Security benefits. Yet they would have paid substantial payroll taxes to the Social Security trust fund.
A Social Security system that collects substantial payroll taxes from everyone but provides the bulk of its Social Security benefits to retirees who earned below-average wages and their spouses and survivors is not likely to endure. The private accounts would appear to a large segment of the population to be a much better deal than Social Security, and pressures to shift more of workers' contributions from Social Security to their individual accounts would inevitably mount and could prove irresistible. The Feldstein plan thus contains the seeds of its own transformation to a much fuller privatization of Social Security.
While posing these problems, the plan appears to fall short of achieving the basic goal of restoring long-term solvency to the Social Security system. In their analysis of the Feldstein plan, the Social Security Administration
actuaries found it unlikely the proposal would fully restore Social Security
(2)solvency. (This matter is discussed in the box below.)
Finally, although the plan's proponents claim it would boost national saving, the plan would be at least as likely to reduce national saving as to enlarge it. In its analysis of the plan, the Congressional Budget Office noted that compared to current law, "The Feldstein proposal would increase future budgetary
(3)pressures and most likely reduce national saving...." The Social Security
actuaries also concluded that the plan's "effects on national saving and
(4)investment are unclear."
These issues are discussed in more detail below.
How the Feldstein Proposal Works
Under the Feldstein proposal, workers would contribute two percent of their earnings, up to the maximum amount of earnings subject to the payroll tax (currently $68,400), into private retirement accounts managed by financial investment companies. These contributions would be in addition to the payroll tax that workers currently pay to the Social Security trust fund. Workers' contributions to these accounts would be reimbursed dollar-for-dollar by the
federal government through a refundable income tax credit. As a result, the government would pay all of the cost of these deposits in private accounts; workers would get these accounts without paying additional amounts themselves.
When a worker retired, the worker's account would apparently be converted to an annuity paying a monthly benefit for as long as the beneficiary remained alive. As noted, for each $4 dollars the retiree received in income from his or her account, the Social Security benefits to which the retiree otherwise would be entitled would be reduced $3.
Under this approach, all retirees would appear to come out ahead. If due to some catastrophe a retired worker received no income at all from his or her account, he or she still would receive his or her full Social Security benefit, without any benefit reductions. And as long as the worker received any income from the individual account, the combined amount the retiree would get from the private account and Social Security would exceed the Social Security benefit the retiree would receive under current law.
Faced with a Social Security shortfall that results from retirement income promises that exceed the revenue the government will collect to make good on them, the Feldstein plan would make the promises of government-funded retirement income more generous and do so without increasing the revenue the federal government would collect. This raises an obvious question. Where
does the money come from to cover the large additional cost of financing the refundable tax credit that would reimburse the workers for their deposits into private accounts?
According to Feldstein and his colleague Andrew Samwick, the refundable tax credit would be paid for through about 2015 by using government budget surpluses. They acknowledge that between 2015 and 2030, as the surpluses dissipate, the refundable tax credit would have to be financed through other means — cuts in other parts of the budget, tax increases, or deficit spending. Feldstein and Samwick contend that starting in 2030, the plan would pay for itself; they assert that the private accounts would increase national saving and investment to such a degree that corporate profits would rise to substantially higher levels than would otherwise be the case and the increased corporate tax revenue collected on these increased profits would provide all of the additional funding needed. The amount of additional funding needed would be significantly reduced because Social Security would not be paying out as much in benefits due to the provision of the plan specifying that Social Security benefits be lowered when a beneficiary receives income from a private account.
Weaknesses of the Plan
1. Increasing Retirement Income at the Expense of Other Needs
As noted, retirees would receive retirement income from their private accounts as well as a Social Security benefit initially calculated under current benefit rules but then reduced $3 for each $4 the beneficiary is receiving from his or her private account. This means workers would be guaranteed a level of retirement income equal to the Social Security benefit they would receive under current law plus at least 25 percent of the income from their individual accounts. As Brookings economists Henry Aaron and Robert Reischauer note in their new book, Countdown to Reform: The Great Social Security Debate,
the Feldstein plan would provide larger total retirement benefits than those offered under any other major reform plan under consideration or under the current Social Security system, despite the fact that the current system is short
(5)of revenue to honor its promises.
To address the costs of increasing government-funded retirement income, the plan would first consume much of the unified budget surplus, 98 percent of which over the next decade is contributed by the Social Security system. When the surpluses wane, a budget crunch would hit. Taxes would have to be raised, other programs cut, or large deficits incurred.
The plan thus would render it more difficult to provide increased resources to meet unaddressed needs in other areas such as Medicare — a program with a
long-term financing shortfall much larger than Social Security's — and areas
ranging from education to expanding health care coverage to promoting basic research that can help boost productivity. It also would make it harder to pass tax cuts. In fact, once the surpluses dissipate, the overall resources available for other needs would have to be reduced substantially; the plan would create a necessity at that time for major new rounds of budget-cutting or tax increases, unless budget deficits were allowed to rise to unprecedented levels. Aaron and Reischauer note that the plan "... would generate severe budget pressures, particularly after currently projected budget surpluses end. The fiscal duress
(6)would affect all government spending and taxes."
In short, the plan would increase retirement income for the elderly —
especially the more affluent elderly — at the expense of other priorities. When
the fiscal impact of the plan is considered in combination with the impact of whatever steps ultimately are taken to shore up Medicare, the consequences for the rest of the budget could be grim.
2. Boosting Retirement Income Without Paying for It
There is substantial risk that offsetting budget cuts or tax increases of sufficient magnitude to finance the plan would not be approved. (There also is a risk that budget surpluses of the magnitude currently forecast might not materialize.) If this occurred, budget deficits — which CBO already forecasts will return after
2020 and climb to record levels for periods other than war or recession when the baby boomers retire in increasingly large numbers — would climb to
CBO has sounded a warning about this aspect of the plan. In an August 4, 1998 analysis of the Feldstein proposal prepared for House Ways and Means Committee chairman Bill Archer, CBO warned that because the plan contained no mechanism to finance its added costs, it would add to long-term deficits. CBO also stated that while most other Social Security reform plans seek to reduce Social Security's large unfunded liabilities, "the Feldstein proposal guarantees the current retirement benefits and does not reduce the
(7)government's overall liabilities..." CBO added that because the plan's costs
"must be financed one way or another, the plan would implicitly increase the tax burden on future workers if no further adjustments are made on the spending side of the budget."
These problems are not limited to a transition period, as Feldstein contends. CBO rejected Feldstein's claim that the plan would eventually pay for itself because it would boost national saving substantially, which in turn would lead to large increases in corporate investment, corporate profits, and corporate income tax collections. CBO finds these claims to rest on highly unrealistic
The analysis of the Feldstein plan that the Office of the Chief Actuary at the Social Security Administration issued December 3 reveals the magnitude of the fiscal problem the plan poses. The Social Security actuaries examined three types of costs (or savings) that would result from the plan: the cost of the tax credit the plan establishes to reimburse workers for deposits into private accounts; the savings in Social Security expenditures that would result from the plan's provision that Social Security benefits be lowered when a beneficiary receives income from a private account; and the increased interest payments on the national debt the government would have to make. (Because the plan increases government costs, it would cause the national debt to be larger than would otherwise be the case, thereby increasing the cost of interest payments on the debt.) The actuaries found that when these costs and savings are all taken into account, the plan would entail an added cost of $6.4 trillion over the next 25 years. (The $6.4 trillion consists of $3.4 trillion in costs for the plan's tax credit, minus $500 billion in Social Security savings, plus $3.5 trillion in increased interest payments on the debt. These costs could be offset by $2.9 trillion in program cuts or tax increases — rather than $6.4 trillion — since
program cuts or tax increases of that magnitude would keep the national debt from growing larger and would thereby avert increases in the cost of interest payments on the debt.)
The actuaries found the plan would have a negative effect on the federal budget in each of the next 75 years, failing to pay for itself in even a single year. The actuaries reported that while the plan would lessen the size of the funding shortfall in the Social Security system, it would do so by requiring "substantial contributions from the General Fund of the Treasury indefinitely into the future." The actuaries also determined that "...the effect on annual unified budget balances would continue to be substantially negative throughout the
(9)long-range period [i.e., for the next 75 years]..."
Moreover, the plan would not only punch gaping holes in the budget but might fall short of fully restoring Social Security solvency. The actuaries' analysis concludes that "it is unlikely that this proposal alone could completely eliminate the currently projected actuarial deficit." (See box on pages 8-9.)
In summary, the Feldstein plan promises future retirees higher benefits than under current law without making any tough choices. It does so by relying upon unrealistic assumptions that overstate the plan's effects on government revenue collections and leaving it up to future Congresses to fill the plan's yawning financing gaps. The Feldstein plan would lead to shrinkage of other parts of government, sizeable tax increases, and/or much larger deficits and also may fail to restore long-term balance fully to the Social Security system.
3. Inequitable distribution of benefits
Under the Feldstein plan, the affluent would receive much larger increases in retirement income than people with low or moderate incomes. This means that unless budget deficits are allowed to swell, the plan ultimately entails cutting other government benefits or services that may be of primary value to the lower half of the population, or increasing taxes in a manner that cannot be predicted at this time, to finance increases in retirement income primarily for the more affluent half of the population. Ultimately, the net effect is likely to be a transfer of income from those of more modest means to those already living comfortably. This would be done even though high earners have less need for added retirement income since they are more likely to be covered by employer-sponsored pension plans and to have significant personal savings
(10)they can use in retirement.
Aaron and Reischauer provide an example which illustrates that gains in retirement income would be much greater for those at higher income levels than for those who earn modest wages. They examine both a low earner whose average earnings over his or her career equal $12,000 a year and a more highly paid worker with average earnings of about $67,000. Under current law, the low-wage worker would receive a Social Security benefit of $560 a month. Aaron and Reischauer estimate that under the Feldstein plan, this worker could be expected to receive $240 a month from his or her private account. Since each $4 in private-account income would result in a loss of $3 in Social Security benefits, the receipt of $240 a month in income from the worker's private account would cause the worker's Social Security benefits to be reduced $180. The worker's net gain would be $60 a month.
The Actuaries' Analysis of the Feldstein Plan
A memorandum the Office of the Chief Actuary of the Social Security
Administration issued December 3 examines the impact of the Feldstein
plan both on the solvency of the Social Security system and on the overall
federal budget. The memorandum essentially summarizes the actuaries'
principal findings in the following two sentences: "While it does not appear
likely that this provision alone [i.e., the Feldstein plan] could completely
eliminate the currently projected OASDI long-range actuarial deficit of 2.19
percent of taxable payroll, it could eliminate a substantial portion of the
deficit. While the proposal could improve the solvency of the OASDI
program, without reducing the total expected level of retirement income, it
would require substantial contributions of revenue from the General Fund
(11)aof the Treasury indefinitely into the future."
The memorandum's most significant finding concerns the impact of the
Feldstein proposal on the federal budget. The actuaries project that the
plan would lower unified budget surpluses and/or increase deficits by $6.4
btrillion over the 25-year period from 2000 to 2024.
These amounts equal the costs both of the tax credit the plan establishes and of the increased interest payments the Treasury would have to make on the national debt (since the plan's increased costs would swell the
national debt to higher levels), minus the savings in Social Security expenditures that would result from the provision of the plan that reduces Social Security benefits when a beneficiary receives income from a private account.
Using modestly different economic assumptions, CBO has projected
unified budget surpluses totaling $3.4 trillion over the next 25 years. By adding $6.4 trillion in cost over this period, the Feldstein plan would turn an aggregate $3.4 trillion surplus over this period into approximately a $3
The plan would wipe out the surplus that CBO projects will emerge in the non-Social Security budget starting in 2006; the non-Social Security budget
would instead be in deficit every year. The plan also would accelerate the
year in which deficits return in the unified budget. In its August 1998 long-term projections, CBO forecast that surpluses would continue in the unified budget until about 2021. The actuaries' estimates of the budgetary effects of the Feldstein plan suggest that unified budget surpluses would
end — and deficits return — in about 2014.
The actuaries' other major finding is that the long-term shortfall in the
Social Security program would be reduced but probably not eliminated. That the plan would improve Social
Security solvency is to be expected given that the plan pours trillions of dollars into private accounts and requires that Social Security benefits be reduced $3 for each $4 paid in retirement income from a private account.
Under what the actuaries term the "basic plan" — their best assessment of
how the Feldstein plan would work — the plan would reduce the long-term
shortfall in the Social Security system by close to two-thirds. But it would
delay the point at which Social Security becomes insolvent by only four
years, from 2032 to 2036.
The actuaries also make a series of alternative assumptions about how the plan might work. Under the set of assumptions most favorable to Feldstein, in which an optimistic assumption is used in nearly every area in which an
assumption must be made, the plan would eliminate 97 percent of the long-term Social Security shortfall, although the program still would
experience a temporary period of insolvency starting in 2039. This set of assumptions assumes more aggressive and risky investment strategies by
beneficiaries than may actually occur; the actuaries note that the level of stock market investment reflected in this assumption "is well above the average 401(k) experience, and thus likely represents more risk than the
average investor desires." This set of assumptions also assumes there will be no requirement for workers to convert their accounts to annuities when they retire and that workers will "self annuitize" instead — i.e., will withdraw
amounts from their accounts on a monthly basis without purchasing an
annuity. The actuaries note that such an approach carries "substantial risk" to beneficiaries and that "the retiree who attempts to self annuitize has a very good chance of outliving the assets." (Moreover, Feldstein has said
his plan includes an annuitization requirement, so the highly optimistic assumptions would not appear fully applicable to the plan.) Only when the optimistic assumptions are employed simultaneously in each area does the plan come close to restoring Social Security solvency.
Overall, the actuaries analyze eight different possible scenarios (i.e., eight different sets of assumptions) for the plan. The portion of the long-term
Social Security shortfall that would be eliminated ranges from less than half
of the shortfall to nearly all of it. In no case would the year of insolvency be delayed more than seven years, from 2032 to 2039, and Social Security would still be insolvent in 2073 under all but the most optimistic set of assumptions. One of the striking findings of the actuaries' analysis is that despite the large new amounts of federal resources that would be poured into retirement pensions — and the very large costs that would result (as
well as the increases in federal deficits and the national debt that would
ensue unless major budget cuts or tax increases were enacted) — Social
Security solvency probably would not be fully restored.
Finally, all eight scenarios make a crucial assumption in an area where the Feldstein plan is vague. The plan fails to specify what would happen to the
funds in an individual account when the account-holder dies. The actuaries
assumed that the government would repossess three-fourths of all funds in
such accounts and deposit the proceeds in the Social Security trust funds.
It is unlikely, however, that such a provision — which would likely be
viewed as a confiscatory 75 percent death tax on private accounts and opposed strongly by account-holders and their families — could survive
politically over time even if it could be enacted in the first place. Without the assumption that the government would take back 75 percent of an account at death, the Feldstein plan falls well short of restoring Social Security solvency no matter how rosy the other assumptions regarding the plan are.
a Memorandum from Stephen C. Goss, December 3, 1998, p. 1.
b This amount is the actuaries' projection of the fiscal impact of what they
term the "basic plan," which is their best assessment of how the Feldstein
plan would work. The actuaries also examined alternative assumptions
regarding the Feldstein plan, some more pessimistic and others more
optimistic than the assumptions reflected in the "basic plan." The plan's
negative fiscal impact over the first 25 years would be about the same even
under the most optimistic assumptions — $6.2 trillion rather than $6.4
The more highly paid worker would receive a $1,375 monthly Social Security benefit under current law. Under the Feldstein plan, he or she would receive an estimated $1,340 a month from his or her private account. The $1,340 monthly payment from the worker's account would result in a reduction of $1,005 in the worker's monthly Social Security benefit. This worker's net gain would be $335.
Although the federal government was covering the cost of all deposits into the individual accounts (through the refundable tax credit), the more highly paid worker would receive a net gain five to six times larger in dollar terms than the
low-paid worker — $335 a month (about $4,000 a year) compared to $60 a
month (or $720 a year). In percentage terms, the highly paid worker's gain would be more than two times the gain the low-paid worker would receive; the low-paid worker's pension income would rise 11 percent, while the more highly paid worker's pension income would climb 24 percent. (See Table 1.)
Moreover, these figures probably understate the degree to which the plan would disproportionately benefit the more affluent. Highly paid individuals would be more likely to place the funds in their accounts in investments carrying more risk but providing higher yields, both because these individuals would have access to (and the ability to afford) better investment advice and because their financial position would enable them to bear more risk. Low earners would be likely to invest more conservatively and receive below-average rates of return as a result. Because high earners would tend to receive higher rates of return on their accounts than low earners, the degree to which these plans would disproportionately benefit the affluent would probably be greater than the above example suggests.
Wage Average Social Monthly Social Total Overall
Earner Monthly Security Income Security Pension Change
Earnings Benefit from Benefit Income in
under Private After under Pension
current Account Offset Feldstein Income