Social Security Reform: President Bush's 2005 Individual Account Proposal

Publication Date: March 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

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Abstract:

The Old-Age, Survivors, and Disability Insurance (OASDI) program, commonly referred to as Social Security, is facing a long-term financial deficit. In response to this challenge, President Bush made Social Security reform the key focus of his 2005 domestic social policy agenda. On February 2, 2005, the President laid out specifications for a system of voluntary individual accounts to be phased-in as part of a reformed Social Security system. Administration officials concede that the individual accounts themselves do not alleviate the solvency problem. The individual account proposal would likely make the solvency problem worse over the next 75 years. The President stated that these accounts are just one piece of a comprehensive Social Security reform package and that additional measures will be needed to achieve long-term solvency.

Under the President's 2005 individual account proposal, individuals born prior to 1950 would have experienced no change in their Social Security benefits. Individuals born in 1950 and later would have had the option to participate in Social Security individual accounts (IAs). Workers who chose to participate in IAs would not have been permitted to opt-out of the IA system. Workers would have been allowed to divert up to 4% of their payroll taxes to IAs, subject to a dollar limit that increased over time. But on average people would have had to earn at least 3.3% per year after inflation to break even. This would have occurred because, in addition to administrative costs, their traditional benefits would have been reduced or "offset" by the amount of their contributions, plus 3% a year in interest. The proposal did not include a "minimum benefit" guarantee to ensure that participants would receive a total benefit at least equal to the poverty threshold.

Analyzing the President's 2005 IA proposal using assumptions on investment returns and administrative costs provided by the Social Security Administration, CRS found that the total of the reduced Social Security benefit plus the annuity that would have been available using the actual IA balance would have exceeded Social Security current-law promised benefits if the account earned the 4.6% annual real rate of return projected by the Social Security actuaries. However, if the account earned the 2.7% risk-adjusted annual real rate of return projected by the actuaries, workers would have faced a slight reduction in overall Social Security income relative to current law. Younger workers and those with higher lifetime earnings would have benefitted the most from IAs. Younger workers would have been able to contribute to their IA throughout their careers and would have had higher contributions as a result of continued wage growth. Higher earners would have benefitted from being able to accrue larger account balances as the dollar cap on contributions increased.

This report is based on the President's 2005 IA proposal. The version portrayed in his FY2007 budget submission is not significantly different from his 2005 proposal. The main substantive difference is that the average interest that a worker would need to earn to break even would be reduced to 2.7% from 3%. Thus, if the account earned the 2.7% risk-adjusted annual rate of return, the worker would experience no reduction in overall Social Security income relative to current law.