The Wrong Way to Fix Social Security

Peter R. Orszag
Peter R. Orszag Vice Chairman of Investment Banking, Managing Director, and Global Co-Head of Healthcare - Lazard

January 28, 2005

The Bush Administration has not yet put forth a specific plan to reform Social Security. Every indication, however, suggests it favors the leading plan developed by the President’s Commission to Strengthen Social Security. Unfortunately, this plan, often referred to as “Model 2,” is seriously flawed. It manages both to increase government debt for the next 60 years and to reduce benefits substantially.

Under the Commission plan, Social Security would wither away over time. According to the Congressional Budget Office, for example, young workers today in the middle of the income distribution would experience a reduction in benefits of almost 40 percent, or about $9,000 a year, even including the payout from the individual accounts included in the plan. The result of these excessive and unwarranted benefit reductions is that Social Security would increasingly fail to provide an adequate core tier of retirement income upon which to build other retirement saving.

Despite this substantial reduction in benefits, Model 2 involves a considerable increase in public debt over several decades. The troubling combination of large benefit reductions and large increases in debt is not limited to the plan from the President’s Commission. Instead, it is inherent in the broader approach that the Administration appears to support. The President appears to be opposed to devoting additional revenue to Social Security. The absence of such additional dedicated revenue forces large benefit reductions to close the deficit. Then the diversion of existing payroll tax revenue into individual accounts, again without any new dedicated revenue devoted to Social Security, triggers significant borrowing.

Although this problematic combination of large benefit reductions and large increases in debt would be present in almost any plan consistent with the Administration’s principles, it is useful to see how it plays out in the specific model provided by the President’s Commission.

Model 2 includes two key components: a change in how Social Security benefits are determined and the diversion of payroll revenue into individual accounts.