Issue Summary: Wealth Building (Basics) updated 2/14/2004
Detailed Issue Summaries contain a quick reference to Centrists.Org policy ideas. They will be revised and updated periodically for clarity and usefulness, and as events and policy ideas change. Questions or comments? Please contact us at information@centrists.org .
Basics:
Overview
Social Security Reform
Stakeholder Accounts and Pension Reform
Detailed Issue Summary: Social Security Reform
Subcategories:
Magnitude of the Social Security Problem
What the Social Security (and Medicare) "Trust Funds" Mean
How to Evaluate Social Security Reform Proposals
1. Impact on the Budget
2. Degree of Progressivity
3. Opportunities for Wealth Creation
4. Absence of Gimmicks
Liberal Approaches
Universal Entitlements vs. Means Testing
The Do-Nothing Approach
The Government Pre-Fund or "Lockbox" Approach
Incremental Tax Increases and Benefit Cuts
The Diamond-Orszag Proposal
The Right-Wing Free-Lunch Approach
Peter Ferrara Proposal
Centrist Social Security Reform Proposals
Sen. Lindsey Graham Proposal
Kolbe-Stenholm Proposal
Comparing Recent Social Security Proposals
Wealth Building Overview
Too many Americans approach retirement without sufficient financial assets. Many own a home, but possess few financial assets. Some reach retirement age without assets of any kind, and are therefore completely dependent on Social Security and (possibly) some welfare programs.
Over the last two decades, the availability of generous defined benefit pensions (a fixed pension based on years of service and wages at a given firm) has declined. It is no longer common for workers to stay with one employer for 20 or 30 years and retire with a pension that replaces a decent percentage of their income.
Most workers now have access to 401k savings programs at work, and many people have established Individual Retirement Accounts (IRAs) or an alphabet soup of other tax-favored savings programs. However, some have used these retirement savings programs instead to fund education or housing or consumption expenses, sometimes paying a steep tax penalty as a result.
Meanwhile, Social Security is headed for a demographic crunch. The bulge of baby boomer retirees will raise Social Security spending by roughly 2 percent of GDP over the next 25 years. At the same time, the number of working age Americans is expected to stagnate. Absent a large, unforeseen increase in immigration or birthrates, tomorrow's Social Security beneficiaries will be dependent on fewer workers paying taxes into the system.
This is a politically unstable situation. For the first time in world history, the U.S. economic boom of recent years has created a mass upper-middle class with considerable assets. At the same time, many workers reach old age with next to nothing. Moreover, many younger workers are uncertain whether or not Social Security benefits will be available when they retire, and may increasingly resent paying taxes into the system. Finally, exploding retirement costs (including health care entitlements) may force unpopular tax increases and spending cuts in the future, or may push the federal budget much deeper into deficit, which would hurt the prospects for long-term economic growth and job or business opportunities.
Centrist Wealth Building Principles and Policy. Here is a revolutionary centrist idea: the federal government should be at once smaller and more progressive. Weirdly enough, many conservatives are hesitant to reduce the cost of Social Security benefits. Instead they promote "free lunch" proposals that would create huge individual investment accounts for workers, and would expand or fully maintain promised Social Security benefits. Needless to say, their proposals don't plausibly explain where all the money would come from.
Old-style liberals, on the other hand, are reluctant to shift any Social Security spending from the upper-middle class to the poor, enhancing benefits for low-income workers at the expense of upper-middle class retirees. They fear any such redistribution, however progressive, would reduce political support for Medicare.
Centrists don't believe it's necessary to bribe the upper middle class with expensive entitlement benefits in order to gain political approval for social insurance programs for those in need. Retirement and health programs for the elderly should have two components: a social insurance component and additional options or opportunities for retirees to get extra benefits. For poor retirees, those options could be heavily subsidized; for affluent retirees, the subsidy would be small or zero. That is probably the only way to provide a socially appropriate level of support to people with few assets without bankrupting the nation providing entitlements to affluent seniors with little need.
Centrist wealth building policy is focused on expanding retirement savings and helping all Americans accumulate financial wealth. Sufficient retirement savings and income is a moral and social imperative -- we simply don't want seniors to be desperately poor.
However, asset building is also extremely important. Income support is not enough. In the U.S. capitalist system, wealth allows people to take risks, to launch businesses or educate children. Without some wealth, families can't make the investments necessary to get ahead. With some assets, people can borrow; without assets, it is hard to get that first loan.
Changing lifestyles should be reflected in more flexible retirement and savings systems. Social Security was designed for one-worker families. Defined benefit pensions were designed to lock-in employees' long-term loyalty to one firm. Neither approach is well suited to a flexible labor force, to families where both parents work, to workers with multiple or frequently changing jobs, to people wishing to work part-time or part-year or to take several years out of the labor force, or to the increasing numbers of micro-business, free-lance and self-employed workers.
Finally, we don't want workers to have the impression that government programs will take care of them in their old age -- income from Social Security, health benefits from Medicare, nursing home care from Medicaid -- without any effort or sacrifice on their part. For one thing, none of those programs provides a rich or satisfactory benefit: Social Security benefits are small, Medicare benefits require supplementation, and Medicaid nursing homes are often substandard. People shouldn't be fooled. All of the entitlement programs should be reformed in a way that gives workers of all income levels the responsibility to plan ahead and prepare themselves for old age.
Specific imperatives for centrists include expanding opportunities for all workers to save for retirement, reforming and simplifying pension and retirement accounts so that they are more flexible for businesses and so that individuals find it easier to save, reforming Social Security by reducing its future liabilities and adding a personal wealth-building component, and, if the budget allows, creating individual stakeholder accounts, funded from birth as a nest egg and a guarantee that all Americans have a long-term savings account.
Boosting National Savings. Not all savings proposals would affect national savings, that is, private savings plus the government surplus (or minus the deficit). Ideally, savings incentives that would reduce the federal deficit should increase total private savings by a like amount. That way, the reduction in public savings would be matched by an increase in private savings.
For example, payroll tax "carve-outs" (shunting a portion of payroll taxes to individual savings accounts) and "add-ons" (adding a tax that funds individual savings accounts) would both increase private savings. If people viewed funds from a Social Security carve-out or add-on as a substitute for traditional Social Security benefits down the road, they would not view the accounts as a windfall and change their consumption patterns. Therefore, even if the funds for carve-out or add-on accounts added to the federal deficit, the reduction in public savings would be largely matched by the increase in private savings.
Ultimately, boosting national savings, or at least maintaining the national savings rate, is a key to improving the long-term rate of economic growth, and would greatly improve the nation's ability to cope with the extra costs of the baby boom generation's retirement.
Link:
Centrists.Org No-BS Long-Term Budget Baseline homepage
Social Security Reform. Social Security reform is essentially a timing deal for U.S. society: pay more now (to fund investment accounts for workers) and pay less later (by reducing the promised Social Security benefits in the future). Under most proposals, the gains from workers' investment accounts would allow them to maintain their retirement incomes, even with smaller regular payments from Social Security.
The timing deal is necessary because of the demographics of the baby boom generation. There will be almost 40 million new Social Security beneficiaries after 2010 as the baby boomers retire, and (absent an unforeseen and dramatic increase in immigration or birthrates) there will be proportionately fewer workers paying payroll taxes to fund Social Security benefits for retirees.
The decade between 2005 and 2015 is relatively benign demographically. Baby boomers -- born after 1945 -- will begin applying for Social Security benefits at age 62 in 2008. (They will start to join the Medicare rolls at age 65 in 2011.)
However, the slow build up of the number of retirees relative to workers will have very powerful long-term effects. On the current budgetary trajectory, Centrists.Org anticipates intense budgetary pressures after 2015, with annual budget deficits approaching 6 percent of GDP by in 2015 and the national debt exceeding 100 percent of GDP less than a decade later.
There are two primary ways the government could pre-fund the Social Security imbalance, and thereby alleviate some of those budgetary pressures: (1) paying down the national debt, and (2) funding individual investment accounts. Either approach would involve sacrifice over the next decade in order create a politically sustainable Social Security system thereafter.
The first approach has been tried: in 1998, President Clinton announced a policy of deferring politically popular tax cuts in order to build budget surpluses and pay down the national debt. The idea was to pay the public debt down to sufficiently low levels that the federal government could afford to borrow large amounts in the future from the public to cover increased costs for Social Security benefits.
The Clinton approach worked only briefly -- it did not prove durable politically. In the presence of budget surpluses, legislators from both sides of the political aisle lost their appetite for spending discipline. That, in turn, caused the public to demand tax cuts, eliminating the prospect for long-term surpluses.
The more plausible approach to Social Security pre-funding is forced savings, compelled by public mandate, but held by individuals in personal investment accounts.
Probably the only way to convince workers to pay more into Social Security is to allow them to hold the payments themselves. It is clear workers don't trust the political system -- with its endless gimmicks and contrivances -- to responsibly hold and invest the needed funds on their behalf.
There is an important political debate over whether or not the funds for workers' investment accounts should be "carved-out" of existing payroll taxes or paid from "general revenues," ie. simply funded from new taxes or via deficit spending. This debate is economically irrelevant. Either way, pre-funding Social Security involves some sort of up-front sacrifice: higher taxes, lower government spending, or higher deficits. There is no way to pre-fund Social Security without spending money. However, some sacrifice now could prevent much greater sacrifices later.
It will take up to 25 years after enactment for a Social Security reform program to start reducing overall federal spending. Therefore, Congress cannot wait until budgetary pressures become extreme before taking action.
Detailed Issue Summary: Social Security Reform
Subcategories:
Magnitude of the Social Security Problem
What the Social Security (and Medicare) "Trust Funds" Mean
How to Evaluate Social Security Reform Proposals
1. Impact on the Budget
2. Degree of Progressivity
3. Opportunities for Wealth Creation
4. Absence of Gimmicks
Liberal Approaches
Universal Entitlements vs. Means Testing
The Do-Nothing Approach
The Government Pre-Fund or "Lockbox" Approach
Incremental Tax Increases and Benefit Cuts
The Diamond-Orszag Proposal
The Right-Wing Free-Lunch Approach
Peter Ferrara Proposal
Centrist Social Security Reform Proposals
Sen. Lindsey Graham Proposal
Kolbe-Stenholm Proposal
Links:
CentristPolicyNetwork.Org's Bush Social Security Reform Commission page
Centrists.Org No-BS Long-Term Budget Baseline homepage
Stakeholder Accounts and Pension Reform. The principle of stakeholder accounts for all Americans is simple: Capitalism works best when everyone is a saver and has an opportunity to accumulate capital.
The motivating value is equal opportunity. Centrists are not class warriors. But it is only fair for children to enter life with a fair chance to succeed.
One way to give them that chance is for government policy to help them develop a financial stake, either from birth or once they enter the workforce. For centrists, the issue isn't really that inheritances are bad; it is that all children should have one.
In addition to the financial stake itself, government policy should ensure that every American has a long-term savings account into which they can deposit funds. This could be accomplished through Social Security, or through other sorts of individual savings systems.
Many people may be baffled by the multitude of tax-favored retirement and other savings plans. One nice feature of 401k retirement plans at the workplace is that there is generally only one plan (several investment choices, but one main program). You join or not.
However, there are many 401-style plans, tailored differently for non-profits, the self-employed, and so on. And there are two main types of Individual Retirement Accounts (IRAs). Since most 401-style plans and IRAs do roughly the same thing, it makes sense to try to simplify the alternatives. People might take better advantage of savings opportunities if the savings alternatives were easier to understand.
The key words for pension reform should be "simplification" and "flexibility." Those ideas are not necessarily at odds -- flexibility does not necessary lead to increased complexity.
The pension system needs to adapt to the changing nature of work. As the workforce gets more complex, with contingent and part-time labor, as people choose freelancing and self-employment for economic as well as creative or life-style reasons, as two-worker families adjust their work lives to take care of children, retirement systems should be more flexible, both for businesses and workers. Rules intended to serve the public's interest in fairness can end up reducing employers' and employees ability to adapt retirement systems for their mutual benefit. In such cases, the government's role should shift from regulation and prescriptive rules to oversight and adjudication of fairness issues.
Finally, many low-income Americans remain "un-banked," that is, without regular back accounts or investment programs. The un-banked are dependent on check cashing services and cash-transfer systems for their financial needs. This is not appropriate.
With a nudge from the government, all citizens could have access to mainstream banking and financial services. Hard work should yield assets that, in turn, can help families get ahead. This is the foundation of upward social mobility and middle class values.
"KidSave" or "Baby Bond" Proposals. These proposals were first introduced in the U.S., but have taken hold most firmly in Great Britain. The British government is poised to stake each newborn with about $400 at birth (twice as much for children of poor families). The government would supplement the initial stakes in stages as a child grew older, and families could also add funds to the account. The accumulated funds could be used when a child reached adulthood for education, business formation, home ownership, or retirement.
In the U.S., Senator Robert Kerrey and others proposed similar "KidSave" accounts. Unlike the British proposal, the Kerrey KidSave accounts could only be used for retirement. The accounts would provide an initial stake of $2,000 and would also create a central repository for additional savings of families who would otherwise find it difficult to seek out commercial savings or investment accounts. The accounts would be modeled on the federal Thrift Savings Plan (TSP), the 401k program for federal workers. TSP options include stock, bond, and government bond funds.
The U.S. proposal would probably boost private savings by a greater amount. Some families would consider their children's accounts as newfound wealth, and, feeling richer, would consume more than otherwise. Similarly, some adults, seeing the money in their accounts grow since childhood, might save less for retirement through other means. But since the accounts could not be tapped until retirement, most people, especially those with modest incomes, would not change their plans for consumption and savings very much. And the very presence of the accounts could induce some families to save more than otherwise.
Universal Savings Account Proposals. The Clinton Administration proposed a slightly different stakeholder proposal: a plan to supplement the savings of low-and moderate-income people through government-provided matching funds. The so-called USA accounts were progressive: lower-income savers would have received a larger match. However, significant matching funds would have extended well up into the middle class, and the USA proposal would be quite expensive. On the other hand, USA accounts would provide a strong new incentive to save, and the federal cost and consequent loss of public savings would be largely offset by an increase in private savings.
Individual Development Accounts (IDAs). IDAs are special matching accounts for very low-income people. They were originally designed in cooperation between private charitable foundations and governments as a demonstration program. The first results of the demonstration have been favorable, showing that even very poor people found ways to save small amounts when considerable matching funds were available, and that the resulting nest eggs were generally put to good use.
"Saver's Credit." The saver's credit was enacted in 2001. It provides a small tax credit to match the savings of low-income people. Because the credit is not refundable, that is, available to taxpayers who have no net income tax liability, few people can take advantage of it. For example, low-income people with children can receive the refundable Earned Income Tax Credit (EITC) and the partially refundable Child Tax Credit, which often reduce net income tax liability to zero. Therefore, many low-income families with children have no positive income tax to credit, and the saver's credit is of no value. To make the saver's credit more popular, Congress could consider raising the income limits for eligibility, or making the credit fully or partially refundable.
Default or "Roll Over" Accounts. All Americans should be required to establish a default or "roll-over" long-term savings account. This could be done automatically in conjunction with Social Security accounts or stakeholder accounts. Or people could simply be required to register an Individual Retirement Accounts (IRA) as their default account. The federal government could open the federal employees' Thrift Savings Plan (TSP) for people who preferred that option.
The reason for establishing a default or roll-over account is simple: Workers sometimes receive sudden, large distributions from 401k plans or other tax-favored investment plans if they change (or lose) their jobs. Without a pre-established roll-over account, they will simply be given their distribution as a large check or automatic payroll-type deposit at the bank.
With a big check or large back deposit, some workers might be tempted to spend the money, rather than re-investing what may look to them like a windfall.
However, spending (rather than rolling over) early distributions from retirement savings plans causes a double penalty: not only are funds a worker may truly need for retirement potentially lost, but there is a 10 percent tax penalty if distributions from tax-favored funds are not rolled over into another qualifying long-term savings account within a specified period of time.
It seems plausible, and well within the bounds of the public interest, to require participants in long-term savings programs to pre-designate a roll-over account. If employer-based enrollment in roll-over accounts is easy and/or automatic, and if there are no fees or initial deposit requirements imposed when the accounts are established, the requirement would not discourage workers from signing up for tax-favored savings plans in the first place.
Links:
The Congressional Budget Office (CBO) has published a comprehensive on-line guide to retirement savings alternatives, and an excellent statistical paper with thorough but somewhat dated (1997) information on the use of those alternatives. The statistical paper also includes much useful summary and background information:
Congressional Budget Office Online Guide to Tax Incentives for Retirement Savings
Congressional Budget Office Utilization of Tax Incentives for Retirement Savings (August 2003)
The Urban Institute has published a working paper that summarizes current tax incentives for retirement, the Portman-Cardin pension proposal, and President Bush's proposal. The paper also recommends a compromise set of pension simplifications and reforms. Includes tables and graphics at the end that are very helpful:
Pamela Perun and C. Eugene Steuerle Reality Testing For Pension Reform Urban Institute Working Paper (May 1, 2003)
Full Paper in PDF format, 23 pages (recommended)
Progressive Policy Institute Individual Development Accounts: How Are They Working? (August 2000)
