IV. Options for Social
Security Reform: Diamond-Orszag vs. Feldstein-Samwick
Diamond and Orszag argue that
Social Security should be reformed through a “balanced approach,” that is,
conventional methods that would increase revenue—via increases in marginal
payroll taxes—and decrease benefits via lowering lifetime benefits to wealthier
Americans. Their opponents, Feldstein
and Samwick, argue that Social Security should be reformed through mixed system
that includes both payroll tax funding and investment based initiatives.
Diamond-Orszag
·
The Plan — Only 13% of income for the highest lifetime earners should escape
the payroll tax cap. Their benefits should
also be reduced. The legacy debt accrued by earlier generations must be paid
off by, (1) mandating that newly higher government
workers pay into Social Security (approximately 4 million) (2) imposing a legacy
tax on earnings above the maximum taxable earnings base for high lifetime
earners (3) imposing a universal legacy charge via increases in payroll taxes
beginning in 2023.
·
Advantages — (1) Progressive:
This is a progressive plan that adversely affects top income earners and
benefits lower income earners. As a result, in a static model, it may help
reduce income inequality. (2) Tax Base
Widens — The newly hired workers who would have to pay into Social Security
(approximately 4 million) will increase OASDI revenues via the payroll tax.
·
Disadvantages — (1) Deadweight
Loss (DWL): Higher marginal tax rates will generate a deadweight loss
(loss of economic efficiency). More analysis needs to be done to determine the
magnitude of the DWL. (2) Politics — It may be politically unpopular in the U.S.
High income earners already pay 39.6% of their income in taxes. Therefore, such
a policy may not fare well with Republicans (and some Democrats) and may be
stopped dead in its tracks. (3) Tax
Incidence — If employers are hit with a tax increase, they may shift
the tax burden to their employees via reduced wages. If the pool is expanded to government
workers, then state and local governments must also finance part of Social
Security.
Feldstein- Samwick
·
The Plan — If they also make an out-of-pocket equal contribution, employees allocate 1.5% of their 12.4%
payroll tax to Personal Retirement Accounts (PRAs). By their analysis,
Feldstein and Samwick determine that the funds in the PRAs and variable-rate
annuities will earn a 5.5% real rate of return.[1] [2]
Pay-as-you-go benefits from the payroll tax would gradually fall over time, but
would not be eliminated. The PRAs can be bequeathed to anyone one chooses if one
dies before retirement age.
·
Advantages — (1)
Increased National Savings — Because S = I + NX, the accounting identity tells us that
national savings would increase. (2) Increase
in future business activity— business activity would rise from the increased
national savings. (3) Government cannot access funds — The
PRAs would not allow Congress access to the funds for additional projects. (4) Labor
Supply: More people would be incentivized to join the labor force
because PRA funds depend on the payroll tax; the payroll tax would presumable
not increase and may gradually decrease over time.
·
Disadvantages — (1)
Transitional burden: Today’s
workers bear the burden of financing current retiree benefits. They also have
to save for their own benefits. The transitional costs are high to today’s
workers. (2) Risk— The market (variable rate annuities) may expose individuals to
unnecessary risk compared to fixed rate annuities.
Policy Recommendation:
After
completing the cost-benefit analysis in this memo, it would be prudent for the
U.S. Senate Committee on Finance to support the Feldstein-Samwick mixed system
reform proposal as outlined in section “The Plan,” under “Feldstein-Samwick. In order to offset the
transitional costs of the reform policies, the U.S. Senate Committee on Finance
is advised to provide appropriate tax deductibles to current workers and to
consider reducing marginal tax rates on current workers so that their burden of
financing the inception of the reform policies is alleviated. Lastly, in order to tackle the problem of risk, the
U.S. Senate Committee on Finance is strongly advised to implement essential
provisions in the reform policies as advocated by Jeffrey Liebman: protecting
investors from high costs and poor investment decisions during accumulation,
maintaining redistribution, and protecting retirees from decumulation.[3]
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