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likelihood, if the existing system survives in

Table 2

some form, benefits will be cut. The intent of

Market-Based Replacement Rates

this analysis is that they would not be cut further

under Different Saving and Investment Assumptions

because of introducing a market-based alterna-

Pre-retirement Investment Return*

Employee

tive.

Saving Rate

7%

8%

9%

10%

5.3%

48.4%

62.0%

80.2%

104.7%

Saving Rates and OASI Taxes

6.0%

54.8%

70.2%

90.8%

118.6%

7.0%

64.0%

81.9%

106.0%

138.3%

In 1998, both employers and employees pay

8.0%

73.1%

93.6%

121.1%

158.1%

an OASI tax of 5.35 percent of payroll up to

$68,400. The combined 10.7 percent tax is

*Investment returns are nominal and inflation is 3.5%.

scheduled to fall to 10.6 percent in 2000 and the

wage base is scheduled to rise indefinitely. The

percent replacement rate. This feature leaves

market-based system would contain an employ-

nobody worse off and implicitly recognizes

er tax and a mandatory employee saving deduc-

workers' taxes already paid to the system. Given

tion. The employer tax would continue to

a span of market assumptions, saving rates, and

finance current benefits. The tax and saving

dates of birth, the probability that the govern-

rates influence the replacement rate, transition

ment would have to honor the guarantee ranges

financing, timing of cash flow deficits and sur-

from certain to remote.

pluses, personal disposable income, and the

time it takes to extinguish the unfunded liability.

Because so many variables are affected and in

Investment Objective and Options

different ways, there is no correct set of tax and

saving rates, but there are choices.

The investment objective is to achieve high-

risk adjusted returns throughout both working

and retirement years. This objective requires

Benefits at Retirement--No Ceiling

multiple asset classes, the returns of which are

not highly correlated. At a minimum, portfolios

Benefits at retirement as a percentage of one's

should be diversified across domestic stocks

last working year's wage, the so-called replace-

and bonds, foreign stocks and bonds, and

ment rate, greatly depend on saving and invest-

money market instruments to achieve reason-

ment rates (see Table 2). There would be no

able diversification.

stipulated replacement rate ceiling as there is

with Social Security.25

Ownership

Social Adequacy--The Floor

Portfolio assets would be one's personal

property, totally portable, and assets of one's

Social Security's replacement rate is an

estate at death.

income floor. For the average-income worker

retiring at age 65 in 1998 the replacement rate is

about 42 percent.26 For low- and maximum-

Accessing Retirement Benefits

income27 workers, the replacement rate is 56

percent and 25 percent, respectively. For sim-

Assets necessary to fund a specified replace-

plicity, this paper refers to the 42 percent rate

ment rate or base level of income would be

throughout, although the assumption is that the

available only for retirement. Excess assets

full range may apply.

could be used for any purpose.

One assumes that the market-based system

would have a government-guaranteed replace-

Financing the Transition

ment rate equal to Social Security's if one's

Under present law, OASI will enjoy a posi-

accumulated wealth were insufficient to achieve

tive cash flow until 2015 after which it turns

it. For example, average-income workers who

negative. Depending on the assumptions, a pri-

retire with a portfolio replacing only 37 percent

vatized system will incur a negative cash flow

of their last year's wage would receive from the

immediately, although temporarily, after which

government monthly benefits equal to 5 percent

it turns positive. This analysis assumes that neg-

so that the total would equal Social Security's 42

7