Unfunded Transition Costs of the Ferrara Social Security Proposal 
Jeff Lemieux
(revised December 10, 2003 to clarify that certain payroll tax reductions in the proposal after 2050 were treated as Social Security "costs" in Figure 1.  Originally published on December 2, 2003.)

Anti-tax activist Peter Ferrara has proposed a Social Security reform plan that includes large personal accounts and a guarantee that benefits would not be reduced from current levels.  What's the catch?  The enormous unfunded transition costs.  By comparison, another recent proposal -- the plan introduced in November by Sen. Lindsey Graham -- is much less expensive, but achieves a similar solution to the Social Security's impending budgetary problems.

Outline:
Social Security Reform Proposals and Transition Costs
Ferrara Proposal
Comparison with Sen. Lindsey Graham's Proposal
Preliminary Comment

Social Security Reform Proposals and Transition Costs:  Social Security's budget problem is simple -- its costs will grow substantially when the large baby boom generation retires, while its tax revenues stay flat.  Bringing the system back into balance will require tax increases, benefit cuts, or a workable method of advance funding; that is, paying more now to save money later.

Personal account proposals would essentially convert Social Security from a pay-as-you-go system, which mostly distributes payroll tax revenues to retirees, to a pre-funded system, where workers build accounts from which to draw a significant share of their Social Security benefits. 

Pre-funding via accounts that are owned and managed by workers is an important component of real reform.  Past efforts to pre-fund Social Security's future liabilities via trust funds or other accounting mechanisms have failed to work in an economic sense, because Congress tends to spend the money in trust funds or "off-budget" accounts anyway.

Most Social Security reform proposals that include personal accounts have large transition costs.  In general, the larger the account, the higher the transition cost. 

There are three main types of Social Security reform proposals that involve personal accounts:

1.  Paid-for proposals, where the transition costs of reform are offset by tangible tax increases or spending cuts.  These "pay-fors" can be within the Social Security system, such as payroll tax increases or benefit cuts, or they can be outside the system.

2.  Partially funded proposals whose transition costs would be large, but economically manageable.  This type of proposal usually contains offsetting benefit reductions or other tangible or "scorable" provisions to at least partially pay for the transition costs of reform.

3.  Unfunded "free lunch" proposals whose transition costs would be huge.  These proposals make no tangible or scorable efforts to reduce or pay for the transition costs, and generally guarantee that no Social Security beneficiary could possibly lose money on reform (compared with the current benefits promised in the law).

Many proposals have non-specific "pay-fors."  For example, the Ferrara proposal includes an unspecified reduction in overall government spending and a questionable business tax increase.  Senator Graham's proposal calls for reductions in corporate welfare.  Most proposals include "general revenue transfers" to boost the Social Security trust fund during the transition period. 

This analysis does not factor in any of those sorts of non-specific provisions or intra-governmental transfers.  It only considers the more substantive items in the proposals.

Ferrara Proposal:  Pension analyst and anti-tax activist Peter Ferrara recently proposed an unfunded Social Security reform plan with enormous transition costs.

Figure 1 shows how the Ferrara proposal compares with current Social Security costs.  These cost estimates are based on a new memorandum from Social Security's Office of the Actuary.

The proposal would raise Social Security costs by over 2 percent of GDP for the next 20 years.  Social Security costs would peak at nearly 8 percent of GDP just prior to 2030, before falling back toward current levels between 2030 and 2050.  After 2050, Social Security costs would stabilize at just under 5 percent of GDP, only a little more than current costs.  Interestingly, at its peak, the cost of the Ferrara proposal would be higher than that of the current system at any time over the next 75 years. 

Figure 1.


(Note that Figure 1. includes certain payroll tax cuts after 2050 as part of the "costs" of the proposal.  Technically, those tax cuts would be considered revenue reductions, not outlays in a budgetary sense.  But including them in Social Security costs allows Figure 1 to illustrate the overall cost of the proposal vs. current law baseline in a fair and simple way.)

Another way to look at Social Security costs is the program's surplus or deficit, the gap between its costs and dedicated tax revenues (mostly payroll taxes).

Figure 2 shows the Social Security surplus or deficit by this measure compared with the current law baseline.  Under the Ferrara proposal, the deficit would rise to nearly 3 percent of GDP by 2030, before shrinking back to zero after 2055.

Figure 2.


Comparison With Sen. Lindsey Graham's Proposal:  Figure 3 shows a comparison of Social Security costs under the Ferrara proposal with those under the partially funded proposal advanced by Senator Lindsey Graham.  The Graham proposal would cost much less during the transition period, and would begin saving money (compared to baseline) sooner.  The long-run savings under the Graham proposal (after 2050) would be greater.  (Centrists.Org will attempt to publish comparisons of the cost of additional Social Security reform plans in coming months.)

Figure 3. 


A comparison of the partially funded Graham proposal with the unfunded Ferrara proposal is shown in Figure 4.  The cumulative deficits are much more favorable in the Graham proposal.

Figure 4.


Preliminary Comment:  The Ferrara proposal will probably be supported by the same anti-tax  groups who brought us unfunded supply-side and business oriented tax cuts.  A motivating belief in these proposals is that very large federal deficits will not hurt the economy very much.  True believers in the "free lunch" philosophy actually seem to favor huge federal deficits and debts, in order to cause an economic crisis that would (presumably) lead to dramatic reductions in federal spending at some point in the future.  This is the so-called "starve the government" political philosophy and its rhetoric has occasionally been incorporated by the Bush Administration.

However, deficits do matter, even when they are used for valid social goals, such as pre-funding future Social Security costs.  For example, under current budgetary trends the cost of interest on the public debt will likely exceed Social Security costs in future decades if the federal deficit is not reduced.

Social Security reformers should not promise too much.  The transition costs of reform should be addressed seriously, not waved off as inconsequential.  Overly large unfunded transition costs would defeat one of the primary purposes of Social Security reform, which is to protect future generations from undue tax burdens.

Links:
Social Security Administration, Office of the Actuary Memorandum Estimated Financial Effects of the [Ferrara] "Progressive Personal Account" Plan (December 1, 2003)

Centrists.Org The Fourth Entitlement:  Interest (December 1, 2003)

Centrists.Org A Preliminary Analysis of Sen. Graham's Social Security Proposal (November 18, 2003)

Social Security Administration, Office of the Actuary Memorandum Estimated OASDI Financial Effects of S.1878, The Social Security Solvency and Modernization Act of 2003 as introduced by
Senator Lindsey Graham (November 18, 2003)

Centrists.Org Raising the Cap on Payroll Taxes Doesn't Solve the Social Security Problem
(November 17, 2003)

CentristPolicyNetwork.Org Put Social Security Reform in the President's Budget (November 17, 2003)

Centrists.Org Projected Structural Budget Deficit for 2004:  $391 Billion (revised November 6, 2003)

Centrists.Org No-BS Long-Term Budget Baseline Homepage

Centrists.Org Suggestions for Income Testing in Social Insurance Programs (October 27, 2003)

CentristPolicyNetwork.Org A Challenge To Both Left and Right on Social Security Reform (September 16, 2003)

Centrists.Org Issue Summary:  Wealth Building (Basics)

Centrists.Org Issue Summary:  Social Security