Borrowing from Future Social Security Benefits: The Administration’s Proposal for Individual Accounts

Mr. Chairman, thank you for inviting me to testify before you this morning. On February 2, the Bush Administration released some details about its proposal to replace part of Social Security with individual accounts. Even with these admittedly incomplete details, several points now appear clear:

Under the Administration’s plan, payroll taxes deposited into an individual account are essentially a loan from the government to the worker. The Administration’s proposal is the equivalent of a loan that mortgages future Social Security benefits: Workers opting to divert payroll taxes into an account today would pay back those funds, plus interest, through reductions in Social Security benefits at retirement. In other words, just as with a loan, the worker receives cash up front and then owes money back, with interest, later. Someone who borrows money to make an investment benefits if the assets purchased with the borrowed funds grow faster than the debt; the person is worse off if the debt grows faster than the investment. Similarly, under the Administration’s plan, workers wind up with higher retirement income if the income from their accounts exceeds the benefit reductions that pay off the loan, and vice versa.

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