The Kolbe-Stenholm Social Security Plan
Jeff Lemieux
revised February 14, 2004 to correct the footnote in Figure 5 and for minor editorial changes.
NOTE: JIM KOLBE HAS REINTRODUCED THE PLAN IN THE 109TH CONGRESS WITH REP. ALLEN BOYD
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The new Social Security reform plan proposed by Reps. Jim Kolbe and Charlie Stenholm combines fiscal responsibility with the wealth-building potential of personal Social Security retirement accounts. The proposal is comparable to the bill introduced last year by Senator Lindsey Graham. However, the Kolbe-Stenholm approach does a better job of limiting and "paying for" its transition costs, which will be very important as U.S. budget problems worsen.
Outline:
Social Security's Budget Problem
A Responsible Personal Accounts Plan
Financial Impact of Kolbe-Stenholm Proposal
Comparison with Other Reform Plans
Social Security's Budget Problem: Using forecasts for the next 75 years from the Social Security Administration, Figure 1 shows that Social Security costs will rise from about 4.5 percent of the economy toward 7 percent of gross domestic product (GDP) as the baby boom generation retires. Meanwhile, dedicated tax revenues (mostly payroll taxes) are projected to remain flat at about 5 percent of GDP.
Figure 1.
The difference between these costs and dedicated revenues is Social Security's effective cash-flow surplus or deficit. Because benefit costs are currently lower than revenues, Social Security is running a surplus. However, Social Security's current surplus is expected to disappear and become a deficit after 2010 as the large baby boom generation starts to retire in large numbers. After 2030, the Social Security deficit is projected to be about 2 percent of GDP (see Figure 2).
Figure 2.
Social Security is essentially a pay-as-you-go social insurance program, not an advance-funded retirement plan. Workers pay payroll taxes roughly sufficient to cover Social Security's outlays at the time. Social Security's future budget problem is simple: payroll taxes will not be high enough to cover future benefits.
To fully solve Social Security's budget problem, a reform proposal must close the 2 percent of GDP gap between revenues and costs in the long run, without (1) creating overly high or unmanageable transition costs over the next 20 years, or (2) relying on financing gimmicks or "one-sided bets," such as overly optimistic assumptions about investment returns in personal accounts or absolute guarantees that Social Security benefits would never be reduced.
A Responsible Personal Account Plan: The Kolbe-Stenholm approach uses personal accounts for two purposes: (1) as an incorruptible storage location for monies designated to "pre-fund" Social Security's future costs, and (2) to start a national process of individual wealth-building for all workers.
Because the balances in the accounts would be owned and controlled by workers, they would not be part of legislators' subsequent budget calculations, either directly or indirectly. That is, the funds set aside in personal accounts would really be used for Social Security.
The main elements of the Kolbe-Stenholm plan are:
1. Personal accounts of 2 percent of earnings (3 percent for the first $10,000). Workers could make additional voluntary contributions of up to $5,000 a year to the accounts. The voluntary contributions would be after-tax, but the income or “inside build up” of personal contributions would not be taxed each year or at withdrawal.
2. Matching funds for voluntary contributions to personal accounts. Low-income workers would be eligible for extra matching funds for personal contributions they make. The government would match the first $500 of personal contributions of workers with earnings of less than roughly $30,000 a year. Each year, the government match would be $100 for the first dollar, and 50 percent for each additional dollar up to a maximum additional government contribution of $500. Low-income workers could designate their Earned Income Tax Credit (EITC) refund for this purpose.
3. A redefinition of the Consumer Price Index (CPI) for the purposes of Social Security post-retirement benefit indexation, and also the indexation of tax brackets and certain spending programs outside the Social Security program. The bill would use a new "chained" price index developed by the Bureau of Labor Statistics, which is estimated to grow about 0.2 percentage points slower than the customary CPI.
4. A gradual reduction in Social Security's benefit "replacement rates," beginning in 2012. In general, the reductions would be progressive, that is, replacement rates would be lowered mostly for earnings above the average. Technically, the adjustments would include direct changes designed to lower promised benefits, and a "longevity" adjustment designed to keep lifetime benefits constant as life expectancy increases.
5. A speed-up of the increase in Social Security's normal retirement age, which would be phased-up to age 67 by 2011. (These changes would not prevent workers from retiring at reduced benefits as early as age 62.)
6. A small reduction in benefits for workers who retire prior to the normal retirement age, coupled with additional incentives to work past the normal retirement age.
7. An increase in the number of years of work for the computation of benefits. This has the effect of slightly reducing benefits for most workers.
8. A new minimum benefit for low-wage workers. Roughly speaking, workers with 40 years of work would be guaranteed a benefit no less than 120 percent of the poverty line. Workers with 30 years of work would be guaranteed a benefit at or above the poverty level, and those with 20 years of work would receive a benefit no less than 80 percent of poverty.
9. An Increase in the cap on Social Security payroll taxes from the current level of 84.8 percent of payroll ($87,000 in 2003) to 87 percent of payroll by 2008. (The extra payroll taxes would count toward future benefits and contributions to personal accounts.)
The personal accounts could only be used for retirement. The investment choices would be patterned after the federal Thrift Savings Plan (TSP), which offers several broad index funds. Workers could select outside investment firms -- with unrestricted choices of investments -- for balances above $7,500.
Financial Impact of the Kolbe Stenholm Proposal: The Kolbe-Stenholm proposal would reduce the long-run Social Security deficit by about 1.8 percent of GDP (see Figure 3). The new funding for personal accounts would reduce Social Security surplus by a little less than 1 percent of GDP in the short run. However, the cost savings provisions would prevent the Social Security deficit from getting much worse than 1 percent of GDP as the baby boom generation retires and ages over the next 30-50 years. After that, the Social Security deficit would stabilize at less than one-half of one percent of GDP.
Figure 3.
Most of the long-term improvements in Social Security's budget would come from gradually reduced benefit levels. Benefit costs in the long-run would be reduced from about 7 percent of GDP to about 5.6 percent (see Figure 4). (Of course, beneficiaries could offset those reductions from their personal accounts.)
Figure 4.
The Kolbe-Stenholm proposal would raise Social Security revenues by increasing the cap on payroll taxes, from $87,900 in 2004 to just over $100,000 by 2008. This would raise Social Security revenues by about 0.2 percent of GDP.
The proposal would also use an alternative measure of the CPI for the purposes of indexing tax brackets, other tax parameters, and certain spending programs outside the Social Security program. (The alternative "chained" measure is estimated to grow about 0.2 percentage points slower than the current CPI.)
Even though this financing mechanism takes place outside the Social Security system, it is specific and plausible, and therefore "score-able" as a method of paying for the Kolbe-Stenholm reforms. The CPI indexation policy would raise Social Security revenues by about 0.2 percent of GDP (see Figure 5).
Savings from CPI indexation outside Social Security are counted in Figure 5 as "revenues" to the Social Security system associated with the Kolbe-Stenholm plan. However, from a larger budgetary perspective, the CPI indexation would both raise federal revenues and reduce outlays. (The estimates of this part of the Kolbe-Stenholm proposal are included as a transfer to the Social Security fund in the analysis prepared by the Social Security actuaries. The original estimate on which that transfer amount is based was prepared by the offices of Reps. Kolbe and Stenholm, based on analysis of the cost and revenue impact of CPI indexing changes prepared by the Congressional Budget Office and Brookings Institution.)
Figure 5 shows baseline Social Security payroll tax revenues, and the incremental impact of indexing the CPI outside Social Security and raising the payroll tax cap. In total, these provisions would raise Social Security revenues by 0.4 percent of GDP in the long run.
Figure 5.
Comparisons with Other Reform Proposals: The Kolbe-Stenholm proposal is the best-funded personal accounts proposal we have analyzed. Over the next 75 years, it would reduce Social Security's unfunded liability by almost half (see Figure 6).
The new Kolbe-Stenholm proposal is roughly comparable to the proposal introduced last year by Senator Lindsey Graham, which also has personal accounts. However, the Kolbe-Stenholm proposal does a better job of paying for its transition costs than the Graham proposal.
Figure 6.
In budgetary terms, the net transition costs of Kolbe-Stenholm proposal would total about $0.8 trillion between 2005 and 2014 (see Table 1). In the following decade, the transition costs would shrink to $0.6 trillion.
By contrast, "free-lunch" proposals like that offered by anti-tax activist Peter Ferrara -- which promise large personal accounts and include benefit "guarantees" -- would have transition costs of over $9 trillion over the next 20 years.
On the other hand, the proposal of economists Peter Diamond and Peter Orszag has no transition costs -- it does not attempt to pre-fund future Social Security benefits, and relies mostly on tax increases to solve the program's budget problem.
| Table 1. Cost Comparisons (in Trillions of Dollars) |
|
|
| |
|
Current Law |
|
Ferrara |
Graham |
Kolbe-Stenholm |
Diamond-Orszag |
| |
|
|
|
|
|
|
|
| Present Value of Surplus or Deficit (2005-2078) |
5.1 |
|
7.6 |
3.5 |
2.7 |
1.0 |
| |
|
|
|
|
|
|
|
| Transition Cost (+) or Savings (-) in Current Dollars: |
|
|
|
|
|
|
| 2005-2014 |
|
N/A |
|
3.7 |
1.6 |
0.8 |
-2.0 |
| |
|
|
|
|
|
|
|
| 2015-2024 |
|
N/A |
|
5.5 |
2.2 |
0.6 |
-2.0 |
| |
|
|
|
|
|
|
|
| Source: Centrists.Org |
|
|
|
|
|
| Note: Calendar Years |
|
|
|
|
|
NOTE: JIM KOLBE HAS REINTRODUCED THE PLAN IN THE 109TH CONGRESS WITH REP. ALLEN BOYD
Links:
Kolbe-Stenholm Social Security ProposalSocial Security Administration, Office of the Actuary Memorandum
Estimated OASDI Financial Effects of the "Bipartisan Retirement Security Act" proposed by Reps. Kolbe and Stenholm (February 11, 2004)
Centrists.Org
Budgetary Effects of the Diamond-Orszag Social Security Proposal (revised December 31, 2003)
Centrists.Org
Unfunded Transition Costs of the Ferrara Social Security Proposal (
revised December 10, 2003
Centrists.Org
A Preliminary Analysis of Sen. Graham's Social Security Proposal (November 18, 2003)
Centrists.Org
Raising the Cap on Payroll Taxes Doesn't Solve the Social Security Problem (November 17, 2003)
Centrist Policy Network
Put Social Security Reform in the President's Budget (November 17, 2003)
Centrists.Org
Suggestions for Income Testing in Social Insurance Programs (October 27, 2003)
Centrist Policy Network
A Challenge To Both Left and Right on Social Security Reform (September 16, 2003)
Centrists.Org
Detailed Issue Summary: Social Security Reform
