A 9 percent rate of return eliminates the sys-
Table 7
tem's unfunded liability. Table 8 examines this
The 1.8 Percent Market-Based Solution
scenario in more detail.
Pre-retirement
Sum of
Market-Based
Column four is the difference between OASI
Investment
Employee
Employer
Employee/
Unfunded
benefits and taxes at the 12.4 percent rate. In
Return*
Saving Rate
Tax Rate
Employer Rates
Liability**
2019 the system's cash flow turns negative and
7%
4.60%
7.80%
12.40%
$ 1.9
then stays that way. In contrast, the market-
8%
3.60%
8.80%
12.40%
0.8
based cash flow (column 8) turns negative in
9%
2.80%
9.60%
12.40%
0.0
2009, peaks in 2038, turns positive in 2047,
10%
2.10%
10.30%
12.40%
-4.3
and then stays that way. The reason that the
market-based cash flows are temporarily nega-
* Investment returns are nominal; inflation is 3.5%.
tive is that the investment wealth is not close
** All amounts are estimated in trillions of dollars, excluding the initial Trust Fund.
enough to the 42 percent replacement rate to
reduce the government's costs below its rev-
enues from the 9.6 percent payroll tax. As
wealth builds, however, the government's con-
Figure 4
tribution to the 42 percent replacement rate
Long-Run Government Benefit Obligations Needed to Achieve a
falls (see Figure 4). It never falls in the pay-as-
42 Percent Replacement Rate Under a 12.4 Percent Pay-As-You-Go Tax
you-go structure.
vs. a Market-Based 12.4 Percent Payroll Deduction*
This means that, although in both systems the
payroll deduction and the unfunded liability are
18,000
the same, the market-based system produces a
far superior long-term result. In the 75th year,
16,000
the pay-as-you-go system will have a cash flow
14,000
deficit of about 1.7 percent of gross domestic
Pay-As-You-Go
product (GDP) while the market-based alterna-
12,000
tive will have a surplus of about 3.5 percent of
10,000
GDP. Taxes in the pay-as-you-go system will
have to be about 17 percent of payroll to pay the
8,000
current benefits under today's law. In the
6,000
market-based system there will be no taxes but
there will be a mandatory saving rate of about
4,000
2.8 percent. As time passes these differences
Market-Based
widen further.
2,000
Again, no increase in payroll deductions is
0
being advocated. Such an increase is totally
unnecessary when there are other methods of
Year
financing the transition, such as reducing gener-
*Assumes a 2.8% savings rate, at 9.6% payroll tax rate, 9% nominal return, and a 3.5% inflation rate. Derived from columns 3
al revenue spending, selling government assets,
and 7 of Table 8.
and using projected general revenue surpluses.
Several transition plans have been presented
that do not include any tax increases. The impor-
tant point of this analysis is that, regardless of
mental reform, those liabilities will continue to
the transition financing mechanism, moving to a
grow.
market-based Social Security system will ulti-
Transforming Social Security to a market-
mately be less costly than trying to prop up the
based system of individual accounts does
current program.
require a transition period, a cost, and a change
in the timing of cash flows. However, any cost is
Conclusion
reasonably less than staying with the present
law. Little if any reason exists to retard neces-
Any discussion of the transition cost of mov-
sary reform because of this issue. Indeed, the
ing to a market-based Social Security system
relative transition benefits should be another
cannot be conducted in a vacuum. The current
incentive to move quickly toward reasoned
Social Security system has unfunded liabilities
reform.
of about $3 trillion and, in the absence of funda-
11