Republican Presidential candidate Fred Thompson is boldly going where none of the other current Presidential hopefuls has yet dared to tread and courageously offering a comprehensive plan for fixing the Social Security retirement system. Unless changes are made, the Social Security system will begin drawing down its trust fund balance in 10 years and will exhaust that balance by about 2041. Politicians have generally shied away from specific proposals because they necessarily involve uncomfortable choices between revenue increases or benefit decreases to bring the system back into balance. Because the trust fund has already effectively been spent, a successful reform must also address how future trust fund inflows can be put beyond the reach of government spenders.
Thompson's proposal has two main parts to it. First, he would create voluntary "add on" retirement savings accounts. Workers would contribute 2 percent of their wages into the accounts, and each dollar of personal contributions would be matched by $2.50 in government contributions on the first $1000 of monthly wages and matched by 50 cents of government contributions for higher amounts. The government's contribution would be drawn from social security taxes that workers and employers already pay. For instance, a worker earning $2,000 per month would contribute $40 on her own (= .02 x $2,000) and be subsidized $60 by the government (= (2.50 x $20) + (.5 x $20)). For the year, this worker would have $1,200 added to her retirement account, which she could then invest into stocks, bonds, or some combination just like a 401(k) defined contribution plan. The funds would be available to the worker beginning at age 62, and any unused funds could be passed on to heirs.
The second part of Thompson's plan is to slow the growth in Social Security outlays by changing the initial retirement year benefit formula so that a person's history of wage contributions would be adjusted for inflation using the Consumer Price Index (price inflation) instead of the current wage index (wage inflation). Wages have usually grown faster than prices, so pegging initial benefits to price inflation should reduce benefits. For workers with the new voluntary retirement accounts, their Social Security benefits would be further reduced by the amount of the government matching contributions.
Thompson's plan would only affect current workers who are at least several years from retirement; it would not affect current retirees or older workers nearing retirement.
Thompson's plan addresses all three elements of reform. It would move Social Security closer to balance by gradually reducing benefits. It would also, however, strengthen overall retirement savings by bringing in more revenue--the workers' own contributions, which would come on top of taxes they are already paying into the Social Security system. If long-run trends in stock returns continue, the funds invested in those private accounts should also grow faster than the funds in the government's accounts, also adding revenue. Finally, the plan protects those new revenues from government spenders by moving them from public to private accounts--in effect individuals will hold portions of the trust fund.
There are downsides to be sure. Higher income households will benefit more than lower income households. The current benefit formula pays a higher return to low-wage earners than to high-wage earners, providing a considerable degree of redistribution. This redistribution would be reduced. Also, high-income households would be more likely to participate in the voluntary savings component than lower-income households. So the benefits from the savings component would flow mainly to them while the decreases in the benefit formula from the new indexing scheme would fall more heavily on the poor. Lastly, the plan shifts more financial risks toward households.
There is also a little distraction going on as each element of this plan could be proposed on its own. The voluntary contribution portion does nothing to "save" Social Security; indeed, it would do the opposite if only high-wage workers participate. So absent the voluntary component, it might be possible to get by with smaller benefit cuts. Also, we still need to see a bottom-line analysis on the Social Security system's finances.
Thompson's plan is a good first start that could form the basis for an ultimate reform. As written, the costs of his plan fall too heavily on the poor. Modifications to better protect the poor would make his plan a hands-down winner. Watch for all sorts of demonizing rhetoric, especially from the Democratic candidates. However, Thompson has put out an important marker, and it's up to the other candidates to improve on his plan and not just complain about its inevitable sacrifices.