Social Security: "Transition Costs"

Publication Date: December 2004

Publisher: Library of Congress. Congressional Research Service

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Research Area: Banking and finance

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Abstract:

The Social Security Administration's chief actuary forecasts that under current law, the Social Security Trust Funds will be depleted in 2042. Many Members of Congress have expressed concern that restoring the program to long-term fiscal balance will impose burdens on future generations by requiring them to pay higher taxes, accept benefit cuts, or undertake substantial government borrowing to pay the full benefits promised under current law.

Some policy analysts have suggested that pre-funding Social Security benefits through individual accounts could improve the solvency of the current system, thus reducing or eliminating the need for higher taxes, lower benefits, or increased borrowing. However, there is general agreement among economists that any transition to a pre-funded system results in additional costs, so-called "transition costs," in the short-run. Most Social Security tax revenues are immediately used to fund payments to current Social Security beneficiaries. Therefore, a system of individual accounts that is funded by diverting part of the current Social Security tax into individual accounts will worsen the fiscal imbalance of Social Security and the overall budget, at least temporarily. Over a 75-year period, individual accounts could improve the unfunded liability of the Social Security system by $0.8 trillion or worsen it by up to $4.6 trillion, depending on how the account is structured. However, beyond the 75-year actuarial period, the benefit offset feature of most individual accounts would ultimately cover these transition costs and improve the long-term solvency of the Social Security system, leading some to refer to "transition costs" as "transition investments." This report will be updated as legislative developments occur.