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Second, the transition debt interest rate is the

ative cash flows of both systems would be

financed exclusively with debt. Therefore, it

same that is credited to the OASI Trust Fund

expresses the worst case scenario from the per-

bonds. Third, individual saving, employer tax,

spective of indebtedness.

and market investment rates are stipulated for

Debt financing is assumed, in part, for sim-

each scenario.

plicity. It allows for greater transparency in

The number of workers who would actually

comparing Social Security's future under pres-

choose the new system is unknown, but if all

ent law to a privatized alternative. It explicitly

workers did, annual deficits in the early years

does not consider such options as raising the

would be worse than under any other assump-

retirement age, reducing cost-of-living increas-

tion. This scenario, although unlikely, is the

es, taxing benefits, selling government assets, or

most conservative from the perspective of near-

cutting other government spending, all of which

term borrowing.

may be meritorious in their own right, and each

The need for the government to guarantee the

of which would reduce borrowing costs.28

replacement rate is critical in the early years

One significant

Resources must be made available both to

although it lessens over time. For instance, a 64-

advantage of

pay the OASI tax and to save for retirement.

year-old average earner will not be able to save

a privatized

These resources would have to come from per-

enough before retirement to replace 42 percent

sons' consuming less or the government's

of wages, but will be able to replace a small

system is

spending less than they would otherwise. This

amount even with one year's saving. The guar-

the greater

reality cannot be ignored; debt finance does not

antee would replace the remainder so that the

retirement

obviate the need for additional resources.

total would equal 42 percent, the same as the

Also, additional resources are required if the

existing law. For a 21-year-old average earner

income earned

system is not reformed. Under this condition,

the market-based replacement rate would likely

from investing

given that the OASI tax must rise endlessly,

exceed 42 percent, as is shown in Table 2, in

in markets.

other personal consumption or government

which case the need for the guarantee would be

spending must fall endlessly.

moot.

No consideration is made for any estimate of

When a worker achieves 42 percent from sav-

increased economic activity due to privatization,

ing and investing, the government's obligation

most likely a conservative proposition.29 Nor is

to that worker ends. Over time, as more workers

any consideration made for any economic slow-

reach this point, the government's benefit pay-

down that may occur owing to the required

ments fall and eventually reach zero. But,

increase in taxes to pay promised benefits under

because of the bridge financing incurred during

the present structure.

the transition, the employer tax continues until

all of the debt is retired. At this point the

employer tax ends. The steady state is no

Sources and Uses of Funds

employer or employee tax but mandatory

employee saving.

In the present structure taxes pay benefits, and

any surplus is borrowed by the government and

spent on goods and services not related to Social

Defining the Objectives

Security. In the market-based model, funds from

In designing a transition plan, several factors

taxes and/or saving would pay benefits, would

and priorities must be considered, including the

be invested for future benefits, and would amor-

amount of unfunded liability within the system,

tize bridge-financing debt incurred during the

the expected rate of return on investment, the

transition. None of the funds would be ear-

guaranteed replacement rate, and the maximum

marked for any other purpose.

tax or contribution rate. Depending on the

objectives, plan specifics vary. Different saving,

tax, and investment rates will yield entirely dif-

Assumptions Underlying

ferent results.

Transition

The examples below show how these factors

For simplicity, the following transition analy-

interact. In each example the following factors

sis involves several assumptions: First, all work-

are considered: the real rate of return earned by

ers choose the market-based alternative and are

investments in the private accounts; the mini-

guaranteed the present Social Security replace-

mum desired replacement rate; the employer's

ment rate consistent with their wage histories.

payroll tax rate; the employee's mandatory con-

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