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Important note: The following draft was prepared by staff for presentation to the 

members of the Commission for their review. It has been neither reviewed by nor 

approved by the full Commission and therefore does not necessarily reflect the official 

views of the President’s Commission to Strengthen Social Security. 

Strengthening Social Security and Creating Personal Wealth for All Americans 

Report of the President’s Commission 

December 11, 2001
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Introduction by the Co-Chairs.......................................................................................... 3

Executive Summary ......................................................................................................... 8

Chapter 1: Strengthening Social Security Through Personal Accounts ........................ 16

Chapter 2: Administration of Personal Accounts ........................................................... 34

Chapter 3: Achieving a Fiscally Sustainable Social Security System............................ 55

Fiscal Sustainability Findings ........................................................................................ 57

Chapter 4: Alternative Paths to Fiscal Sustainability ..................................................... 71

Executive Summary: Personal Accounts and Social Security Reform .......................... 72

Personal Accounts – the Unifying Element ................................................................... 73

Understanding the Three Reform Models ..................................................................... 73

Methodology.................................................................................................................. 77

Three Approaches to Strengthening Social Security..................................................... 86

How the Commission’s Reform Models Improve Social Security’s Treatment of Women

...................................................................................................................................... 88

Reform Model 1: Voluntary Personal Account and Offset Combined with No Changes to 

Traditional Social Security System................................................................................ 89

Reform Model 2: Voluntary Progressive Investment of Payroll Taxes in Accounts 

Combined with an Inflation-Indexed Traditional System.............................................. 104

Reform Model 3: Voluntary Add-On Accounts with Matches from Payroll Taxes 

Overlaying a Traditional System Balanced with a Blend of Revenue and Outlay 

Changes...................................................................................................................... 117

Reform Model 3: Voluntary Add-On Accounts with Matches from Payroll Taxes 

Overlaying a Traditional System Balanced with a Blend of Revenue and Outlay 

Changes...................................................................................................................... 118

The Role of Guarantees.............................................................................................. 134

The Role of Supplemental Security Income In Social Security Reform....................... 137

Treatment Of Disability Insurance In Social Security Reform...................................... 139
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Introduction by the Co-Chairs 

 From the first, Social Security was a work in progress. It remains so now. In 

1939, just four years after enactment, the Administration and Congress added major 

provisions. FDR called for more. As he signed the 1939 Amendments he stated: “we 

must expect a great program of social legislation, as such as is represented in the 

Social Security Act, to be improved and strengthened in the light of additional 

experience and understanding.” He urged an “active study” of future possibilities. 

 One such possibility – personal retirement accounts that would endow workers 

with a measure of wealth – has emerged as the central issue in the ongoing national 

debate over social insurance. 

 There are a number of reasons for this. The first is the most obvious, if perhaps 

the least commented upon: Social Security retirement benefits are no longer the bargain 

they once were. There is nothing sinister about this. Early retirees benefited from the 

fixed formula of retirement benefits. For years the Social Security Administration would 

distribute photographs of Ida May Fuller of Ludlow, Vermont, who having paid $24.75 in 

Social Security taxes lived to age 100 and collected $22,889 in benefits. 

 In Miss Fuller’s time there were almost 42 covered workers for each Social 

Security beneficiary. We are now down to 3.4 workers per beneficiary. As a result, 

Social Security as a retirement measure has become a poor investment. It is, even so, 

an essential insurance program. Widows and dependent children are very reliant on 

dependent benefits. For widows, widowers, singles and children, the monthly check can 

be a steady, stabilizing factor in life. That said, however, Social Security’ actuaries 

estimate that, for a single male worker born in 2000 with average earnings, the real 

annual return on his currently-scheduled contributions to Social Security will be only 

0.86 percent. This is not what sends savers to savings banks. For workers who earn the 

maximum amount taxed (currently $80,400, indexed to wages) the real annual return is 

minus 0.72 percent.1

 This should come as no surprise. Demography is a kind of destiny. The founders 

of Social Security always assumed it would be supplemented by individual forms of 

savings. (In his original Message to Congress, President Roosevelt envisioned 

pensioners owning annuities.) In the first instance, savings took the form of housing; 

government subsidies were created in the 1930s, followed by the enormous influence of 

Veterans Administration mortgages following World War II. By 2000, two-thirds – 67.4 

percent – of Americans owned their homes. 

 The Crash of ’29 left an indelible mark on the generation that lived through it -- 

and for that matter, the one that followed, such that direct investment in markets was 

slow in returning. But eventually it did. 

 

1

. OACT/SSA projections, May 27, 2001, Table 9. 
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 Partly as a consequence of 1929, we have learned a great deal about how a 

modern economy works. During the Depression, the Federal government did not even 

calculate the unemployment rate; it was taken every ten years in the Census. Today, 

our economic statistics are extraordinary in range and accuracy, and since enactment of 

the Employment Act of 1946 economic policies have, on balance, been successful. The 

great swings in economic activity have been radically mitigated. In November 2001, the 

Dating Committee of the National Bureau of Economic Research gave out its judgment 

that the period of economic expansion that began in March 1991 ended in March 2001. 

Such a ten-year period of uninterrupted growth is something never before recorded. 

There will continue to be ups and downs, and all manner of risks, but in the main the 

modern market economy appears to have settled down to impressive long-term growth. 

 The post-World War II growth period was reflected, naturally enough, in the stock 

market. More important, a new form of investment, the mutual fund, was developed 

which enabled small savers to “pool” their investments over a range of stocks and 

bonds. As reported by the Investment Company Institute, “As of May, 2001, 93.3 million 

individuals, representing 52 percent of all U.S. households owned mutual funds.” 

Further, “Nearly half of mutual fund shareholders have household financial assets below 

$100,000; 29 percent have less than $50,000.” 

 The surge in mutual fund ownership began in the early 1980s. One of the more 

notable innovations was the development of such a fund, the Thrift Savings Plan, as 

part of the retirement arrangements for Federal employees. The legislation was enacted 

quietly by Congress and signed by President Reagan in 1986. In terms of the markets, 

the timing could not have been better. The results have been stunning, as the 

Commission learned from testimony by the Director of the Federal Retirement Thrift 

Investment Board, Roger Mehle. Three funds were available, in whatever combination 

the employee chose. A “G” Fund is invested in short-term non-marketable U.S. 

Treasury securities specially issued to the TSP. An “F” Fund is invested in a commercial 

bond index; and a “C” Fund is invested in an equity index fund. The compound rates of 

return for the closing decade of the last century were as follows: 

G Fund 6.7 percent 

F Fund 7.9 percent 

C Fund 17.4 percent 

 Actual trading is contracted out and administrative expenses are minimal: 50 

cents for every $1,000 of G Fund account balance, 70 cents for the F Fund, and 60 

cents for the C Fund. (Additional funds are now being developed and offered.) As of 

September 2001, 86.6 percent of all Federal employees participated in the program. It is 

a singular success. 

 Martha Derthick’s classic study Policy Making for Social Security begins with a 

quotation from Arthur Altmeyer, who was chief executive of the program from 1937 to 

1953: 
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Social Security will always be a goal, never a finished thing because human 

aspirations are infinitely expandable... just as human nature is infinitely perfectible. (p. 

17) 

This would not quite have been the view of the Founders, who thought human nature to 

be anything but “infinitely perfectible.” Hence checks and balances were needed to 

make up for the “defect of better motives.” And indeed some things, notably 

demography, proved anything but perfectible. The Social Security tax (F.I.C.A. for 

Federal Insurance Contribution Act) began at two percent and has been raised more 

than twenty times, reaching the present 12.4 percent. This is a regressive tax that is 

paid on the first dollar of income by rich and poor alike. In fact, as of 1997, 79 percent of 

American households paid more in payroll taxes than in income taxes.2

 

 One egregious failing of the present system is its effect on minorities with shorter 

life spans than the white majority. For black men age 20, only some 65 percent can be 

expected to survive to age 65. Thus, one of every three black youths will pay for 

retirement benefits they will never collect. No one intends this; and with time the gap 

may close. But it is not closed now. And because Social Security provides no property 

rights to its contributors – the Supreme Court has twice so ruled – a worker could easily 

work forty years then die and own not a penny of the contributions he has made for 

retirement benefits he will never collect. There are, to be sure, survivors and 

dependents benefits, but many workers die before eligibility for these is established. 

Disability insurance was added during the Eisenhower Administration so that workers 

are covered during their working years. But far too many never receive any retirement 

benefits and leave no estate. 

 Similarly, the present Social Security provision can prove unjust to women, 

especially divorced women who too often share nothing of the benefits acquired by a 

previous spouse. It is time we addressed this matter. There are a number of legitimate 

approaches that simply need to be worked out, with the plain objective of equal 

treatment. 

 As the early administrators of Social Security anticipated – and very much hoped 

for – the program steadily evolved. Health insurance (Medicare) was enacted in the 

1960s. By the 1990s, the time had come for Personal Retirement Accounts. (As with 

much else in social insurance, other nations had preceded us.) In the mode of earlier 

innovations, the subject was first broached in academic circles, notably by economists 

such as Harvard’s Martin Feldstein. In the fall of 1997, the Clinton Administration began 

to analyze proposals to create a system of individual retirement accounts, either as part 

of Social Security or outside of it. By early 1998, working groups were formed within 

Treasury and other departments to study issues related to such proposals. 

 A primary issue was how a feasible system of accounts could be administered 

and what would be the associated costs. In the spring of 1999 the Treasury had 

contracted a study by the State Street Bank entitled, “Administrative Challenges 

 

2

. Congressional Budget Office, “Effective Federal Tax Rates, 1979-1997,” October, 2001, p. xxi. 
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Confronting Social Security Reform.” The sum of it was that the task was feasible – the 

Thrift Savings Accounts were already in place – and the cost modest. Accenture 

(formerly known as Andersen Consulting) produced similar findings. In 1998 and 1999 a 

range of similar measures were introduced in Congress. None were enacted, but there 

was now a striking new item on the national agenda. 

In the course of the Republican presidential primary campaign of 2000, then 

Governor George W. Bush gave a major address on Social Security, proclaiming it “the 

single most successful government program in American history...a defining American 

promise.” He went on to discuss Personal Retirement Accounts that would, in the words 

of a Democratic Senator, “take the system to its ‘logical completion.’” Then-Governor 

Bush envisioned a program that would “give people the security of ownership,” the 

opportunity “to build wealth, which they will use for their own retirement and pass on to 

their children.” He cited a range of legislators, Republican and Democrat, who shared 

this general view, including Senator Bob Kerrey, who had recently stated: “It’s very 

important, especially for those of us who have already accumulated wealth, to write 

laws to enable other people to accumulate it.” Governor Bush then added: 

Ownership in our society should not be an exclusive club. Independence 

should not be a gated community. Everyone should be a part owner in the 

American dream. 

 In his address, then-Governor Bush insisted that “personal accounts are not a 

substitute for Social Security,” but a supplement, a logical completion. He proposed 

several measures necessary to ensure the long-term fiscal viability of Social Security 

itself. Among them was the following: 

Reform should include personal retirement accounts for young people – 

an element of all the major bipartisan plans. The idea works very simply. A 

young worker can take some portion of his or her payroll tax and put it in a 

fund that invests in stocks and bonds. We will establish basic standards 

of safety and soundness, so that investments are only in steady, reliable 

funds. There will be no fly-by-night speculators or day trading. And money 

in this account could only be used for retirement, or passed along as an 

inheritance. 

Personal retirement accounts within Social Security could be designed and 

financed in a number of ways, some of which are analyzed by the Commission in detail 

in the pages that follow. We, the co-chairs, note here that it would be straightforward for 

the government to set up such accounts. This approach would establish an opportunity 

for all people with earnings to set up a personal retirement account, on a voluntary 

basis. These accounts could be financed by the individual worker voluntarily adding one 

percent of his pay on top of the present 6.2 percent employee share of the Social 

Security payroll tax. The Federal government could match the employee’s contribution 

with a matching one percent of salary, drawn from general revenues. The result would 

be retirement savings accounts for all participating American workers and their families, 
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which might or might not interact directly with the Social Security system, depending on 

design choices that are discussed further in Chapter 4. The cost to the Federal 

government would be approximately $40 billion per year, depending on rates of 

participation. The magic of compound interest now commences to work its wonders. 

 To illustrate what a participant might anticipate from setting aside one percent of 

his or her pay, matched with the government’s one percent, we can forecast the 

situation of a “scaled medium earner” entering the workforce at age 21 and retiring at 

age 65 in the year 2052.3

 Assume a portfolio choice – there should be choices – 

roughly that of the current Thrift Savings Plan: 50 percent corporate equity, 30 percent 

corporate bonds, and 20 percent U.S. Treasury bonds. Real yields are assumed to be 

6.5 percent for equities, 3.5 percent for corporate bonds, and 3 percent for Treasury 

bonds. Also assume that this worker pays 0.3 percent of his account assets for annual 

administrative costs. At retirement, she or he will have an expected portfolio worth 

$523,000 ($101,000 in constant 2001 dollars). A two-earner family could easily have an 

expected net “cash” worth of $1 million. 

 As the Commission’s interim report has shown, Social Security is in need of an 

overhaul. The system is not sustainable as currently structured. The final report 

demonstrates that there are several different approaches that national policymakers 

could take to address the problem, and we hope the pages that follow will provide 

sufficient analysis and suggestion to prompt a reasoned debate concerning how best to 

strengthen Social Security. 

In the accompanying report, the Commission recommends that there be a period 

of discussion, lasting for at least one year, before legislative action is taken to 

strengthen and restore sustainability to Social Security. Regardless of how 

policymakers come to terms with the underlying sustainability issues, however, one 

thing is clear to us: the time to include personal accounts in such action has, indeed, 

arrived. The details of such accounts are negotiable, but their need is clear. The time 

for our elected officials to begin that discussion, informed by the findings in this report, is 

now. 

Carpe diem!

Daniel Patrick Moynihan, Richard D. Parsons 

Co-Chairs 

December 11, 2001 

 

3

 Today, a scaled medium earner earns $35,277 annually. 
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Executive Summary 

Findings: 

The Commission agrees that while there are multiple paths to fiscal sustainability that 

are consistent with the President’s principles for Social Security reform, we have chosen 

to include three reform models in the report that improve the fiscal sustainability of the 

current system, are costed honestly, and are preferable to the current Social Security 

system. 

Under the current system, the benefits to future retirees are scheduled to grow 

significantly above the benefits received by today’s retirees, even after adjusting for 

inflation, and the cost of paying these benefits will significantly exceed the amount of 

payroll taxes collected. To bring the Social Security system to a path of fiscal 

sustainability—an essential task for any legitimate reform plan--there are differing 

approaches. The Commission believes that no matter which approach is taken, 

personal accounts can enhance benefits expected by future participants in the Social 

Security system. 

Unifying Elements of the Three Reform Plans: 

• The Commission has developed three alternative models for Social Security 

reform involving personal accounts. Under all three reform plans, future 

retirees can expect to receive benefits that are at least as high as those 

received by today’s retirees (inflation adjusted). 

• All three models include a voluntary personal retirement account that would 

permit participants to build substantial wealth and receive higher expected 

benefits than those paid to today’s retirees. Thus, all of the plans would 

enhance workers’ control over their retirement benefits with accounts that 

they own and can use to produce retirement income, or pass on to others in 

the form of an inheritance. 

• Because the Commissioners believe that the benefits currently paid to lowwage workers are too low, we have included a provision in two of the three 

plans that would enhance the existing Social Security system’s progressivity 

by significantly increasing benefits for low-income workers above what the 

system currently pays. This provision will raise even more of our low-income 

elderly – most of whom are women – out of poverty. Two of the three 

models also boost survivor benefits for below-average income widows and 

widowers. 

• The Commission has set a goal of moving the Social Security system toward a 

fiscally sustainable course that reduces pressure on the remainder of the 

federal budget and can respond to economic and demographic changes in the 

future. The three reform models outlined here are therefore transparently 
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scored in terms of plan provisions, effects on workers’ expected costs and 

benefits, and effects on Trust Fund operations as well as the unified federal 

budget. We also identify clearly how large the personal account assets may 

be expected to grow as the system evolves. 

• All three of the models improve the fiscal sustainability of the program, 

though some move farther than others. All three require a transition 

investment from general revenues to strengthen Social Security, but all three 

reduce the long-term need for general revenue as compared to the current, 

unsustainable, system. In all three plans, the system’s cash flow needs are 

met so that the benefits promised by each plan can be paid as retirees need 

them. 

• All three of the models are expected to increase national saving, though some 

more than others. 

• The Commission concludes that building substantial wealth in personal 

accounts can be and should be a viable component of strengthening Social 

Security. We commend our three models to the Members of Congress and to 

the American public in order to enrich national understanding of the 

opportunities for moving forward. 
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President’s Principles 

The President directed the Commission to propose Social Security reform plans that will 

strengthen Social Security and increase its fiscally sustainability, while meeting several 

principles: 

hModernization must not change Social Security benefits for retirees or nearretirees. 

hThe entire Social Security surplus must be dedicated to Social Security only. 

hSocial Security payroll taxes must not be increased. 

hGovernment must not invest Social Security funds in the stock market. 

hModernization must preserve Social Security’s disability and survivors 

components. 

hModernization must include individually controlled, voluntary personal 

retirement 

accounts, which will augment the Social Security safety net. 

Understanding the “Benchmarks” 

In analyzing any plan for reforming Social Security, it is important to be clear about the 

benchmarks for comparison. Benchmarks could include: 

• Currently scheduled benefits from the existing system, which cannot be paid by 

existing payroll tax revenues (“scheduled benefits”). 

• Benefits that are payable given in the existing tax revenues (“payable benefits”). 

• Benefits currently paid to retirees (“currently paid benefits”). 

All of these benchmarks are legitimate, but they are significantly different. For 

example, comparing benefits under a reform plan to “promised benefits” is an unfair 

comparison because currently promised benefits are not payable. Without adding more 

revenue to the system, a more appropriate comparison would be to “payable benefits.” 
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Three Reform Models 

The three models for Social Security reform devised by the Commission demonstrate 

how alternative formulations for personal accounts can contribute to a strengthened 

Social Security system. 

Reform model 1 establishes a voluntary personal account option but does not specify 

other changes in Social Security’s benefit and revenue structure to achieve full longterm sustainability.

• Workers can voluntarily redirect 2% of their payroll taxes to a personal account. 

• In exchange, traditional Social Security benefits are offset by the worker’s 

personal account contributions compounded at an interest rate of 3.5% above 

inflation. 

• No other changes are made to traditional Social Security. 

• Expected benefits to workers rise while cash deficit of Social Security falls at end 

of valuation period. 

• Workers, retirees and taxpayers continue to face uncertainty because a large 

financing gap remains that requires future benefit cuts or substantial new 

revenues. 

• Additional revenues are needed to keep the trust fund solvent starting in mid2030’s. 

 

Reform Model 2 enables all future retirees to receive a Social Security benefit that is at 

least as great as today’s retirees, inflation adjusted, and, in addition, increases the 

Social Security benefits paid to low-income workers. Model 2 establishes a voluntary 

personal account, without raising taxes or requiring additional worker contributions, it 

achieves solvency and it balances Social Security revenues and costs. 

• Workers can voluntarily redirect 4% of their payroll taxes up to $1000 (wage 

indexed) to a personal account. 

• No additional contribution from the worker would be required. 

• Workers who opt for personal accounts can reasonably expect to receive a 

combined benefit greater than benefits paid to current retirees and also greater than 

the future benefits payable under the current system. 

• The plan makes the system more progressive, since additional protections against 

poverty are provided for low-income workers and survivors. 
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• Expected benefits payable to a medium earner electing a retirement account would 

be 59% above benefits currently paid to today’s retirees by 2052. At the end of the 

75-year valuation period, the personal account system would hold $2 trillion (in 

today’s dollars), much of which would be new saving, an accomplishment that would 

not need increased taxes or increased worker contributions over the long term. 

• Solvency will be achieved by price indexing instead of wage indexing initial benefits, 

beginning in 2009. 

• Temporary transfers from general revenue would be needed to keep the Trust Fund 

solvent from 2025-2054. Furthermore, this model achieves a positive system cash 

flow during the 75-year valuation period under all participation rates. 

Reform Model 3 establishes a voluntary personal account option that enables workers to 

reach or exceed current-law scheduled benefits and wage replacement ratios, by adding 

new sources of revenue and by slowing benefit growth less than price indexing. 

• Workers who opt for personal accounts can reasonably expect to receive total 

social security benefits (including their PRA) that exceed scheduled benefit levels 

and current replacement rates.

• Personal accounts are created by a match of part of the payroll tax – 2.5% up to 

$1000 annually – for any worker who contributes an additional 1% of wages 

subject to Social Security payroll taxes. 

• The add-on is partially subsidized for workers in a progressive manner by a 

refundable tax credit (33% up to a $100 maximum). 

• Solvency is restored to the traditional social security system by: 

♦ adjusting the growth rate in benefits for actual future changes in 

life expectancy, 

♦ increasing work incentive by decreasing the benefits for early 

retirement and increasing the benefits for late retirement, and 

♦ flattening out the benefit formula (reducing the third factor from 15 

to 10%). 

• New sources of dedicated revenue are added. 

• Transition burden is reduced by charging a 2.5% benefit offset, making 

additional contributions to the personal account. 

• Progressivity is enhanced and poverty reduced by providing a minimum benefit 

for low earners and an improved survivors’ benefit. 

• Additional temporary transfers from general revenues are needed to keep the 

trust fund solvent from 2028-2057. 
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Specifications of Commission Reform Models 

Model 1 Model 2 Model 3 

PERSONAL 

ACCOUNTS 

 

Personal Account 

Size 

2% 4% up to $1000 

($1000 is wage 

indexed) 

1% new 

contribution 

plus 2.5% up to 

$1000 

($1000 is wage 

indexed) 

Voluntary Yes Yes Yes 

Additional 

Contributions 

Required? 

This is a generic 2% 

plan that can be done 

with or without new 

contributions 

None 

1% of wages 

required to 

participate 

(subsidized through 

income tax system) 

Real return that 

makes person 

better off with 

accts than without 

(SS defined 

benefit offset 

rate). 

3.5% 2.0% 2.5% 

Accounts owned 

by participants? 

Yes Yes Yes 

Accounts can be 

bequeathed to 

Yes Yes Yes 
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heirs? 

Participants can 

choose from a 

mix of low-cost, 

diversified 

portfolios? 

Yes Yes Yes 

Contributions and 

account earnings 

splitting in case of 

divorce? 

Yes Yes Yes 

TRADITIONAL 

SOCIAL 

SECURITY 

BENEFITS 

 

New minimum 

benefit 

None 

By 2018, a 30-year 

minimum wage 

worker is 

guaranteed benefit 

= 120% of poverty 

level, inflation 

indexed. 

By 2018, a 30-year 

minimum wage 

worker is 

guaranteed benefit 

= 100% of poverty 

level, then rising. 

Widow/Widower 

Benefits 

No changes 

Increase to 75% of 

couple benefits (vs. 

50% to 66% today) 

for lower wage 

couples 

Increase to 75% of 

couple benefits (vs. 

50% to 66% today) 

for lower wage 

couples 

Changes to 

growth rate 

Of traditional 

benefit for future 

retirees 

None specified 

Indexed to inflation 

instead of wages 

starting for those 

turning 62 in 2009. 

Indexed to gains in 

average life 

expectancy 

(results in average 

annual growth of 

0.5% over inflation) 

Additional 

changes to 

traditional benefit 

formula 

None specified None specified 

1. Reduce benefit 

for early 

retirement and 

increase benefit 

for late 

retirement. 

2. Gradually
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decrease bend 

point factor for 

highest income 

bend point from 

15% to 10% 

starting in 2009 
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Chapter 1: Strengthening Social Security Through Personal Accounts 

Summary of Findings 

Social Security will be strengthened if modernized to include a system of voluntary 

personal accounts.

Retirement security will be increased through personal accounts because they would 

facilitate wealth creation for individual participants. 

Financial security is enhanced by asset ownership. Correspondingly, retirement security 

for Social Security participants will be enhanced by ownership of assets accumulated 

through the Social Security system, relative to a claim to benefits that must remain 

subject to political negotiation. 

Social Security should be extended to include inheritable assets. 

Strengthening Social Security to include personal accounts can add valuable 

protections for widows, divorced persons, low-income households and other Americans 

at risk of poverty in old age. 

Partial advance funding of Social Security should be a goal of any effort to strengthen 

the system. 

Personal accounts would permit individuals to seek a higher rate of return on their 

Social Security contributions, offering higher total expected benefits to individuals with 

accounts than those lacking them. 

Advance funding within Social Security can best be accomplished through personal 

accounts rather than direct government investment in the stock market. 

The Commission finds that the establishment of personal accounts is likely to lead to an 

increase in national saving. 

The Commission believes that the establishment of personal accounts will improve 

incentives for labor force participation. 
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Introduction 

In President Bush’s Executive Order establishing the Commission to Strengthen Social 

Security, he instructed the Commission to submit “bipartisan recommendations to 

modernize and restore fiscal soundness to the Social Security system.” 

The Commission has reviewed dozens of possible future courses for Social Security, 

including several developed by outside experts, and projections developed by the Office 

of the Chief Actuary of the Social Security Administration. 

These examinations have led us to the following conclusions concerning the 

establishment of personal accounts within the Social Security system. 
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Finding: It is the finding of the President’s bipartisan commission that Social Security will 

be strengthened if modernized to include a system of voluntary personal accounts. 

Specifically, the Commission finds that the Social Security system would be 

strengthened through personal accounts regardless of the level of benefits promised 

from, and the level of revenues committed to the Social Security system. These are 

decisions that are yet to be made by the Congress and the President, involving tradeoffs elucidated later in this report. 

However, whether additional revenues are committed to the Social Security system or 

benefit growth is brought to a level that can be sustained within currently projected 

revenues, the Commission finds that the creation of personal accounts will enhance 

retirement security, relative to their absence, for reasons outlined on the following 

pages. 
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Finding: Retirement security will be increased through personal accounts because they 

would facilitate wealth creation for individual participants. 

Approximately half of United States households save nothing in an average year, and 

millions hold no appreciable financial assets. Establishing personal accounts within 

Social Security would advance a highly progressive principle: accumulating assets for 

the half of American households who have not compiled this measure of wealth after 

contributing 12.4 percent of their wages to support the Social Security system. 

This 12.4 percent of wages currently buys for these Americans an inflation-indexed 

annuity upon retirement, as well as insurance against disability and protections for 

dependents and survivors. The Commission believes these protections should be 

continued. Projections show that if a portion of this 12.4 percent is contributed to 

personal accounts, these protections can continue, while at the same time establishing 

the progressive result of creating a measure of wealth through financial asset 

ownership, for millions of Americans who do not now enjoy it. 

In testimony before the Commission, Professor Michael Sherraden of Washington 

University stated that: 

For the vast majority of households, the pathway out of poverty is not through 

income and consumption but through saving and accumulation.... When people begin 

to accumulate assets, their thinking and behavior changes as well. Accumulating assets 

leads to important psychological and social effects that are not achieved in the same 

degree by receiving and spending an equivalent amount of regular income. 

Accumulating research shows that asset accumulation has positive effects on individual 

well-being that extend far beyond the income those assets provide. In other words, 

personal accounts can be more than simply a way to provide Social Security benefits. 

By saving and accumulating assets in an account, individuals and their families benefit 

in other ways as well. 
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Examples: 

• Several studies show that asset-holding has a substantial positive effect on longterm health and marital stability, even when controlling for income, race and 

education.4 

• Among participants in trial programs of individual development accounts, 84 

percent report feeling more economically secure, 59 percent report being more 

likely to make educational plans, and 57 percent report being more likely to plan 

for retirement because they are involved in an asset-building program.5

• Individuals with investment assets, and their children, perform better on 

educational tests and reach higher educational attainment, even after accounting 

for income.6

• Single mothers and their children are less likely to live in poverty if the mother 

came from a family with asset holdings, again even after controlling for education 

and socio-economic status.7

 

• Saving patterns are passed on from parents to children; parents who save are 

more likely to have children who save, even after other factors are counted.8

• Among individuals with experimental Individual Development Accounts, 93 

percent say they feel more confident about the future and 85 percent more in 

control of their lives because they are saving. Approximately half of account 

holders report that having accounts makes them more likely to have good 

relationships with family members, and 60 percent say that they are more likely 

to make educational plans for their children because they are saving.9

 

Moreover, recent research has concluded that individuals with personal defined 

contribution accounts would voluntarily choose to save more than individuals with a 

comparable defined benefit plan. This is important, given the importance of reforming 

Social Security in a manner that increases national saving.10

The authors find that “interest in leaving a bequest ... is positively related to the 

proportion of pension wealth received as lump sums rather than annuities. Thus, it 

 

4 Galligan & Bahr (1978); Hampton (1982); South & Spitze (1986)

5 Moore et al. (2001)

6

 Mayer (1997), (Hill and Duncan, 1987). 

7

 Cheng (1995) 

8 Pritchard, Myers & Cassidy (1989)

9

 Moore et al., 2001. 

10 “The Impact Of The Shift To Defined Contribution Plans On Bequests And Living Standards In 

Retirement,” Alicia H. Munnell, Mauricio Soto, Annika Sundén, and Catherine Taylor, Prepared for “The 

Role and Impact of Gifts and Estates,” Conference Sponsored by the Center for Retirement Research at 

Boston College, 

Woodstock, VT, October 21-23, 2001 
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appears that lump-sum payments affect intended as well as unintended bequests.” 

Moreover, “workers react very differently to their defined contribution accumulations 

than they do to the present value of annuity pensions. They do not reduce their other 

saving in anticipation of payments from defined contribution plans as they do in 

response to promised Social Security and defined benefit pension payments. Finally, 

the most significant increase in lump-sum pension accumulations occurs in the middle 

and lower quintiles of the wealth distribution, so that the increase in bequests should 

help to reduce wealth inequality.”11

“Asset poverty” is of particular concern to minorities. Sherraden reported to the 

Commission that that while the median income of whites versus African Americans is 

1.6-to-1, the median net worth ratio is 11-to-1. Similar disparities exist between whites 

and Hispanics. 

The benefits of personal asset ownership could not be achieved either through the 

Social Security system as currently structured or through government investment of the 

trust fund in the stock market. 

 

11 Munnell, et al, p.3 
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Finding: Financial security is enhanced by asset ownership. Correspondingly, retirement 

security for Social Security participants will be enhanced by ownership of assets 

accumulated through the Social Security system, relative to a claim to benefits that must 

remain subject to political negotiation. 

Throughout the history of Social Security, benefit formulas have been statutorily altered 

numerous times. Benefits have been expanded when deemed affordable to do so, and 

reduced in response to financial pressures. The large projected Social Security funding 

shortfall virtually ensures that benefits from the traditional Social Security system will 

remain at risk of being reduced, compromising the retirement security of participants. 

The Social Security Administration points out that: 

There has been a temptation throughout the program’s history for some people 

to suppose that their FICA payroll taxes entitle them to a benefit in a legal, 

contractual sense. That is to say, if a person makes FICA contributions over a 

number of years, Congress cannot, according to this reasoning, change the rules 

in such a way that deprives a contributor of a promised future benefit.12

However, the SSA notes, “Congress clearly had no such limitation in mind when crafting 

the law.” 

“Like all federal entitlement programs,” the Social Security Administration 

acknowledges, “Congress can change the rules regarding eligibility--and it has done so 

many times over the years. The rules can be made more generous, or they can be 

made more restrictive. Benefits which are granted at one time can be withdrawn, as for 

example with student benefits, which were substantially scaled-back in the 1983 

Amendments.” 

By contrast, assets held in personal accounts would be more secure. The owner can 

choose the level of risk to which such assets are to be subjected through investment 

policies, but there is little substantial risk that these assets will be taken away, other 

than through the normal process of income taxation. Personal accounts, which would 

give workers a legal right to their assets and the benefits derived from them, thus 

provide a substantially stronger guarantee than does the current unsustainable 

program. 

International experience bears out this judgment. At the Commission’s San Diego public 

hearing, Anita Schwartz of the World Bank noted that in many countries where 

participation in personal accounts was voluntary, many workers opted for a personal 

account even when “on paper” it appeared that they would have received higher 

benefits through the traditional system. For instance, Schwartz noted that experts in 

Uruguay had projected that less than 15 percent of the 600,000 participants in the 

traditional social security system would choose to take a personal account, but that 

when the choice came, more than two-thirds actually opted for them. One reason, 

Schwartz said, is that many people feel more secure with an asset than with an 

entitlement: an account that is their own property is perceived to be safer than an 

untenable government promise to be fulfilled decades in the future. 

 

12 Social Security Administration website; http://www.ssa.gov/history/nestor.html 
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Retirement security is also enhanced by diversification of risk. The creation of personal 

accounts would diversify the risk inherent in the Social Security system by allowing 

individuals to split risks between political risks (the risk of reductions in government-paid 

benefits) and financial risks (risk of depreciation of personally-held assets.) Workers 

demanding absolute security can, through personal accounts, have risk substantially 

below that of the current system simply by choosing to invest in government bonds. 

In short, with a personal account each worker would have a legal right to his benefits, 

and can choose the combination of risk and return to which his age and temperament 

make him most comfortable. 
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Finding: Social Security should be extended to include inheritable assets. 

Almost one in five 20-year-olds will not live to age 65. Among African American males, 

this percentage is even higher. While Social Security offers survivors benefits to 

spouses who have reached retirement age and to children under the age of 16, Social 

Security – which constitutes the total saving for many lower-income workers – offers no 

opportunity for workers to build and pass on any substantial wealth to their heirs, even if 

the worker died prior to receiving any benefits at all. The only lump sum wealth Social 

Security provides to pass on is a one-time payment of a $255 death benefit. 

The Commission recommends that Social Security preserve its current system of 

survivor benefits, but supplement these insurance protections with a system of personal 

accounts whose assets could be passed on to a spouse or heirs. Inheritable assets 

would improve Social Security’s treatment of demographic groups with lower incomes 

and shorter life expectancies and enhance the possibilities for asset accumulation and 

wealth-building in underserved communities. 

Social Security effectively annuitizes the contributions a worker pays in over the course 

of his lifetime, converting them from a lump sum of wealth into an entitlement to 

specified monthly payments for life. This Social Security annuity provides valuable 

protections against outliving one’s assets, but it also pays the highest lifetime benefits to 

individuals who live the longest. Since longevity is correlated with income, poorer 

workers will tend to die younger and therefore receive fewer benefit payments. 

Moreover, since lower-income 

workers are almost totally reliant 

upon Social Security for income 

in retirement, this means they 

have very little inheritable wealth 

to pass on to their heirs. 

The combination of these two 

factors can be particularly 

harmful to African Americans, 

who on average have both lower 

incomes and shorter life 

expectancies than other 

Americans. 

If lower-income workers had the option to receive at least part of their Social Security 

benefits as a sum of wealth that could be passed on at their death, younger generations 

might have opportunities to attend college or start a business that would otherwise be 

unavailable to them. These opportunities would further contribute to an easing of asset 

inequality in the United States. 

African Americans Hold Substantially Less Wealth At 

Retirement 

Total Net Worth Financial Assets 

Percentile All African 

American 

All African 

American 

10 $150 0 0 0 

20 $8,000 0 0 0 

30 $28,005 $700 $600 0 

50 $77,800 $17,000 $8,000 0 

70 $154,000 $45,000 $36,000 $1,000 

90 $384,000 $114,600 $152,000 $11,000 

95 $618,000 $182,000 $275,000 $32,300 

Source: James P. Smith, “Wealth Inequality among Older 

Americans,” RAND Corporation Working Paper Series, 95-

06, April 1995, p. 20. 
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Finding: Strengthening Social Security to include personal accounts can add valuable 

protections for the segments of American society at greatest risk of poverty in old age. 

Poverty among the elderly tends to be concentrated among women relative to men, 

single individuals relative to married couples, and ethnic and racial minorities. A 

properly designed individual account program should assist each of these groups. 

Widows would be assisted by allowing for inheritable personal accounts in addition to 

Social Security’s current, or a strengthened, widow’s benefit. 

Divorced persons would be assisted by the establishment, for the first time, of joint 

property rights in Social Security benefits accumulated during marriages that last for 

less than ten years. 

Single working women would be assisted by the creation of an element that lacks Social 

Security’s current redistribution away from single earners to married couples. 

Lower-income groups would be assisted by the opportunity to build financial assets with 

a portion of the 12.4 percent of their wages that are currently contributed to Social 

Security. 

Demographic groups with shorter life expectancies would benefit from adding 

inheritable assets to Social Security’s current survivors’ protections. 
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Finding: Partial advance funding of Social Security should be a goal of any effort to 

strengthen the system.

This Commission agrees with the unanimous finding of the 1994-96 Social Security 

Advisory Council that partial advance funding of Social Security promises is desirable. 

Advance funding raises national saving, increasing the nation’s capital stock and 

productive capacity and reducing Social Security’s financial burden on future 

generations. 

As detailed in our Interim Report, the current system operates primarily as an income 

transfer program in which every penny of benefits paid each year comes from taxes 

collected or money borrowed from the public in that year. 

Over the next 50 years, the number of workers available to support each Social Security 

beneficiary will drop from 3.4-to-1 to only 2-to-1. The cost of supporting the current 

system will increase 69 percent13 during that period, with a corresponding deterioration 

in Social Security’s equitable treatment of different generations. 

To ensure that Social Security’s financing burdens are equitably shared, it is imperative 

that a portion of these revenues be devoted to advance funding. The resulting increase 

in national saving will raise the country’s capital stock, and therefore boost our 

productivity and output. In essence, increased national saving increases the size of the 

economic pie that is available for everyone, old and young alike, to consume in the 

future. 

 

13 2001 TR page 44. Intermediate projections show 2001 cost rate of 10.5 and a 2050 cost rate of 17.79. 
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Finding: Personal accounts would permit individuals to seek a higher rate of return on 

their Social Security contributions, offering higher total expected benefits to individuals 

with accounts than those lacking them. This finding holds true regardless of the other 

steps taken to balance the traditional system. 

Any properly constructed personal account option should increase expected benefits for 

Social Security participants. This is true regardless of the overall resources devoted to 

the program. Under plans that retain the current payroll tax, an individual opting for a 

diversion to a personal account can expect higher overall benefits than one who does 

not choose an account. Similarly, under plans that increase revenues available to the 

system, individuals opting for a personal account can expect to receive higher benefits 

than those choosing not to have such an account. 

It is relatively straightforward to show that, for a given level of funding, a personal 

account system can offer higher total expected benefits than the current system. 

However, confusion occasionally arises when comparisons are made between two 

different plans that employ different levels of tax revenue. For example, scheduled 

benefits for the current system could only be provided if significant tax increases are 

enacted. It is not an equal comparison to assume these tax revenues will materialize 

for the current system, but not for a specific personal account system . For comparisons 

to be meaningful, all factors other than the presence of the account must be held 

constant. 

Going forward, the 

nation faces a range 

of choices to bring the 

existing Social 

Security system to a 

path of fiscal 

sustainability. For 

purposes of 

illustration, In Chapter 

4, the Commission 

shows the effects of 

one approach to 

balancing the Social 

Security system 

without tapping 

additional tax 

revenues, as well as 

the total cost of 

meeting the unsustainable current pace of benefit growth through additional revenues. 

Regardless of the path chosen by policy makers, the Commission’s projections show 

that individuals who are given the opportunity to invest in personal accounts should 

expect increases in total benefits. 
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The opportunity to receive a higher rate of return would derive in turn from an 

individual’s opportunity to realize the gains that come from returns on capital. Over a 

working lifetime, these returns – sometimes referred to as the “miracle of compound 

interest” – can make an enormous difference in an individual’s level of wealth. Because 

of the impact of compound interest, diversified personal accounts can be expected to 

grow rapidly. 
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The Commission recommends that personal accounts augment the Social Security 

safety net by increasing total benefits relative to what the current system can pay. 

B A 

Today, all of a retiree’s

retirement protections come

from the traditional system. 

Tomorrow, workers could have the option to

receive some of their benefits from a personal

account – “Social Security Part B” – while still

receiving benefits from the traditional system

– “Social Security Part A.” And the total of

these two parts will provide greater

protections from poverty than the current

system can provide. 
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Finding: Advance funding within Social Security can best be accomplished through 

personal accounts rather than direct government investment in the stock market. 

The Commission agrees that advance funding cannot be reliably accomplished through 

a Social Security Trust Fund invested wholly by the federal government. While it is 

theoretically possible to build up a fund in this manner, the past two decades have 

taught our nation a clear lesson about how unlikely this is in practice. The availability of 

Social Security surpluses provided the government with an opportunity to use these 

surpluses to finance other government spending, rather than saving and investing them 

for the future. A failure to increase national saving means that future taxpayers will bear 

a higher tax burden without the benefit of the increase in productivity that such saving 

might have stimulated. 

This Commission strongly believes that investment in private securities should be 

handled through personal accounts rather than direct government investment, for 

several reasons: 

• When people own the personal account assets themselves, this is likely to 

limit the diversion of these assets for non-Social Security purposes. 

• Personal accounts allow every participant to choose an investment portfolio 

that is consistent with his or her preferences, while central government 

investment essentially forces everyone into a “one size fits all” portfolio. 

• Government investment will likely be subject to pressures for investment 

based on non-financial criteria, which may threaten account performance. 

These political forces might lead to intense lobbying and campaign 

contributions designed to influence investment policy, which would be bad for 

the government as well as the economy. There are many examples of this 

occurring in other contexts: 

The California public pensions system’s decision to divest its tobacco 

stocks cost retirees an estimated half billion dollars. 

Government investment of pension funds in other countries has resulted in 

returns averaging below those available from standard bank accounts, 

according to the World Bank. 

The argument over political restrictions over centrally-controlled 

investment has already begun in the United States. When the Clinton 

administration suggested investing Social Security reserves in the private 

market, several union leaders sent a letter to Congress expressing their 

opposition to investment of such funds in corporations that engaged in 

practices opposed by the labor unions. 

• Government investment of personal accounts could place the government in 

a position to interfere with corporate decision-making. 

• Government investment can lead to serious conflicts of interest. For example, 

the government would be simultaneously regulating and investing in the same 

companies, or even filing lawsuits against such companies. 
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Finding: The Commission finds that the establishment of personal accounts is likely to 

lead to an increase in national saving. 

The Commission believes that establishing personal accounts will lead to increased 

national saving. This would apply under almost any reasonable proposal to establish 

personal accounts. 

The first reason is that, to a first approximation, if the federal government would 

otherwise save 100 percent of the money that would be saved in personal accounts, 

then establishing personal accounts would not increase national saving. If the 

government would otherwise spend such Social Security revenues, then establishing 

personal accounts would increase net government saving. It is impossible to know with 

precision the degree to which the federal government would otherwise save Social 

Security revenues that are to be deposited in personal accounts. The most that can be 

said is that as a matter of historical record, the government has not tended to save this 

money. To the extent to which this pattern would continue in the future, saving this 

money in personal accounts would increase net government saving. 
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Finding: The Commission believes that the establishment of personal accounts will 

improve incentives for labor force participation. 

The nation’s ability to support its retiree population is directly related to the ratio of those 

in the workforce to those in retirement. Accordingly, the maintenance of an adequate 

supply of labor is a critical element of Social Security reform. However having to pay 

additional Social Security taxes is a deterrent to work, particularly for those who derive 

no additional benefit when they pay these taxes. 

Numerous studies indicate that Social Security has led to earlier retirement in the US. 

For instance, Social Security rules impose a large “implicit” tax on labor supply around 

the Normal Retirement Age, and the tax is high at even younger ages for some 

workers.14 Importantly, these implicit taxes on labor are in addition to the tax levied via 

the U.S. income tax system. High tax rates provide an incentive for individuals to retire 

rather than to remain in the labor force. 

The effect of Social Security on labor supply is not limited to issues relative to retirement 

decision. Research suggests that workers do not fully understand the complex linkage 

between the taxes they pay and the benefits they receive.15 As a result, the Social 

Security payroll tax may have the effect of increasing the marginal tax rate faced by 

individuals working throughout their lives. Since the payroll tax is larger than the income 

tax for the large majority of U.S. households, the marginal tax rates created by the 

Social Security system are an important issue. 

High tax rates on labor distort both the supply of labor and the form of compensation 

that individuals receive, resulting in what economists call a “deadweight loss” to the 

economy.16 These distortions are a drain on the nation’s economy, reducing output and 

growth, and make it that much more difficult to finance the provision of future retirement 

benefits. 

Relative to the current system, contributions to personal accounts are less likely to 

discourage work. Personal account contributions are less likely to be viewed as a tax, 

because the money is deposited into an account that is owned by each system 

participant. Because workers perceive a direct link between the contributions and future 

benefits, their labor supply decisions throughout their work life are less likely to be 

distorted.17 Near retirement, workers may perceive that accumulations in their accounts 

will grow and the annuities they can purchase will increase if they work and contribute 

 

14 Peter Diamond and Jonathan Gruber “Social Security and Retirement in the US” NBER WP 6097 July 

1997 p. 24. Courtney Coile and Jonathan Gruber, “Social Security Incentives for Retirement,” in Themes 

in the Economics of Aging 2001. 

15 Alan Gustman & Tom Steinmeier “What People Don’t Know About Their Pensions and Social Security: 

An Analysis Using Linked Data from the Health and Retirement Survey, NBER WP 7369, September 

1999 

16 Martin Feldstein & Jeffrey Liebman “Social Security” NBER WP 8451, forthcoming in Handbook of 

Public Economics

17 Lawrence H. Summers, “Some Simple Economics of Mandated Benefits, American-Economic-Review; 

79(2), May 1989, pages 177-83. 
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longer. This may encourage them to stay in the labor force – an incentive that becomes 

particularly important as baby boomers retire. 
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Chapter 2: Administration of Personal Accounts 

Summary of Findings 

Personal accounts can be administered in an efficient and cost effective manner. 

The adoption of a “mixed” two-tier structure most effectively balances the desire for low 

administrative costs along with consumer choice and efficient financial markets. 

The Governing Board should investigate ways to reduce the time that it takes to credit 

contributions to personal accounts, without increasing employer compliance costs. 

Investment allocations should be allowed to be changed not more than once during a 

12-month period; but access to account information should be immediate. 

The Governing Board must bear the primary responsibility for providing participants with 

the necessary financial information. Non-profit organizations are encouraged to 

continue their efforts in this area. 

Participants in Tier I should be able to choose one of three indexed balanced funds 

(conservative, medium, and growth) or any combination of five index funds, patterned 

after the current TSP funds, as well as an inflation-protected bond fund. 

A standard fund should be established for those individuals who do not select a fund in 

Tier I. 

Private-sector account administrators in Tier II may offer the same funds as in Tier I, 

and possibly other broadly diversified mutual funds certified by the governing Board 

according to appropriate criteria. 

Pre-retirement access to funds in personal accounts should not be allowed; accounts 

may be bequeathed by those who die before they receive retirement benefits. 

At retirement, personal account distributions can be taken as an annuity or as gradual 

withdrawals, and balances above a threshold can also be taken as a lump-sum 

distribution. The threshold amount is chosen so that the yearly income received from an 

individual’s defined benefit plus the joint (if married) annuity keeps both spouses safely 

above the poverty line during retirement, taking into account expected lifetimes and 

inflation. 

All account balances attributable to contributions during marriage, and all earnings on 

account balances brought into marriage, should be divided equally in the event of 

divorce. Account balances brought into marriage would not be shared. 

Upon retirement, a joint and survivor two-thirds annuity (as under Social Security) 

should be required unless both spouses agree to an alternative arrangement. 
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To isolate the Governing Board from political risk, Congress should follow the models of 

the Thrift Savings Plan and the Federal Reserve Board when designing the Board 

structure. 

Equity shares in the mixed system should be voted by fund managers. 
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Background 

The Commission sought to determine whether personal accounts could be 

implemented in a cost-effective manner that give Americans a good value for the 

services they receive. We have concluded that personal accounts can be administered 

in an efficient and effective manner. Non-partisan experts in Executive Branch 

departments helped in the evaluation of design options for personal accounts. 

Finding: Personal accounts can be administered in an efficient and cost effective 

manner. 

The international experience is consistent with this finding. More than 20 

countries spanning five continents have now created personal accounts to either 

augment or replace their public pension systems. Personal accounts have been created 

in a diverse set of countries including Argentina, Australia, Chile, Hong Kong, Mexico, 

Poland, Switzerland and the United Kingdom. Numerous other countries are also now in 

the process of creating personal accounts, including Russia and China. Even Sweden – 

the country traditionally offering a large amount of publicly provided welfare – has also 

recently added personal accounts to their public pension program. Experience in the 

United States with 401(k) plans and Individual Retirement Arrangements18 have given 

U.S. financial providers a tremendous amount of experience in administering personal 

accounts. The United States – the country whose approach to Social Security was 

copied throughout the world during the 20th century – is now behind in modernizing its 

social security system for the 21st century. 

 Both the international experience and the Commission’s own examination have 

provided two valuable lessons. First, personal accounts can be administered in a costeffective fashion. Second, the design details are important. The United Kingdom’s 

system, for example, has been criticized for high administrative costs and ‘account 

churning.’ The U.K. government has recently re-reformed this system to help solve 

these problems. 

 

18 Individual Retirement Arrangements (IRAs) are also commonly referred to as “Individual Retirement 

Accounts.” 
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The General Structure of Personal Accounts 

Personal accounts can be structured in several different ways. The ideal 

administrative structure must balance several goals. First, administrative fees must be 

reasonable and proportional to the services that are provided to the owners of personal 

accounts, which should be achieved to the extent possible through competition among 

managers. Second, investment choices must be designed to reduce the risk for 

individual account holders, especially for those who currently do not participate in 

financial markets, by requiring that investments be made in broadly diversified 

portfolios. Third, workers and retirees must be given some flexibility in the choice of 

personal accounts that they own in order to realize the benefits of competition. Fourth, 

personal account owners are entitled to have their contributions credited to their 

personal accounts in a timely and accurate fashion, but without imposing additional 

compliance costs on employers. Fifth, the government must be diligent in ensuring that 

any personal account system is operating efficiently and fairly. 

At one end of the administrative structure spectrum, is the so-called “centralized” 

approach. Under this approach, payroll collections are transferred to a governmentappointed central administrator using the existing Social Security payroll tax system. 

Workers have a choice among a limited number of low-cost, diversified investment 

indexed funds, like under the Thrift Savings Plan (TSP), which is a retirement plan for 

many federal and military workers. The central administrator keeps all records and 

invests worker contributions according to their preferences. These indexed funds 

purchase stocks in numerous companies and the amount invested in each company is 

proportional to the company’s value relative to that of other companies in the fund. Like 

TSP, a Governing Board contracts fund management to multiple private managers on a 

competitive basis. 

 The centralized approach is sensible to implement in the short term but probably 

not the best approach in the long run. The centralized approach does not incorporate 

the market discipline that might be necessary to provide workers and retirees with good 

value and choices. Consumers who are unhappy with the services that they are 

receiving from the central administrator could not “vote with their feet” by moving to 

another provider. De-regulation in the telephone industry and the airline industry provide 

ample evidence that consumers like choice even for relatively homogenous products 

and that choice generally leads to lower prices and better services. The importance of 

choice is accentuated by the fact that the central administrator in a Social Security 

system augmented with personal accounts would be required to interact with 

businesses of many sizes as well as with self-employed individuals. A centralized “onesize-fits-all” approach, therefore, is not the best approach. 

 At the opposite end of the administrative spectrum is the “decentralized” 

approach. One version of this approach includes existing 401(k) programs that are 

offered by many large and medium-size employers. Under this approach, payroll 

collections are transferred directly from employers to private-sector investment funds 

that satisfy diversification and other requirements. Workers make investment choices 
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through their employers, and workers can choose from a wide range of private-sector 

funds, switching funds if they so desire. The government must still interact with each 

fund and employer in order to enforce compliance. 

 The decentralized approach, though, faces its own problems. First, the cost of 

compliance would increase on employers that do not currently offer 401(k) programs, 

including many small employers. Even those companies that do offer 401(k) programs 

often use only one fund complex; in the decentralized approach, some workers might 

wish to invest in a fund from a different complex. To prevent compliance costs from 

increasing, employers must be allowed to continue to submit contributions through the 

existing payroll tax system, which requires some centralization. Second, some standard 

fund must be available to those who do not make a selection. Third, close to 28 million 

Americans in the year 2000 had wages and salaries below $5000. Many of these 

people are students and teenagers who will earn larger incomes in the future, but even 

small transaction fees could be large relative to account balances for many people, an 

unacceptable outcome. While caps on transaction fees could be used to pool 

administrative costs across participants, such caps could also stifle innovation. 
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Finding: The adoption of a “mixed” two-tier structure most effectively balances the 

desire for low administrative costs along with consumer choice and efficient financial 

markets. 

The Commission recommends the adoption of a “mixed” two-tier structure that 

adopts the best features from both the centralized and decentralized approaches. Under 

the mixed approach, collections are transferred to a central administrator using the 

existing payroll tax system. The central administrator verifies that the correct amount of 

contributions is submitted for each worker. Initially, investments for each employee are 

made through the central administrator (as in the centralized plan) into “Tier I” of the 

program. In Tier I, workers choose from a range of funds that are currently offered by 

the Thrift Savings Plan, plus three additional balanced funds and an inflation-protected 

bond fund discussed below. When employees have accumulated a threshold account 

balance (say, initially, $5000), however, they are allowed to move their personal 

accounts to a range of “Tier II” qualified private-sector funds. Multiple private-sector 

funds are allowed but they must satisfy stringent rules as determined by the Governing 

Board. The funds must be very diversified and reflect the performance of many 

companies spanning all major commercial sectors. Moreover, the share of the fund 

invested in each corporation cannot exceed strict limits as established by the Governing 

Board.19 The Governing Board chooses the threshold amount that is required for people 

to move their balances into Tier II so that it would be feasible for such accounts to be 

charged low transaction costs without the need for price caps. Within three years from 

the creation of personal accounts, the Governing Board must produce a plan that is 

necessary for Tier II to be fully functional; within five years, it must implement the rules 

and administrative support, including personnel, hardware and software. 

Funds in both Tiers cannot charge sales “loads” or other marketing fees on entry 

or exit. Instead, all fees must be included in one annual charge and clearly stated as a 

percentage of assets. These restrictions provide added protection to low-income 

workers. Fund selection is made through the central administrator, which will list key 

information about each fund, as determined by the Governing Board, including fees. 

Competition, along with information provided by the Governing Board, will keep fees low 

and in proportion to services received. The Governing Board must have broad authority 

to provide workers with informative advice, and to implement reasonable changes in 

either Tier that it believes is in the best interest of workers and retirees. It must also be 

able to make recommendations to Congress on larger, structural changes that the 

Board believes is necessary to make the system more efficient. 

 

19 With “passively managed” funds, the amount of stock that is invested in any particular corporation is 

simply based on the market value of that corporation relative to others in the index. “Actively managed” 

funds, though, require more investor judgment by fund managers who try to pick under-valued 

companies. Since funds must be broadly diversified, the practical distinction between passively managed 

and actively managed funds is diminished. 
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Finding – The Governing Board should investigate ways to reduce the time that it takes 

to credit contributions to personal accounts, without increasing employer compliance 

costs. 

 Using the current payroll contribution system, it would take about 15 months on 

average before payroll contributions are credited to personal accounts. This delay is 

known as the “reconciliation period.” This reconciliation period is much longer than that 

in private-sector 401(k) plans. The reason for the difference is that, while firms send 

employee taxes to the government throughout the year,20 firms do not actually identify 

the employees for whom the tax payments are made until the end of the year. Since 

many smaller firms file their returns on paper rather than electronically, it then takes the 

government several additional months to process this information.21 We propose that 

the aggregate pool of contributions be invested in government bonds until information 

on contributions by individuals is reconciled with aggregate employer payments.22

Personal accounts are then credited with the contribution amount and the bond yield 

earned during this reconciliation period. 

While shortening the reconciliation process would allow people to more quickly 

invest in higher-yielding assets, the Commission does not recommend any immediate 

change in the current reconciliation process for two reasons. First, since 1978, firms 

have not been required to identify employees in their tax reporting until after the end of 

the year in order to keep reporting costs to a minimum.23 Personal account 

administration should not, therefore, add any burden to small employers. Second, 

quicker reconciliation would have little actual effect on the retirement benefits of most 

people. A person who wishes quicker access to stocks could simply hold more stocks 

using their previously reconciled contributions, or using assets held outside of the new 

personal retirement saving accounts.24

The Governing Board should, however, investigate ways of accelerating the 

reconciliation process without imposing higher costs on employers. Faster reconciliation 

could increase confidence in the personal account system by allowing employees to 

 

20 Even here, though, firms differ significantly in how frequently they pay taxes. Very large firms pay daily 

while smaller firms pay quarterly. Many self-employed workers pay taxes annually. 21 On average, the initial postings of employee earnings (W2 records) are 99% complete nine months 

after the end of the relevant liability year (seven months after Form W-2’s are required to be filed with the 

government). Thus, contributions would be, on average, held 15 months before posting (e.g., 

contributions collected in January 2001 would be 99% posted by September 2002). The initial posting of 

self-employed earnings (Schedule SE) are 99% complete one year and nine months after the end of the 

relevant liability year (eleven and a half months after reports are required to be filed with the government). 22 This process effectively happens automatically throughout the tax year, as the government changes its 

debt issuance with tax receipts on a fairly continual basis. Hence, no extra mechanism is necessary here. 23 Beginning in 1978, firms were no longer required to engage in quarterly reconciliation of their tax 

payments with the employees for whom the payments were made. The change to annual reconciliation 

was instituted in order to reduce the costs on both employers and the government by allowing employers 

more time to identify and correct errors before reporting. 

24 Only young people with no outside assets and who wish to hold only stocks would feel ‘constrained’ by 

slower reconciliation. However, the impact on their welfare from having to hold bonds in place of even 

more stocks for a short duration would be small. 
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quickly verify that their contributions have been invested. Many firms are already 

capable of being able to match tax contributions to their employees on a quarterly basis. 

These firms would have the incentive to offer this service as a benefit to their 

employees, provided that the central administrator, in turn, credited personal accounts 

in a timely manner.25

 

25 One option may be to expand the Electronic Federal Tax Payment System (EFTPS) to allow for 

matching of tax payments to employees. 
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Finding – Investment allocations should be allowed to be changed not more than once 

during a 12-month period; but access to account information should be immediate. 

 Personal retirement accounts are intended to supply retirement income and, 

therefore, should encourage people to think long term about their investments. Personal 

accounts should not encourage shortsighted activities such as “day trading” or “market 

timing” that simply lead to higher transaction costs for most people. We, therefore, 

recommend that changes in investment allocations be limited to once a year. Account 

statements should be mailed annually and reflect the newest investment allocations. 

Investment returns must be credited to the account on a daily basis. Moreover, account 

balance information must be accessible at any time through the Internet or automated 

calling. The efficiency of this system must be diligently monitored by the Governing 

Board, which must be empowered to make changes to the system. The enabling 

legislation should require that the Governing Board seek congressional approval only 

for larger, structural changes. 
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Finding – The Governing Board must bear the primary responsibility for providing 

participants with the necessary financial information. Non-profit organizations are 

encouraged to continue their efforts in this area. 

Financial information must be distributed to people with personal retirement 

accounts. Indeed, one of the exciting outcomes of creating personal accounts is that it 

will give people who do not currently have personal retirement accounts the incentive to 

increase their financial understanding, which could encourage them to save more in 

general. The Governing Board, employers, or fund administrators could provide 

financial information, as could non-profit organizations. However, we believe that the 

primary responsibility lies with the Governing Board, possibly with assistance from the 

Securities and Exchange Commission. Utilizing the Governing Board will reduce 

compliance costs on employers. Moreover, people will have confidence that the 

provided information is objective, and the quality of financial education will not differ 

between employers. 

Investment Choices 

Personal account investment options must be designed to ensure that people invest in a 

broadly diversified portfolio of corporate stocks, corporate bonds and government bonds 

so that they can achieve the best possible returns with a reasonable amount of market 

risk. Moreover, if workers are not comfortable making choices among various options, 

they should be provided with a balanced standard fund. 
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Finding – Participants in Tier I should be able to choose one of three indexed balanced 

funds (conservative, medium, and growth) or any combination of five index funds, 

patterned after the current TSP funds, as well as an inflation-protected bond fund. 

 In Tier I, participants will be able to choose between investing their contributions 

in a balanced fund or any combination of the five index funds that are currently offered 

by the Thrift Savings Plan for federal workers. Fund management services would be 

auctioned off to several private-sector providers in order to provide low fees and to 

avoid any single fund manager holding too much money. 

A balanced fund is invested into a certain percent of corporate stocks, corporate 

bonds and government bonds. A conservative balanced fund holds a relatively larger 

amount of government and high-grade corporate bonds, while a growth balanced fund 

holds a higher proportion of stocks. The holdings of the medium balanced fund fall 

between the conservative and growth funds. The stock fund itself must also be very 

diversified and reflect the performance of many companies spanning all major 

commercial sectors.26 The Thrift Savings Plan includes several funds: the Government 

Securities Investment (G) Fund; Fixed Income Index Investment (F) Fund; Common 

Stock Index Investment (C) Fund; Small Capitalization Stock Index Investment (S) 

Fund; and the International Stock Index Investment (I) Fund.27 In addition to these 

funds, the government should create an Inflation Protected Bond Fund that allows 

participants to invest in Treasury Inflation Protected Securities (TIPS). TIPS allow 

participants to protect the purchasing power of the wealth that they have accumulated in 

their personal accounts. 

The diversification requirement for stock holdings helps minimize the impact that 

any single corporate stock or commercial sector has on the total return to the qualified 

fund. A fund that, therefore, is heavily weighted in the stock of a particular corporation or 

sector would not qualify. While the U.S. capital market currently allows for a large 

amount of diversification, the Governing Board should study how international stocks 

provide additional diversification for participants. 

 

26 Examples include the Standard and Poor’s 500 Index, which includes 500 of the most widely held U.S.-

based common stocks, chosen by Standard and Poor for market size, liquidity, and sector representation. 

The Wilshire 5000 Total Market Index represents the broadest index for the U.S. equity market. It 

includes the performance of all U.S.-headquartered equity securities (now more than with readily 

available price data). 

27 The G Fund specializes in short-term U.S. Treasury securities issued solely to the TSP. The F Fund 

strives to match the returns of the overall U.S. bond market. The C Fund holds large-company stocks and 

tracks the Standard & Poor’s 500 Index. The S Fund consists of medium- and small-company stocks, 

which tracks the performance of the Wilshire 4500 stock index, now consisting of over 6000 companies. 

The I Fund is invested in a diverse set of major corporations located in Australia, Europe and the Far 

East. 
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Finding – A standard fund should be established for those individuals who do not select 

a fund in Tier I. 

 For those individuals who fail to choose a Tier-I fund, their contributions must be 

invested into a standard fund on their behalf. Empirical evidence suggests that many 

participants in private-sector 401(k) plans also base their investment decisions on the 

design of the standard fund.28 It is likely, therefore, that many participants will look to the 

standard fund as a benchmark for their own investment decisions in a Social Security 

system augmented with personal accounts. The standard fund, therefore, must be 

chosen appropriately. If the standard fund, for example, is too conservative by holding 

mostly bonds, then some participants will not be able to enjoy the higher expected 

returns from a fund with more stocks. At the same time, the standard fund must be 

appropriate for the participant’s age, as younger people should invest relatively more in 

stocks. The growth balanced fund discussed earlier, therefore, would be an appropriate 

standard fund for young workers; the medium fund for middle-age workers; the 

conservative fund for older workers. However, the standard fund must also be 

consistent with any promises that are made with respect to personal accounts. If the 

government, for example, promises that the personal accounts will produce a minimum 

return or benefit, provided that the personal account is invested in a particular balanced 

fund, then that fund should be the standard. 

 

28 James Choi, David Laibson, Brigitte Madrian, and Andrew Metrick, “Defined Contribution Pensions: 

Plan Rules, Participant Decisions and the Path of Least Resistance,” Forthcoming in NBER Tax Policy 

and the Economy, 2001. 
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Finding -- Private-sector account administrators in Tier II may offer the same funds as in 

Tier I, and possibly other broadly diversified mutual funds certified by the governing 

Board according to appropriate criteria. 

 Upon reaching a threshold amount in their personal accounts in Tier I, 

participants can transfer their personal account to a private-sector provider. Privatesector funds, therefore, provide competition and choice, thereby preventing a 

government monopoly over fund design and services. Tier-II funds, though, must meet 

very strict diversification requirements as established by the Governing Board. Other 

requirements might include registration with the U.S. Securities and Exchange 

Commission or appropriate banking/insurance regulator and other standards 

established by the Governing Board. Stock funds must be very diversified and reflect 

the performance of many companies spanning all major commercial sectors. Moreover, 

the amount of the fund invested in any particular corporation must not exceed strict 

limits as established by the Board. Some leeway must be given in order to allow firms 

offering funds to innovate and to provide a reasonable level of choice. All innovation, 

however, must be partly constrained by the need for all stock funds to hold a diverse set 

of assets. 

Access to Funds in Personal Accounts 

 The access of funds in personal accounts that should be allowed must balance 

several important goals. First, workers should not be allowed to consume funds in their 

personal accounts in such a manner that would leave them impoverished during 

retirement and then dependent on the government for additional resources. While 

personal accounts are intended to provide workers with ownership over real assets, it is 

important to remember that ownership engenders certain responsibilities, including not 

being allowed to impose additional costs on taxpayers. Second, people with belowaverage life expectancies, including the lifetime poor, must no longer be forced to 

contribute too much during their working years exclusively to a retirement system from 

which they will receive few annuity benefits upon retirement. Personal accounts must 

provide a variety of withdrawal options at retirement, including the ability to leave some 

assets to loved ones upon death. This bequest option is currently missing from Social 

Security. 
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Finding – Pre-retirement access to funds in personal accounts should not be allowed; 

accounts may be bequeathed by those who die before they receive retirement benefits. 

 While prohibiting pre-retirement access might seem very restrictive at first 

glance, it is important to recognize that even among people facing difficult 

circumstances during pre-retirement years, most are still expected to spend some years 

in retirement. Difficulties in pre-retirement years do not justify facing even greater 

difficulties during retirement due to a lack of resources. While some people might 

suggest that accounts should be accessible in some “hard cases” (e.g., disability) we 

believe that those needs are best handled with other government policy, and not with 

funds set aside for retirement. (For example, the commission recommends that 

disability protection continue to be provided through the traditional Social Security 

system.) Furthermore, allowing for pre-retirement access in the “hard cases” potentially 

opens Pandora’s Box for less discriminating account access in the future. In the same 

way that Social Security benefits cannot be accessed before retirement or used as 

collateral for a loan, neither should assets held in personal accounts be available for 

other purposes. 

 However, unlike Social Security, assets held in personal retirement accounts can 

be bequeathed to love ones if the account owner dies before retirement. In this way, 

wealth accumulation in the family need not be cut short with the death of the primary 

earner. 
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Finding: At retirement, personal account distributions can be taken as an annuity or as 

gradual withdrawals, and balances above a threshold can also be taken as a lump-sum 

distribution. The threshold amount is chosen so that the yearly income received from an 

individual’s defined benefit plus the joint (if married) annuity keeps both spouses safely 

above the poverty line during retirement, taking into account expected lifetimes and 

inflation. 

 The primary purpose of personal retirement savings accounts is to provide 

retirement income and wealth that can be passed on to family members and heirs. 

Pensioners, therefore, should not extract all of their resources at the point of retirement 

and then depend on government programs for additional retirement income (e.g., the 

Supplemental Security Income [SSI] program). Instead, individuals should have an 

immediate right to their money only to the extent that they can continue to support 

themselves. 

 People with personal accounts should, therefore, be required to take at least 

some of their money as an annuity or as gradual withdrawals. An annuity pays a fixed 

stream of money until the person dies. The Governing Board is required to make 

available different types of annuities, including inflation-indexed annuities that 

automatically incorporate protection against inflation; standard annuities without that 

automatic protection would have to pay more in terms of purchasing power early in 

retirement in order to protect against poverty later in retirement. Other forms of annuities 

incorporate the ability to leave a bequest if the holder dies before a certain length of 

time. A gradual withdrawal plan allows people to receive back their money bit by bit over 

their expected remaining lifetime. Any money left at death can be fully bequeathed. But 

because it is not an annuity, there is a chance that the person will outlive their 

resources. The withdrawal schedule, therefore, must be chosen to be long enough in 

order to cover the expected lifetimes of the retiree and spouse, and to maintain 

purchasing power, given the probable rate of inflation. 

Only when it can be reasonably assured that retirees can enjoy retirement 

outside of poverty will they be allowed to take money from their accounts as lump-sum 

payments. Some observers, though, might object to this restriction on the grounds that 

people should be allowed full access to their funds if they can prove that they have 

other private resources that they can use in order finance retirement. There are several 

discrepancies, however, with this argument of considering outside resources. First, if 

people have additional resources to consume, then they can simply consume those 

resources first; they don’t need to first consume assets from their personal retirement 

accounts. Second, the government cannot prevent people from consuming resources 

from other sources and then qualifying for additional income subsidies (e.g., SSI). Third, 

verification of outside resources would require a new, costly and intrusive administrative 

governmental structure. Fourth, allowing wealthier people greater access to their 

personal retirement savings account seems like a regressive policy to us. 
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Protection of Spouses 

 In many marriages, one of the two partners takes on a less active role in the 

formal labor market in order to devote time and energy to maintain the home and family. 

Traditionally, women have performed these vital duties by either completely exiting the 

labor market or taking lower-paying jobs, while men have remained in the workforce. 

Upon divorce or death of the primary earner, many spouses, therefore, have been left 

with few assets. Moreover, they often have little opportunity to acquire more assets as 

they face a hard time re-entering the workforce, since the skills that they acquired 

before marriage are now outdated. 

 Former spouses and survivors, therefore, must be protected under any personal 

retirement account program. First, divorce too often spells the beginning of financial 

insecurity for spouses with a limited work history. Personal account ownership, 

therefore, must help provide former spouses better protection relative to Social Security 

and provide them with a fairer sharing of assets that recognizes their contributions to 

the household. Second, widows and widowers today too often fail to live in financial 

security during retirement. Personal account ownership, therefore, must help provide 

better protection to survivors. 
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Finding -- All account balances attributable to contributions during marriage, and all 

earnings on account balances brought into marriage, should be divided equally in the 

event of divorce. Account balances brought into marriage would not be shared. 

Social Security currently recognizes that some spouses may contribute more 

towards fostering a positive home environment, choosing to earn less outside of the 

home. Consequently, a spouse has the option of either claiming a retirement benefit 

based on his or her own work history or a benefit equal to one half of that of his or her 

spouse. In the event of divorce, spouses continue to be eligible for this benefit option if 

the marriage has lasted ten or more years. 

Most marriages, though, last less than ten years, leaving low-earning spouses 

ineligible for a Social Security spousal benefit and, therefore, uncompensated for years 

spent either out of the labor force or working in a limited capacity. In addition, Social 

Security requires a divorced spouse to be unmarried to qualify for retirement benefits 

based on the former spouse’s social security record, thus nullifying these Social 

Security claims in the case of remarriage, regardless of how long the marriage may 

have lasted. 

We, therefore, recommend protecting low-earning spouses by mandating that 

both spouses’ account growth be shared equally in the case of divorce.29 Spouses 

whose marriages have lasted longer period of time, and hence have given up more by 

being absent from the job market, will benefit more by sharing in the larger earnings on 

all account balances. Only initial balances brought into the marriage are not shared. 

 

29 Account balances accrued prior to marriage are not shared because of the complications and potential 

inequity of splitting balances if such a policy were to be applied to a person having had multiple 

marriages/divorces. 
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Finding – Upon retirement, a two-thirds joint and survivor annuity should be required 

unless both spouses agree to an alternative arrangement that is consistent with the 

distribution rules discussed earlier. 

 Social Security currently requires married couples to receive a joint and survivor 

annuity at retirement. The annuity is ‘joint’ because it protects both spouses from 

outliving their resources by continuing to pay income until both spouses die. Social 

Security pays a survivor two-thirds of the previous household benefit after a spouse dies 

provided that the secondary-earner qualified for Social Security based on the earnings 

of his or her spouse. (The reduction in benefit is not larger because household 

expenses typically decrease by less than fifty percent when one of the spouses dies.) 

If, however, both spouses qualified for Social Security based on their own earnings, 

then the household could lose up to half of their combined benefit. We recommend that 

a two-thirds joint and survivor annuity should be required unless both spouses agree to 

an alternative arrangement that is consistent with the findings in the last section. For 

example, some spouses may not want to fully annuitize their personal account balances 

in order to be able to leave assets to their loved ones. 
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Finding: To isolate the Governing Board from political risk, Congress should follow the 

models of the Thrift Savings Plan and the Federal Reserve Board when designing the 

Board structure. 

The Governing Board should be structured with one overriding goal in mind—to 

ensure that the personal accounts system is administered so as to maximize value to 

participants. Achieving that goal requires that the governing Board be insulated from 

political pressures as much as possible. 

One model for a Governing Board is found in the Thrift Savings Plan (TSP). The 

TSP is headed by five part-time Board members appointed by the President, including a 

chairman with a 4-year term; two members with 3-year terms that are chosen in 

consultation with the House and the Senate, respectively; and two members with 2-year 

terms. The TSP Board’s has a strict fiduciary responsibility to holders of individual TSP 

accounts. Neither the Congress nor the President controls the Board’s budget. The 

Board appoints a full-time Executive Director who serves as chief executive officer. 

Each of these six fiduciaries is required to act solely in the interest of plan participants 

and must have substantial experience, training, and expertise in the management of 

financial investments and pension benefit plans. These safeguards have helped ensure 

that the TSP remains unwavering to outside political pressures. 

Another possible model for a Governing Board is the Federal Reserve (FR) 

Board, the entity that controls the U.S. Federal Reserve System. This Board is made up 

of seven members that are appointed by the President and confirmed by the Senate, 

each with a 14-year term. Opportunities for new Board appointments arise only once 

every two years. Like the TSP Board, the FR Board has a funding source that is 

independent of Congress and the President. The long staggered terms for FR Board 

members arguably give the Board even greater insulation from politics than has the 

TSP Board. 

In contrast, investments made by public sector pension plans have often been 

manipulated by political pressures. Appointments to pension boards in many states and 

countries often include ex-officio members and other appointees serving at political 

behest. In pension plans for state and local employees in the United States, for 

example, state boards have demonstrated a preference for in-state investments and 

have avoided investments in socially unpopular companies, rather than maximizing 

financial returns for participants. State boards have even adjusted plan accounting 

practices so that contributions fluctuate for budgetary reasons unrelated to the pension 

system’s needs. Internationally, government-ran pension plans face similar problems 

including a home-bias in investment choices and using investments as social policy. 

Evidence indicates that these pension plans have earned markedly inferior rates of 

return, due to government intervention.30

 

30 Augusto Iglesias and Robert Palacios, “Managing Public Pension Reserves – Part I: Evidence from the 

International Experience,” Pension Reform Primer, The World Bank, January 2000. 
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Public sector pension plans are much more susceptible to political influence than 

the TSP or FR model because benefit liabilities in public pension systems are not 

directly linked to the investment performance of the public pension’s reserves (or ‘trust 

fund’). Instead, benefits are typically based on a worker’s previous wage earnings. As 

a result, politicians can invest in socially popular enterprises while claiming that they are 

not placing the benefits for current voters in direct jeopardy. Inferior returns instead 

accrue as a hidden liability on future taxpayers, with only a possible imperfect link to 

reduced future benefits to those alive today. In sharp contrast, a restriction on 

investments held in personal accounts would directly reduce the expected retirement 

benefit of personal account owners. Since the cost of political interference is much 

more explicit and directly applicable to owners of personal accounts, the temptation for 

political interference is significantly reduced. 
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Finding: Equity shares in the mixed system should be voted by fund managers 

When people buy company stock directly, they become part owners of the 

company and gain a legal right to help determine the direction of the company, including 

its investment and marketing decisions. However in the case of investors in a mutual 

fund, the fund managers almost always directly vote the proxies of the fund. We 

recommend that the fund managers vote the equity shares for Tier I and Tier II, as 

under the Thrift Savings Plan today. Fund managers have a legal fiduciary obligation to 

vote their shares to the benefit of plan participants. Fund managers are in the best 

position to utilize the vote to further the financial interests of fund participants. While, in 

theory, the Governing Board could vote the shares in Tier I, we are concerned that they 

might face undue political influence in terms of their appointments or term renewals. 

Another option would be not to vote the shares in Tier I at all (or, equivalently, vote them 

in proportion to the other shares). To be sure, this approach would likely produce 

efficient business decisions as well. However, we are concerned that, if personal 

accounts someday become large enough, a minority of shareholders (possibly the 

directors and officers in the firm) could gain controlling interest in some firms in which 

they would not otherwise hold a controlling interest. 
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Chapter 3: Achieving a Fiscally Sustainable Social Security System 

 

Summary of Findings 

The Commission recommends that there be a period of discussion, lasting at least one 

year, before legislative action to strengthen Social Security. 

Action should be taken soon to place Social Security on a fiscally sustainable course. 

There are many paths to fiscal sustainability. All of them require some combination of 

changing the rate of benefit growth or committing additional revenues generated by 

taxation or by the proceeds of investment. 

Social Security proposals should be evaluated using several important measures of 

fiscal sustainability. 

Transition investments in personal accounts are not “costs,” but investments in a fiscally 

sustainable Social Security system. 

Personal accounts can reduce the long-term cost growth of the Social Security system, 

thus contributing to fiscal sustainability.

It is not necessary to change benefits for current or near-term retirees. 

Benefits can continue to grow at least as fast as inflation within current Social Security 

system tax levels. 
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The Fiscal Problems Facing Social Security 

The Commission’s Interim Report explained in detail the origin, scope, and extent of the 

problems facing the current Social Security system. As an income transfer program, 

Social Security’s financial health is sensitive to demographic changes determining the 

ratio of contributors to recipients. In particular, increasing life expectancies and a 

decline in birth rates have contributed to a gradual “aging” of the population, reducing 

the number of workers available to support each beneficiary. 

When the United States had a rapidly growing workforce supporting a small elderly 

population, Social Security seemed sustainable. For instance, in 1960, there were more 

than five workers paying into Social Security for every individual collecting benefits. 

However, the burden placed on individual workers increases when fewer new workers 

are paying into Social Security and a larger population of beneficiaries is collecting from 

it. Already, demographic changes have reduced the worker-to-beneficiary ratio to 3.4-to1. By 2050 it will be just 2-to-1. In other words, the relative burden on a worker in 2050 

will be two-and-a-half times larger than the burden on a similar worker in 1960. 

As a result of these trends, beginning in 2016, Social Security will collect less in tax 

revenues than needed to pay full promised benefits. Between 2016 and 2038, Social 

Security will redeem bonds held in its Trust Fund make up the difference, requiring that 

the U.S. Treasury find the resources to redeem these bonds. These resources must 

come from higher taxes, public borrowing, or reductions in other spending programs. 

Social Security’s deficits start small but grow rapidly, reaching $318 billion in 2035 (in 

2001 dollars). The cost of paying benefits will rise from 10.5 percent of taxable earnings 

today to almost 18 percent in 2035. 

Absent Congressional action, the Trust Funds will be exhausted in 2038. At that time, 

Social Security system’s dedicated revenue will be enough to cover only 74 percent of 

promised benefits. To pay full promised benefits would require an increase in the total 

tax rate from payroll and benefit taxation from the current 12.4 percent to 17.8 percent. 

By 2075, the tax rate necessary to fund full promised benefits would equal 19.4 percent 

of payroll, a 57 percent increase over today’s payroll tax rate. 

Social Security’s fiscal problem exists independently of the debate over whether 

personal accounts should be part of a reformed system. With or without personal 

accounts, policymakers must answer a fundamental question: How much of the nation’s 

output should be spent on government support of senior citizens? Those who believe 

that the share devoted to the elderly should continue to consume a larger and larger 

share of the nation’s output have a responsibility to identify where the money will come 

from. Those who believe that growth in spending should be restrained have a 

responsibility to explain exactly how they would change Social Security’s benefit 

structure to achieve this. 
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Fiscal Sustainability Findings 

Finding: The Commission recommends that there be a period of discussion, lasting at 

least one year, before legislative action to strengthen Social Security. 

Social Security is necessarily complex, touching on many aspects of individuals’ lives 

and doing so over the course of generations. Action to strengthen and modernize Social 

Security is much needed – but it should not be undertaken in haste. Congress, the 

President and the public should take the time necessary to consequences of the options 

under consideration, as well as the consequences of inaction. The Commission hopes 

that its efforts will be useful in this regard. Nevertheless, after this period of national 

discussion, steps should and must be taken to keep the President’s charge to 

strengthen Social Security for today’s seniors and generations to come. 
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Finding: Action should be taken soon to place Social Security on a fiscally sustainable 

course. 

In the very near term, Social Security’s finances are strong, with cash flow surpluses 

expected for the next fifteen years. By acting now, lawmakers have an important 

opportunity to address the program’s long-run financing problems while more options 

are available. The existence of short-term surpluses makes it easier to finance a 

transition to a more sustainable system, while still maintaining our commitment to 

current and near-term retirees. 

The financing problem facing Social Security will not go away. A failure to act will only 

make the problems facing the system more difficult to address. It is true that there are 

no easy solutions to the financial problems facing Social Security, but it is equally true 

that a failure to act will only serve to make the solutions more difficult to achieve down 

the road. 

In summary, the longer that action to strengthen Social Security is postponed, the more 

certain it is that necessary measures will include painful benefit reductions or tax 

increases. 
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Finding: There are many paths to fiscal sustainability. All of them require some 

combination of changing the rate of benefit growth or committing additional revenues 

generated by taxation or by the proceeds of investment. 

Despite the complexity of Social Security benefit and tax rules, the financing problem 

facing the program is really quite simple. The projected growth in system revenues is 

insufficient to cover the projected growth in benefits. 

Conceptually, the solution to this problem is equally simple. Either revenues dedicated 

to Social Security must increase faster than currently scheduled, or traditional benefits 

must grow more slowly than currently scheduled, or some combination. 

The need for tough choices to restore fiscal sustainability is real, and it exists 

independently of whether personal accounts are part of the solution or not. Those who 

oppose personal accounts must choose between increasing taxes or slowing benefit 

growth while providing participants with no opportunities to strengthen their retirement 

security in other ways. 

Whatever path to fiscal sustainability is chosen, voluntary personal retirement accounts 

offer individuals the opportunity to pursue higher expected returns by investing in a low 

cost, diversified portfolio. As such, even though personal accounts do not eliminate the 

need for tough fiscal choices, they do provide individuals with an opportunity to pursue 

higher rates of return, and therefore provide higher expected benefits, than the same 

system without accounts. 
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Finding: Social Security proposals should be evaluated using several important 

measures of fiscal sustainability 

In accordance with the Executive Order establishing this Commission, the Commission 

developed a number of criteria for assessing reform proposals. One of these criteria is 

“movement of the Social Security system toward a fiscally sustainable course that 

reduces pressure on the remainder of the federal budget and can withstand economic 

and demographic changes.” This section describes several measures that the 

Commission uses to identify improvements in system sustainability, along with a 

discussion of the strengths and limitations of each measure. In practice, we propose 

that all reform plans be scored along each of these dimensions, so that the tradeoffs 

between the outcomes can be assessed and evaluated in a clear and comparable form. 

1. Positive Annual System Cash Flow Within Valuation Period: 

Each year Social Security faces an obligation to pay benefits, and it also generates 

revenue through its own dedicated tax. When the system has a positive annual cash 

flow, it has sufficient income to cover its costs that year. When the cash flow becomes 

negative, the system must redeem Trust Fund assets (or draw on interest on those 

assets) if available, or cut benefits, unless reform of some sort is enacted. 

Positive annual cash flows may be the single most useful metric of whether the program 

is self-financing. Other measures – such as solvency and actuarial balance – can be 

manipulated by governmental bookkeeping. They are also subject to continued 

argument over their meaning and utility. Positive annual cash flows are also easy to 

measure and to understand. The system is either taking in more money than it must 

spend, or it is not. 

Social Security’s self-financing design is an important component of its policy basis and 

its political support. Self-financing helps to ensure fiscal discipline, by assuring that the 

program’s benefits and dedicated revenues remain aligned. Social Security’s separate 

accounting is also an important protection for the program, helping to ensure that all of 

its dedicated revenues are ultimately used to pay Social Security benefits. 

The current system faces cash flow deficits that are anticipated to grow continually, 

exceeding 6 percent of the nation’s payroll by 2075. This is an annual shortfall of $1.36 

trillion dollars (in constant 2001 dollars). The Commission believes that any reform 

proposal must, at a minimum, reduce the size of these cash flow deficits. The 

Commission also looks more favorably on plans that eliminate these deficits completely 

by the end of the 75-year valuation period. 

Two key advantages to this measure are: 1) it is perhaps the simplest measure of the 

extent to which the program is self-financing in the long run; and 2) it is simple to 

explain to the public, since it does not rely on an understanding of the complexities of 

Trust Fund accounting. One disadvantage of this measure is that it does not indicate 

how the program is to be financed in the period before it reaches self-financing status. 
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Thus, this measure is not, by itself, sufficient to ensure the long-term sustainability of 

the system. 

2. Improvement in System Solvency: 

The Office of the Actuary considers program “solvency” at any point in time in which the 

OASDI Trust Funds have a positive balance.31 Under the Intermediate projections of the 

Social Security Trustees, the present system is projected to enter insolvency in the year 

2038 and never regain solvent status. Solvency is important insofar as it affords the 

SSA the legal authority to make benefit payments. Without a positive Trust Fund 

balance, Social Security is authorized to pay benefits only from its dedicated tax 

revenue. 

However, solvency is a narrow measure of the nation’s ability to pay Social 

Security benefits since it does not indicate the system’s long-run financial health nor 

does it consider the broader budgetary implications of paying for benefits. 

As an illustration of the limitations of the solvency measure, solvency could be 

achieved in an accounting sense by issuing new bonds to the Trust Fund or raising the 

interest rate on existing Trust Fund bonds. However such an approach would not 

produce additional real resources needed to pay benefits. Thus solvency could be 

technically consistent with requiring future generations to make large general revenue 

transfers that they may not desire or be able to afford. In this sense, improving solvency 

is not sufficient to achieve long run fiscal sustainability. 

3. Reduce Rate of Growth in Long-Term System Costs as a Percent of GDP: 

Social Security currently consumes 4.2 percent of the nation’s gross domestic product, 

or GDP. If additional revenues were to be devoted to Social Security to pay benefits 

under the scheduled benefit formula, that fraction would have to rise to 6.7 percent of 

GDP by the year 2075. 

In the future, Medicare is also likely to command an increasing share of the nation’s 

resources, leaving less room in the budget to absorb Social Security’s rising costs. 

Combined, Social Security and Medicare are expected to absorb more than 15 percent 

of the nation’s output by the year 2075 unless these systems are made more 

sustainable. For comparison, all personal income taxes paid to the federal government 

today total approximately 9 percent of GDP. 

An advantage to measuring a reform’s effect on the growth rate of system costs as a 

percent of GDP is that it recognizes that Social Security expenditures are a claim on 

real economic resources, in direct competition with other spending priorities. The 

limitation of this approach is that it does not consider system revenues, and thus 

represents only part of the equation. Therefore, while reducing the rate of growth in 

 

31 In the context of the Trustees’ Report, the implied target also includes a contingency reserve of one 

year of Social Security outflows, or a Trust Fund ratio of 1. 
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system costs is compatible with long-run fiscal sustainability, it does not necessarily 

achieve it on its own. 

4. Improvements in 75-year Actuarial Balance: 

Social Security actuaries calculate the actuarial balance of the OASDI programs as the 

present value of Social Security system expected revenues minus present value of 

scheduled expenditures over the period in question. Social Security actuaries are 

required by Congress to make long-term calculations, and the Office of the Actuary has 

typically used a 75-year valuation period for this long-term analysis. 

The current system is not in actuarial balance. The 75-year shortfall is equivalent, on 

average, to 1.86 percent of the nation’s taxable payroll. This measure is a convenient 

shorthand for quantifying the magnitude of the financing shortfall, averaged over the 

valuation period. 

However, this measure suffers from many important disadvantages. First, the measure 

is largely indifferent as to the timing of the cash outlays and cash receipts. As such, it 

treats a dollar of Social Security revenue the same whether that dollar was spent on 

Social Security benefits, saved, or spent on non-Social Security spending. 

A second disadvantage is that this measure conceals trends in shortfalls. For example, 

the 1.86 percent actuarial deficit of the current system hides the fact that Social Security 

has surpluses today but will experience even larger shortfalls in 75 years -- exceeding 6 

percent of taxable payroll. 

A third disadvantage is that the 75-year time horizon is arbitrary since it ignores what 

happens to system finances in years outside the valuation period. For example, we 

could eliminate the actuarial deficit by immediately raising the payroll tax by 1.86 

percent of payroll. However, as we move one year into the future, the valuation window 

is shifted by one year, and we will find ourselves in an actuarial deficit once more. This 

deficit would continue to worsen as we put our near term surplus years behind us and 

add large deficit years into the valuation window. This is sometimes called the “cliff 

effect” because the measure can hide the fact that in year 76, system finances “fall off 

the cliff.” 

A fourth disadvantage is that the concept of actuarial balance is biased against 

programs that advance fund the system through personal accounts. This is because the 

value of the assets invested in personal accounts is not included as part of the 

calculation. Thus, many reforms that would improve the long-term financial footing of 

the system would appear to worsen it by this measure. In this sense, improvements in 

75-year balance are useful but not the only measure that can be used to achieve fiscal 

sustainability. 
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5. Actuarial Balance Not Deteriorating at the End of Valuation Period: 

The actuarial balance measure just described can have a “cliff effect,“ which is an 

outcome to be avoided. A way to address this problem would be to ensure that the 

actuarial balance is moving in the positive direction by the end of the valuation period. 

One metric which can help assess this is the Trust Fund ratio, which is a 

measure of the balance of the OASDI Trust Fund relative to the level of benefits being 

paid out in the same year. A stable or rising Trust Fund ratio indicates that the actuarial 

balance is not deteriorating. 

6. Reduction in Unfunded Benefit Obligations: 

As previously discussed, the current Social Security system is primarily an unfunded 

system. This means that individuals paying into the system now are expecting benefits 

in the future, yet there are no resources set aside today to pay those future benefits, as 

would be the case in a funded system such as a private pension plan 

In the private defined benefit pension context, a plan sponsor must by law project future 

plan costs and revenues, and sufficient assets must be set aside to cover promised 

benefits. Under a “closed system” approach, the plan sponsor would assume that no 

future additional contributions would be made and no new benefit promises would be 

honored after the valuation date. Under an “open system” approach, the plan sponsor 

would assume that new contributions would come in, and new benefits would be 

accrued, into the indefinite future. Pension law (ERISA) requires that the “closed 

system” concept be used to fund asset reserve requirements for corporate pensions. 

By the 75-Year Open Group method, OASDI is currently under-funded by about $3.157 

trillion (or about $21,000 per worker). According to the 100-Year Closed-Group method 

it is now under-funded by about $9.6 trillion (or about $65,000 per worker).32

 

An important measure of the contribution of a reform proposal to the health of the 

economy is the extent to which a reform reduces the size of this unfunded liability. This 

approach recognizes the contribution to our nation’s long-term economic well-being that 

is missed by standard actuarial measures. The primary limitation of this approach is that 

it is not yet well understood by the general public. 

7. Other Measures 

Some analysts have argued that it would be more complete to measure each 

generation’s total financial burden of taxes and transfers levied on it, including Social 

Security and other liabilities not currently tracked on budget. From this perspective, a 

reduction in generational net burden would be seen as an improvement in fiscal 

sustainability. 

This approach offsets the political bias against pre-funding future implicit liabilities. 

Reducing implicit future liabilities now, in part through explicit debt finance, may be 

 

32 April 5, 2001 calculations by the Office of the Chief Actuary, Social Security Administration. 
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interpreted as a growth in public debt, so that little “credit” is granted for curtailing the 

total stock of unfunded liabilities including OASDI. Measuring the generational burden in 

the government budget would reduce this bias and give policymakers a tool for 

assessing decisions that involve trade-offs between short-term costs and long term 

benefits, and between implicit and explicit debt. 

The primary disadvantage of this concept is that it is not well understood in policy 

circles. In addition, implementing it requires assumptions regarding who bears the costs 

and benefits of government taxes and transfers, as well as social discount rates, and 

there is little agreement about the proper range for these assumptions. Therefore, the 

Commission will not explicitly provide these measures for the reform options discussed 

in this report. 
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Finding: Transition investments in personal accounts are not “costs,” but investments in 

a fiscally sustainable Social Security system. 

The Commission strongly endorses the President’s principle that benefits for current 

retirees and persons nearing retirement should not be changed. This commitment to 

ensure full benefits to current and near-retirees raises the issue of so-called “transition 

costs.” 

The current Social Security program is financed primarily on a “pay-as-you-go” basis, 

meaning that most of the payroll taxes paid by today’s workers are used to finance 

benefits for today’s beneficiaries. For the next 15 years, the program is expected to 

bring in more revenue than is required to pay benefits in each year. 

Under a personal account program, workers would be given the option of investing a 

portion of their payroll taxes in accounts that they own. Like any sound investment 

program, investing in personal accounts requires additional resources up front to fund 

the accounts. During the transition to a personal accounts program, tax revenues 

invested in the accounts would no longer be available to finance traditional benefit 

payments, although during a period of program surpluses, there exist additional 

revenues to finance the accounts. 

Therefore, funds must temporarily be found to finance this investment while 

simultaneously paying benefits to retirees. Over time, these investments in personal 

accounts offer financial returns to the Social Security program in the form of either 

reductions in the rate of growth of system costs, higher expected benefits for retirees, or 

both. 

The temporary increase in resources needed to fund the investment in personal 

accounts is sometimes referred to as the “transition cost.” This terminology is often 

misunderstood, however, because it ignores the corresponding returns on these 

investments. To focus only on the “cost” of the investment while disregarding the 

benefits is to count only one side of the equation. 

A simple analogy illustrates: Suppose an individual had a $90,000 home mortgage with 

a monthly payment of $600 over 30 years. By paying an extra $100 monthly, the 

individual could pay off his mortgage in full within 20 years and thereafter have an 

“extra” $600 per month to spend on other things This additional $100 monthly payment 

is an investment that brings rewards, not a cost. 

Likewise, consider a business that retains profits in order to develop a new and lucrative 

technology. These retained profits could have been paid to shareholders, so retaining 

them for investment could be considered a “cost.” But this cost pays itself back in the 

future in the form of higher profits. 

In short, if the extra saving proposed for Social Security personal accounts is 

considered a “cost,” then any person who saves or sacrifices for the future for any 
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reason pays a similar cost. It is often said that Americans should “save and invest for 

the future.” The so-called “transition costs” associated with personal accounts for Social 

Security are precisely that: saving and investing for the future, to reduce the need to 

raise taxes, cut benefits, or curtail other necessary government initiatives. The more 

Americans can save for the future, the better off we will be in the long run. 

 Measuring the Revenue Needed to Invest in the Transition 

Clearly, the resources needed to finance the movement to personal accounts cannot be 

viewed in isolation from the substantial benefits they bring. It is also important, however, 

to obtain an accurate measurement of the financing needs associated with a specific 

plan. In particular, it is essential to distinguish transition investments associated with 

personal accounts from the additional revenue required to address the fiscal problems 

already besetting the Social Security system. Solutions to fill the existing fiscal gap must 

be found regardless of whether personal accounts are established. 

The current Social Security program faces long-term, growing deficits requiring either 

new revenue or a reduction in the rate of benefit growth. Opponents of reform often 

argue, incorrectly, that personal accounts cause the benefit changes or revenue 

increases required to fix the current system. This is simply and unequivocally false. 

Benefit or revenue changes are required without personal accounts, and over the long 

term these could well be larger in the absence of personal accounts than if such 

accounts are established. Funds needed to establish personal accounts represent 

“transition” funding only to the extent that costs might rise over and above the financing 

needed to keep the current program solvent. 

In addition, Social Security’s traditional 75-year actuarial window artificially overstates 

the cost impact of personal accounts because it counts the “cost” of funding accounts 

within the 75-year period while ignoring benefits paid by those accounts outside of 75 

years. Longer measurement periods or alternate accounting methods that measure both 

the costs and the benefits from personal accounts show that accounts strengthen Social 

Security rather than weakening it. 

The short-term availability of Social Security surpluses will make transition financing 

even easier, if action is taken soon. For the past 20 years, Social Security surpluses 

have been used primarily to fund other government spending. If, instead, these 

surpluses are put into personal accounts they are more likely to be used for their 

intended purpose of funding future Social Security benefits. According to Intermediate 

projections of the Social Security Trustees, Social Security is expected to run cash 

surpluses totaling $811 billion in present value between now and 2016. The 

Commission believes that these resources should be used to fund the transition to 

personal accounts, rather than to finance other government spending programs. 
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Finding: Personal accounts can reduce the long-term cost growth of the Social Security 

system, thus contributing to fiscal sustainability. 

All of the plans presented by the Commission provide individuals the option to invest in 

personal accounts. In all cases, these accounts are at least partially financed by a 

redirection of payroll tax revenue from the existing system. In return for the opportunity 

to pursue higher expected returns through personal accounts, individuals who choose 

the account agree to forgo the benefit that would have been financed by these payroll 

taxes (plus interest). 

Therefore, every dollar invested in a personal account reduces the cost of future Social 

Security payments by one dollar, plus the offset rate of interest that is proposed for each 

plan (ranging from 2 percent to 3.5 percent after inflation). Total expected benefits to the 

worker are increased by the compounded difference between the offset rate of interest 

for the Reform Model and the expected rate of return earned by the personal account. 

So long as the personal account earns a return higher than the offset rate, both Social 

Security and the individual come out ahead. 
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Finding: It is not necessary to change benefits for current or near-term retirees. 

The President has made a firm commitment that all current and near-retirees will not 

have their benefits changed. This commitment can and will be kept. The Commission 

has structured every proposal to be consistent with this charge. No proposal changes 

benefits in any way for any individual aged 55 or over. 

The Commission finds that there are many feasible ways to restore Social Security to 

fiscal sustainability without touching the benefits of current or near-term retirees. 
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Finding: Benefits can continue to grow at least as fast as inflation within current Social 

Security system tax levels. 

Restoring fiscal sustainability to Social Security does not require that we “cut” benefits 

below those paid to today’s retirees. In fact, every Commission Reform Model will 

increase benefits at least as fast as inflation, ensuring that no future generation of 

retirees receives less purchasing power than today’s retirees. Hence, fears that benefits 

will be cut or retirees thrown into poverty are simply false. 

How is it possible to restore sustainability without cutting benefits or raising taxes? It is 

because the current benefit formula increases the starting benefit from year to year at 

the rate of wage growth, which is generally faster than is required to maintain 

purchasing power. This rate of benefit growth, which is faster than the growth of the 

total economy, is not affordable given current system revenues. Fortunately, current 

payroll tax rates are sufficient to afford benefits that grow at least as fast as inflation. 

Two of the three Reform Models presented in this report would peg the future rate of 

growth of benefits within the traditional Social Security system to a new rate that is 

sustainable within the revenues allotted to each program. None would reduce benefits 

below those paid to today’s retirees. All would pay higher benefits than those paid 

today, and in particular would target benefit increases for the low-income workers and 

widows who need them the most. Those who choose personal accounts would expect 

substantially higher benefits. 

What is “Wage Indexation” of Benefits 

Under the current Social Security system, the initial benefits received by each cohort of 

new retirees rises at the rate of wage growth. (Following retirement, benefits rise 

annually to preserve purchasing power against inflation.) This wage indexation was not 

part of the original Social Security system. Until 1977, Congress had no formal policy of 

protecting beneficiaries from cost of living increases or replacing a certain percentage of 

pre-retirement earnings. Instead, Congress prevented the purchasing power of benefits 

from eroding via ad hoc adjustments in benefit levels, applied to persons currently on 

the rolls and to initial benefits for future retirees. In each of the more than dozen 

instances in which benefits were adjusted, the Congressional rationale was to preserve 

the purchasing power of benefits. In 1972, Congress replaced its policy of granting ad 

hoc increases with a policy that permanently indexed benefits to inflation. 

 

An error in the 1972 law led to a major debate over indexing of benefits. All sides to the 

debate agreed that benefits following retirement years should be indexed to the cost of 

living. There was considerably less agreement about how initial benefits should be 

indexed over time. A special commission created by the Senate Finance and House 

Ways and Means committees rejected indexing initial benefits to wage growth, primarily 
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because it was unaffordable.33 Instead, the commission recommended an alternative 

policy under which initial benefits would more closely track increases in prices than in 

wages. Commentators at the time argued that such a policy preserved the affordability 

of Social Security while granting Congress the ability to adjust benefits as needed in the 

context of the times. 

Congress ignored the commission’s warnings and in 1977 adopted the current 

policy of indexing initial benefits to wage growth. Since this policy’s enactment, the 

Social Security Board of Trustees has issued 24 annual reports assessing Social 

Security’s financial status. All but two of these reports, those issued in 1983 and 1984 

following congressional enactment of the Greenspan Commission recommendations, 

have declared that without major tax increases the Social Security program is insolvent 

and will be unable to deliver its promised benefits. 

As this historical record makes clear, wage-indexing initial benefits coupled with future 

demographic trends have never been fiscally sustainable. 

 

 

33 The Commission noted that financing benefits under a wage indexed system would require an 80 

percent increase in the payroll tax rate. (Report of the Consultant Panel on Social Security, August 1976, 

94th Congress 2nd Session, page 6. 
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Chapter 4: Alternative Paths to Fiscal Sustainability 

Summary of Findings 

There are multiple paths to fiscal sustainability within the President’s principles for 

Social Security reform. 

The Reform Models presented in this chapter would contribute varying levels of 

progress to Social Security’s long-term sustainability. Each has been transparently 

analyzed not only for its effects on Trust Fund operations, but on the unified federal 

budget as a whole. 

Each of the actuarially solvent Reform Models presented would effect benefit increases 

for widows and for low-income workers, above current law, whether or not these 

individuals had participated in personal accounts. 

Each of the Reform Models presented shows that, across the full spectrum of choices 

for balancing the traditional Social Security system, a personal account element would 

permit higher benefits to be paid than would be possible within equal revenue devoted 

to current system. 

The Commission commends Congressional sponsors of actuarially sound reform 

proposals, and requests that any criticism of these and other proposals be accompanied 

by constructive alternatives. 
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Executive Summary: Personal Accounts and Social Security Reform 

Findings: The Commission concludes that there are multiple paths to fiscal sustainability 

that are in keeping with the President’s principles for Social Security reform. 

The Commission has developed three reform models compatible with the President’s 

principles that also move Social Security toward fiscal sustainability. All three models 

include a personal account element that would permit participants to build substantial 

wealth, diversify their retirement portfolios, and receive higher expected benefits than 

those paid to today’s retirees. All three models improve fiscal sustainability, though 

some move farther than others. All three require an investment to strengthen Social 

Security, but all three reduce the long-term need for general revenue as compared to 

the current, unsustainable, system. Two of the three models enhance Social Security’s 

progressivity by increasing benefits for low-income workers above what the system 

currently pays. Two of the three models also boost survivor benefits for poor widows 

and widowers. All of the plans would enhance workers’ control over real retirement 

accounts that they own and can pass on as an inheritance. These features will benefit 

women and minorities, as well as all low-income workers. In all three plans, the 

system’s cash flow needs are met so as to ensure that promised benefits can be paid 

as retirees need them. 

The Commission set a goal of moving the Social Security system toward a fiscally 

sustainable course that reduces pressure on the remainder of the federal budget and 

can withstand economic and demographic changes in the future. The three reform 

models outlined here are therefore transparently scored in terms of plan provisions, 

effects on workers’ expected costs and benefits, and effects on Trust Fund operations 

as well as the unified federal budget. We also identify clearly how large the personal 

account balances may be expected to grow as the system evolves. 

 

The Commission concludes that building substantial wealth in personal accounts can be 

and should be a viable component of strengthening Social Security. We commend our 

three models to the American public in order to enrich national understanding of the 

opportunities for moving forward. 

Process 

The Commission is a bipartisan group, and each member brought to the task an 

understanding of the Social Security program and an expressed willingness to seek 

bipartisan recommendations that meet the President’s charge. All of the Commission’s 

work has complied with regulations regarding the group’s deliberations and meetings. 

The Commission has worked together 7 months, held 8 public meetings, heard 

testimony from 34 people, met with numerous members of Congress and the public, 

and worked with experts from the Social Security Administration. 
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Reform Models 

Objectives 

The President directed the Commission to propose Social Security reform plans that will 

strengthen Social Security and increase its fiscally sustainability, while meeting several 

principles: 

hModernization must not change Social Security benefits for retirees or near-retirees. 

hThe entire Social Security surplus must be dedicated to Social Security only. 

hSocial Security payroll taxes must not be increased. 

hGovernment must not invest Social Security funds in the stock market. 

hModernization must preserve Social Security’s disability and survivors components. 

hModernization must include individually controlled, voluntary personal retirement 

accounts, which will augment the Social Security safety net. 

Personal Accounts – the Unifying Element 

The Commission has developed three alternative models for Social Security reform 

involving personal accounts. Individually and as a group, they illustrate how personal 

accounts can be a component of any legislated program to strengthen Social Security. 

To bring the Social Security system to a path of fiscal sustainability, there are two 

choices. On the one hand, significant tax increases might be required in order to pay for 

benefit growth promised, but not payable, under current formulas. On the other hand, 

benefit growth could be restrained to make benefits payable under projected program 

revenues. The Commission believes that no matter which approach is taken, personal 

accounts can enhance benefits expected by participants in the Social Security system. 

Analysis of the reform models described here illustrates the significant gains for workers 

anticipated from personal accounts. 

Understanding the Three Reform Models 

The three models for Social Security reform devised by the Commission show how 

alternative formulations for personal accounts can contribute to a strengthened Social 

Security system. 

Reform Model 1 establishes a voluntary personal account option but does not specify 

other changes in Social Security’s benefit and revenue structure to achieve full longterm sustainability. 

Under this approach, workers could voluntarily direct 2 percent of their payroll taxes to a 

personal account. In exchange, traditional Social Security benefits would be offset by 

the worker’s personal account contributions compounded at a real interest rate of 3.5 

percent. No other change would be effected in Social Security rules, meaning that asyet unspecified actions would be required to avert insolvency. In this model, personal 

accounts would boost expected benefits for workers who elect them while also making a 

modest contribution to long-term system sustainability as measured by reduced cash 

deficits in the last years of the valuation period. Expected benefits payable to a medium 

earner electing an account would be nearly 31 percent above benefits currently paid to 
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today’s retirees by 2052. At the end of the valuation period, the personal account 

system would hold $1.65 trillion (in today’s dollars), much of which would be new 

saving. However, workers and retirees would still face considerable uncertainty because 

filling the remaining financing gap would require substantial general revenue. 

Substantial additional revenues would be needed to keep the Trust Fund solvent 

beginning in the mid-2030s, assuming no legislated changes to Social Security benefit 

formulas. 

Reform Model 2 establishes a voluntary personal account while maximizing the benefits 

delivered without raising taxes or requiring additional worker contributions, and while 

balancing Social Security revenues and costs. 

Under this approach, workers could voluntarily contribute 4 percent of their payroll taxes 

up to $1,000 annually to their personal accounts (the contribution cap would be indexed 

annually for wage growth). In exchange for this, traditional Social Security benefits 

would be offset by the worker’s personal account contributions compounded at a real 

interest rate of 2 percent. In this model, all workers choosing personal accounts could 

expect total benefits higher than those payable by the traditional system. The plan is 

progressive, since additional protections against poverty are provided for low-income 

workers and survivors. This progressivity is brought about by increasing traditional 

Social Security benefit amounts for everyone at the level of increases in the cost of 

living over time. Expected benefits payable to a medium earner electing an account 

would be 59% above benefits currently paid to today’s retirees by 2052. At the end of 

the valuation period, the personal account system would hold $2 trillion (in today’s 

dollars), much of which would be new saving, an accomplishment that would not need 

increased taxes or increased worker contributions over the long term. Some temporary 

transfers from general revenue would be needed to keep the Trust Fund solvent from 

2025-2054. Furthermore, this model achieves a positive system cash flow during the 

valuation period under all participation rates. 

Reform Model 3 illustrates how the Social Security system could be brought to financial 

sustainability while maintaining currently scheduled benefits and existing wage 

replacement ratios. 

Under this model, actions taken to balance the traditional Social Security system 

would be a combination of changes in the rate of benefit growth and commitments to 

new revenue sources. Specifically, the growth rate of benefits would be linked to the 

increasing life span of Americans while allowing workers to continue to choose when to 

retire. Workers would have the opportunity to receive a match of 2.5 percent (up to 

$1,000 annually) of their payroll taxes if they chose to contribute an additional 1 percent 

of their payroll base (a contribution that would be subsidized by a refundable tax 

credit). In addition, Model 3 envisages new sources of tax revenue dedicated to Social 

Security. These extra contributions and new revenue sources would allow participating 

workers to receive expected benefits exceeding those available under the current 

system and to maintain current replacement ratios of benefits to wages. 

The plan is progressive, since additional protections against poverty are provided for 

low-income workers and survivors. This is accomplished by adapting the traditional 
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Social Security benefit formula in several ways, including providing a higher benefit for 

below-average income widows, reducing the benefit formula for high wage earners, and 

adding a minimum benefit for low wage earners. Expected benefits payable to a 

medium earner electing an account under this plan would be 88 percent above benefits 

currently paid to today’s retirees by 2052. At the end of the valuation period, the 

personal account system would hold $2.4 trillion (in today’s dollars), the result of new 

saving as well as the added worker contribution. Additional temporary transfers from 

general revenue would be needed to keep the Trust Fund solvent from 2028-2057. 

The President’s Principles 

All of the models proposed meet the President’s principles. 

hModernization must not change Social Security benefits for retirees or near-retirees. 

None of the models presented would in any way affect any individual over the age of 55. 

One model would not make any changes to Social Security’s basic benefit structure. 

hThe entire Social Security surplus must be dedicated to Social Security only. 

All models assume that all revenues dedicated to the Social Security program will 

ultimately be made available to fund Social Security benefits, and thus that the federal 

government will honor all obligations created by the Social Security surplus. Many 

observers are concerned about the disposition of Social Security surpluses at times 

when the federal government runs a deficit in its non-Social Security accounts. As the 

Commission noted in its Interim Report, it has not been the normal historical practice of 

the federal government to literally “save” surplus Social Security revenue. This surplus 

money, however, remains earmarked for Social Security, and all debt issued to the 

Social Security system must be honored by the federal government. Accordingly, the 

entire amount of the Social Security surplus is available either to issue debt to the Trust 

Fund or to fund Social Security benefits through personal accounts. 

hSocial Security payroll taxes must not be increased. 

None of the models presented on the following pages would increase payroll tax rates 

or the payroll tax base. 

hGovernment must not invest Social Security funds in the stock market. 

None of the models presented on the following pages would allow for any investment of 

Social Security funds in the private markets except through individually-owned personal 

accounts. Confining such investment to individual ownership reduces the risks of 

political influence on private capital markets. 

hModernization must preserve Social Security’s disability and survivors components. 

The models presented here retain disability and survivors’ protection under Social 

Security. Two of the models include a recommendation to increase survivors’ benefits. 

hModernization must include individually controlled, voluntary personal retirement 

accounts, which will augment the Social Security safety net. 
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All the models give workers an option to invest in a personal account through the Social 

Security system. In each case, workers with personal accounts could expect higher total 

benefits than those remaining in the traditional system. Two of the models also make 

substantial improvements to Social Security’s traditional benefit structure to strengthen 

the safety net against poverty. 

 

Going Forward 

The Commission finds that there are multiple paths to fiscal sustainability that are in 

keeping with the President’s principles for Social Security reform. All three models 

include a personal account element that would permit participants to build substantial 

wealth, diversify their retirement portfolios, and expect to receive higher benefits than 

those paid to today’s retirees. All three of the models improve fiscal sustainability, 

though some move farther than others. 

We anticipate that our work will illustrate the key advantages of adding personal 

accounts to the set of options available for Social Security reform. Whatever choices are 

made, our leaders owe it to the American people to explain clearly the value that can be 

provided by personal accounts, the opportunities to use personal accounts to 

strengthen our system so it can actually pay benefits promised, and the realistic costs 

and benefits of these options. Critics of personal account reform models for Social 

Security must offer a comprehensive and fully scored alternative of their own to move 

the debate forward. 

 

Building substantial wealth in personal accounts can be and should be a viable 

component of strengthening Social Security. We look forward to constructive 

suggestions and a reasoned public debate about the advantages of each approach. 
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Methodology 

Rate of Return/Portfolio Assumptions 

The Commission believes it is important to use a consistent set of conservative 

assumptions to evaluate plans. To this end, all three plans scored in this report utilize a 

common set of assumptions about personal account portfolios, rates of return, and 

administrative costs. 

For the main results presented herein, an individual investing in personal accounts is 

assumed to hold a portfolio consisting of 50 percent equities, 30 percent corporate 

bonds, and 20 percent government bonds. Individuals are assumed to annually 

rebalance their portfolios to maintain these portfolio shares throughout life. 

In the pre-retirement period, a portfolio of 50 percent stocks and 50 percent bonds may 

be considered quite conservative, particularly for younger workers. Analysis by the nonpartisan Employee Benefits Research Institute indicates that in 1999, the average 

401(k) retirement plan portfolio allocation was over 70 percent in equities. For workers 

under the age of 40, over 80 percent of assets were held in equities. 

Other more recent sources of data indicate a similar propensity for investors to hold a 

portfolio that is more heavily weighted towards equities. In June 2001, participants in 

TIAA-CREF, a leading retirement plan for college professors and researchers, held an 

average of 58% of their portfolios in equity, suggesting that even in the face of a yearlong market downturn in equities participants chose to hold the majority of their portfolio 

in equities. A similar story is told by the federal Thrift Savings Plan, in which 62% of plan 

assets were held in equities in the first half of 2001. 

The Commission’s projections use the rates of return on these assets recommended by 

the Office of the Actuary of the Social Security Administration. Equities are assumed to 

provide an ultimate expected real rate of return of 6.5 percent.34 Corporate and 

Treasury bonds are assumed to provide a real rate of return of 3.5 percent and 3.0 

percent respectively. Administrative costs are assumed to equal 30 basis points (0.3% 

of the account balance). If the accounts were to be structured according to a Thrift 

Savings Plan model, actual expenses would likely be lower than this. The overall 

expected real return for this 50-50 portfolio, net of expenses, is therefore a conservative 

4.6 percent. 

This portfolio return is much lower than that used in many academic and policy studies 

of personal accounts. For perspective, the historical real rate of return on US equities 

averaged 7.75 percent between 1926-2000. Using a higher portfolio return would 

obviously increase benefits to a level higher than those reported here. 

 

34 By “real return” is meant return in excess of the rate of inflation. 
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In the primary results presented here, the individual is assumed to convert to a variable 

annuity upon retirement that is invested in the same underlying portfolio as during the 

accumulation phase. The variable annuity is priced using an “assumed interest rate” of 

4.6 percent after inflation. Therefore, if the underlying investment portfolio provided an 

actual rate of return that was equal to its expected return, the variable annuity’s value 

would increase in line with the expected rate of inflation. In those periods when the 

portfolio beats its expectation, benefits will increase faster than inflation. In those 

periods when the portfolio return falls short of its expectation, the real value of benefits 

would decline. As with the accumulation phase, the decision to invest in variable 

annuities involves a trade-off between the higher expected rates of return and the 

higher volatility of equities. 

Because the current Social Security system pays benefits entirely as an inflationindexed annuity, some analysts have suggested that personal account balances should 

be converted to inflation-indexed annuities in the retirement phase. Results for inflationindexed annuities are presented in the data appendix. 

However, it is reasonable to assume that some equity exposure in the retirement phase 

may in fact be optimal for most retirees. In every plan presented in this report, the 

personal account annuity supplements an inflation-indexed annuity that is provided by 

the traditional defined benefit portion of Social Security. This defined benefit portion of 

retirement income should be considered part of the overall retirement portfolio. 

Therefore, while equities may make up 50 percent of the variable annuity portfolio, they 

comprise a far smaller share of the overall Social Security retirement income portfolio. 

As a stylized example, consider a situation in which the traditional defined benefit from 

Social Security is expected to account for 60 percent of total retirement income, and the 

variable annuity is expected to account for the other 40 percent. Then the individual’s 

overall retirement income portfolio is essentially invested in 60 percent inflation-indexed 

securities, 20 percent in corporate and government bonds, and only 20 percent in 

equities. In this example, the variable annuity portfolio assumption would be equivalent 

to assuming an 80 percent bond, 20 percent equity portfolio. 
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Why Not Construct the Offset Simply as a Flat Percentage of Benefits? Constructing a 

Simple Personal Account Election 

Under some proposals, participants electing personal accounts would have the 

opportunity to invest a flat percentage of their earnings in a personal account in 

exchange for a flat percentage reduction in their traditional Social Security benefits. The 

Commission found three reasons why such proposals might be problematic under our 

criteria. 

First, the traditional Social Security benefit formula is progressive. Accordingly, benefits 

for low-income workers represent a higher percentage of their lifetime earnings than for 

high-income individuals. For this reason, a flat offset formulation would mean larger 

relative reductions in traditional benefit for low-income workers, thereby reducing the 

program’s overall progressivity. 

The Commission’s Interim Report identified several ways in which Social Security’s 

apparent progressivity is reduced by factors such as differences in life expectancies 

between upper and lower-income workers. Further reducing system progressivity would 

exacerbate these difficulties. 

The Commission stresses that these concerns do not mean that flat percentage offsets 

should be ruled out as a policy option. We note, however, that such a design would 

likely require additional policy changes in order to reach distributional goals. 

A second reason is the fact that a contribution to a personal account would produce 

more in benefits if that contribution has a longer period of time in which to compound. 

Accordingly, a contribution at age 50 should not produce the same percentage offset as 

an equal contribution at age 25, which a flat percentage offset would do. 

A third reason is simplicity. Workers do not know in advance what their Social Security 

benefits will be, but they should have a readily-understood standard by which to choose 

whether to opt for a personal account. 

For this reason, all of the model reform plans contained here use a simple interest rate 

calculation for the personal account election. In exchange for a personal account, the 

individual gives up the amount of benefits that contributions to the account, plus 

interest, could have bought from the traditional Social Security system. For low earners, 

this method will result in a smaller offset than it will for high earners. The plans differ in 

terms of the interest rate that is used to calculate the offset. A lower interest rate for the 

offset means that the worker gets a higher net benefit but there is less progress in 

reducing costs for the traditional Social Security system. Under Reform Model 2, for 

example, the offset is calculated using a 2% interest rate, which means that an 

individual will receive higher total benefits if his account’s return averages more than 2 

percent after inflation. 
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Under this formulation, the individual need not master the complexities of Social 

Security’s benefit calculation. He knows that he is getting more benefits than he is 

giving up if his personal account return exceeds the offset interest rate. 

It is also highly important to recognize that this offset method is not, unlike many 

personal account proposals, a “clawback” mechanism. Many proposals to establish 

personal accounts would “claw back” proceeds from accounts to fund existing Social 

Security benefit promises. None of the models reviewed by the Commission involve 

such reductions in Social Security benefits at the point of retirement. Individuals would 

retain ownership over 100 percent of the proceeds in their personal accounts, and no 

adjustments to traditional Social Security benefits would be made as a function of the 

accumulations in the accounts. The adjustment depends only on contributions to the 

account and the interest rate charged on these contributions. 

The Commission finds “clawbacks,” in addition to other ex-post offsets, to carry some 

undesirable side effects, and thus has included no such proposals among its Reform 

Models. Significant among these is that an individual would be unable to assess the 

financial ramifications of a decision to invest in a personal account at the time the 

decision must be made. 
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Participation Rates in Personal Accounts 

Construction of a voluntary personal account option raises the analytical question of 

what participation rates to assume. Traditionally, the Social Security Office of the 

Actuary produces alternative projections that show the effects of both 0 percent and 100 

percent participation in the accounts. This has the advantage of showing the extreme 

bounds of the possibilities that could arise. 

In practice, however, participation will be somewhere between these extreme bounds of 

0 percent and 100 percent. For that reason, the Commission has also included, in the 

appendix, projections that are premised on an assumption of participation by two-thirds 

of eligible individuals. 

In reality, each of these Reform Models would likely inspire different participation rates. 

Reform Model 1, for example, would exact a steeper benefit offset in exchange for 

personal account benefits than would either Model 2 or 3. Model 3, unlike Models 1 and 

2, would require additional out-of-pocket contributions to the account. These factors, 

among other design features, would influence participation rates. Participation rates for 

Model 2 would likely be highest because no additional out-of-pocket contributions would 

be required, and the offset rate would be the lowest for the three plans. 

Values in Dollars: Current, Constant, and Present-Value 

Over a 75-year time horizon, the value of a dollar varies considerably, in inflationadjusted terms, and in present-value terms. There is no one “correct” way to portray 

dollar figures, and the Office of the Social Security Actuary makes use of each of 

current dollars, constant (inflation-adjusted) dollars, and present-value analyses. 

For the most part, the Commission report avoids use of current dollars, which neglect 

the effects of inflation. Real (constant 2001 inflation-adjusted) dollars will be used in 

most instances when reference is made to an annual amount. When measuring 

amounts that must be summed over a long-term time horizon, such as 75 years, the 

Commission report will use present values, discounted at the Treasury yield rate.35

Measures of Fiscal Sustainability 

Each Reform Model’s fiscal effects will be evaluated according to “scorecards” that 

employ the measures of fiscal sustainability that are defined and appraised in Chapter 

3. 

Charts: Financial Operations of the Social Security System 

 

35 There are exceptions to these conventions in the report, which reflect the limitations on data available 

at the time the report was released. 
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 Each Reform Model will be analyzed according to its projected effects on the 

finances of the Social Security system as a whole, as well as its effect on beneficiaries. 

 For each Model, annual cost and income rates will be shown for each year as a 

percentage of Social Security’s annual taxable payroll. 

For each reform plan, annual cost and income rates will first be shown for the 

remaining pay-as-you-go system, excluding money that is invested in personal 

accounts. This reflects the Commission’s view that individuals should retain ownership 

over the money invested in personal accounts, which ownership would never transfer to 

the government at any point. This treatment shows the investment in personal accounts 

as a reduction in government revenues, with the savings based on the investment 

resulting in lower outlay obligations 

 Additional charts will include the colletions for and flows into personal accounts. 

These charts are useful for two reasons: First, the total investment in the Social Security 

system depends in part on the amount of funding placed in personal accounts, which is 

not visible on charts that show only the operations of the traditional system. (For 

example, “add-on” contributions, to personal accounts, would not be visible as factors 

affecting income and cost rates under the first method of portrayal.) Secondly, this 

treatment follows the conventions of the Congressional Budget Office in scoring Social 

Security reform proposals. 

Solving the Fiscal Problem: Reducing Future Cash Deficits 

 

Under current law, the present value of Social Security’s revenue imbalance is 

commonly said to be $3.4 trillion. This, however, is a net figure, counting past 

attributions to the Social Security Trust Fund, as well as projected surpluses, as 

revenue sources that offset the cost obligations that Social Security faces in the future. 

 Going forward, the net imbalance of the present value of Social Security’s 

revenue intake and its outlay obligations over the next 75 years is $4.2 trillion. The total 

present value of its projected cash deficits over the next 75 years is $5.1 trillion. This is 

the true measure of the program’s unfunded obligations, if indeed there is a failure to 

save near-term Social Security surpluses. 

Measuring Transition Financing Under the Three Reform Models 

 As indicated earlier, the resources needed to finance a transition to personal 

accounts cannot be viewed in isolation from the benefits created by personal accounts. 

Saving requires that some consumption be foregone in the short term in order to meet 

obligations in the long term. Each of the three reform models presented would result in 

a different period of time before new saving and investment would pay off in reduced 

costs. 
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 It is extremely important that different “transition” terms not be confused. Some 

frameworks would involve a “transition loan” to the Social Security Trust Fund to 

preserve its solvency until a period of permanent surpluses is reached -- a loan that 

would not begin for more than two decades from now. This is different from what many 

observers mean when they refer to a plan’s “transition” effects. For example, some refer 

to the “transition” effects of creating personal accounts over the next ten years, even 

though no “transition loans” would be required during that period in order to ensure 

solvency. By this definition, the “transition” is simply the period in which the new 

system’s cash requirements are greater than the current system’s. It is this latter 

definition that shall be referred to these sections concerning “transition” financing. 

In the near term, a transition to each of the following reform models can be 

financed from current-law Social Security surpluses. 

Relationship to the Lockbox: For purposes of clarity, the Commission notes that 

the Social Security “lockbox,” as it was intended to operate before recent national 

securtiy developments, was intended to wall off both Social Security cash and interest 

surpluses. The figures above reference cash surpluses alone. If both cash and interest 

surpluses were protected in the future, then transition financing needs would be 

postponed considerably beyond the years indicated above. 
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Benefit Projections 

Expected benefits for each of the proposals are shown on the following pages. These 

projections employ the intermediate rate of return assumptions of the Social Security 

Office of the Actuary, assuming that account balances are converted to a variable 

annuity upon retirement. Further explication of these assumptions is provided on the 

following pages. 

Comparisons will be made between the levels of benefits that can be provided through 

the personal accounts, and the levels that can be provided by the existing Social 

Security system. 

Each of the frameworks presented here would allocate varying levels of revenue to the 

Social Security system. Thus, benefit levels are not directly comparable across the 

various frameworks. (Within Reform Model 1, for example, decisions remain as to the 

balance between benefit growth and allocations of additional revenues.) The level of 

revenue to be provided to Social Security over the next 75 years remains subject to 

legislative action. 

Each framework, however, can and does show the benefit levels that would be provided 

for those who opted for the accounts in comparison with those who opted to stay in the 

traditional system. In no cases is a benefit “cuts” in real terms required, and all benefit 

levels will be higher than those received by today’s retirees. In addition, projections are 

that individuals who choose personal accounts can expect to receive higher benefits 

than those opting to remain in the current system. 

Perhaps most importantly, each set of projections shows that for a given level of 

revenue, benefits for a system of personal acc ounts would be higher than systems 

without them. 

Each proposal shows the benefits provided under each personal account proposal, both 

in comparison to the current Social Security system within a given revenue stream, and 

in comparison to today’s benefit levels. 

Impact on the Unified Federal Budget 

Each proposal will have different effects on the unified federal budget as a whole. 

Under current projections, spending on Social Security would grow at an unsustainable 

pace that would crowd out many other forms of government spending. It is therefore 

important that any reform proposal have a positive long-term effect on the federal 

government’s ability to produce the resources necessary to fund Social Security 

benefits within the federal budget. 

 Each of these models would have different effects on the federal budget over 

time. For all three of the models, the move towards personal accounts would have 

short-term transition challenges be followed by long-term gains. For two of the models, 
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changes to bring balance to the pay-as-you-go Social Security system would 

themselves have positive effects on the federal budget throughout the valuation period. 

The interaction between these elements produces each proposal’s unique effects on 

federal budget projections. 

 

The Office of the Social Security Actuary has produced estimates of the net 

impact of each proposal on the unified federal cash budget, which are presented in the 

accompanying discussions. 

The Role of Congressional Proposals in the Commission’s Analysis and Reporting 

Many members of Congress have offered plans to sustain Social Security with personal 

accounts, and the Commission has studied and evaluated these in substantial detail. 

Commission members have particularly appreciated the work of Congressmen Jim 

Kolbe (R-AZ), Charles Stenholm (D-TX), Nick Smith (R-MI), Jim DeMint (R-SC) and 

Richard Armey (R-TX) in presenting constructive proposals for the Commission’s 

consideration. The Commission applauds the effort that many Members of Congress 

have demonstrated by working diligently to develop comprehensive, actuarially-scored, 

proposals. 

Congressional sponsors of proposals as well as other sponsors of serious 

comprehensive reform proposals are entitled to have their plans understood and 

discussed. This entails that they be compared to the proper baseline of an imbalanced 

Social Security program in which benefits would be precipitously reduced or taxes 

precipitously raised when the Trust Fund became insolvent. 

They are properly compared not to an unrealistic baseline in which all promised benefits 

materialize without collection of the necessary tax revenue, but to two actual 

alternatives: 1) an insolvent Social Security system (in which benefits will be 

precipitously reduced unless tax revenue is increased) or 2) a system in which tax 

revenues are increased to sustain the scheduled benefit level. We urge that, for 

credibility, critics of our reform plans or those of others should be expected to offer 

comprehensive reform alternatives of their own. 
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Three Approaches to Strengthening Social Security 

Personal Accounts – the Unifying Element 

Congress and the President face a wide range of choices to bring the Social Security 

system to a path of fiscal sustainability. On the one hand, benefit growth for the 

traditional Social Security system could be set at a rate that can be funded within 

projected program revenues. On the other hand, significant new revenues would be 

required in order to fund the currently-scheduled pace of benefit growth. 

The Commission has found that no matter which approach is taken, personal accounts 

will increase the expected benefits received by workers or decrease the cost to 

taxpayers. Analysis of each of the reform models described here demonstrates the 

significant gains for workers that would arise from personal accounts. 

Understanding the Three Basic Approaches 

The reform models presented here are intended to illustrate the basic choices involved 

in strengthening Social Security, both with and without personal accounts. 

Reform Model 1 shows the implications of establishing personal accounts without 

making any changes to Social Security’s benefit and revenue structure. Under this 

approach, the personal accounts would increase expected benefits for workers while 

making a small contribution to long-term sustainability. However, considerable 

uncertainty would remain for workers, because yet unspecified actions would be 

required in the future to permanently avert insolvency. In addition, the personal 

accounts themselves could offer smaller benefit increases than would be the case 

under a wholly balanced system. 

Reform Model 2 is illustrative of the choices facing the nation if it desired to balance the 

Social Security system and to maximize the benefits delivered without tax increases or 

additional worker contributions. Basic Social Security benefits under this reform model 

would grow at the rate that the existing Social Security system can sustain. Specifically, 

initial benefit formulas would grow with inflation for most workers, and benefit growth 

above this rate would be targeted to create additional protections against poverty for 

low-income workers and widows. The personal accounts would be very attractive 

because they would provide all workers with the opportunity to significantly exceed the 

level of benefits that the traditional system can afford to provide. This model also allows 

for a direct comparison between the levels of benefits that can be provided from 

projected revenues, with and without personal accounts, because the traditional benefit 

structure under this model is what is affordable in the absence of personal accounts, on 

average over the 75-year actuarial period. 

Reform Model 3 has the objective of meeting or exceeding current-law benefit promises 

and maintaining wage replacement ratios, by adding revenues. It shows that the 

necessary revenues are smaller under a personal account system than they would be 
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for the current system. Under this model, the traditional Social Security system is 

balanced through a combination of changes in the rate of benefit growth and 

commitments of new revenues. Workers would have the opportunity to redirect part of 

their payroll tax to a personal account if they also contribute an additional 1 percent of 

their pay to the account. This contribution would be subsidized through a partial and 

progressive refundable tax credit. This extra contribution enables the total expected 

benefit to grow at least as fast as wages and to equal or exceed the benefit level 

scheduled under the current system—but at much lower cost. 
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How the Commission’s Reform Models Improve Social Security’s 

Treatment of Women 

While Reform Model 1 retains the current system’s protections for women by making no 

changes to current benefit schedules, Reform Models 2 and 3 would make targeted 

improvements in the treatment of women. 

Both models institute new protections against poverty for low-income workers, among 

whom women are disproportionately represented. By 2018, Reform Model 2 would 

guarantee that an individual who worked for at least 30 years at the minimum wage 

would retire with an income at least 120 percent of the poverty line. Reform Model 3 

would guarantee that such a worker retired with an income at least 100 percent of the 

poverty line. These are new protections against poverty in old age that do not exist in 

the current program. 

Reform Models 2 and 3 would also increase benefits for widows, who suffer from 

among the highest poverty rates in retirement. Currently, a widow’s benefits are 

reduced by between one-third and one half relative to the total benefits she and her 

spouse received. Under these new protections, widows would receive 75 percent of 

their total couple’s benefit, thereby reducing poverty for this vulnerable population. 

Finally, under the current system a woman who is divorced prior to ten years of 

marriage receives no credit toward benefits based on her husband’s earnings. As the 

average divorce takes place prior to the tenth year of marriage, this deprives many 

women of benefits they would otherwise have received. All three Reform Models go 

some way toward addressing this problem by dictating that personal account assets 

accumulated during marriage, as well as interest earned on account assets brought into 

marriage, would be split equally between husband and wife in the event of divorce. This 

would ensure that divorced women would not leave a marriage without any assets or 

wealth. 
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Reform Model 1: Voluntary Personal Account and Offset Combined 

with No Changes to Traditional Social Security System 

• Workers would be given the opportunity to invest 2 percent (or another 

percentage) of their taxable wages in a personal account. 

• In exchange for the benefits provided by the accounts, participating workers 

would give up, in traditional Social Security benefits, the total value of their 

investments in the account, compounded at a 3.5% real interest rate. 

Some have proposed creating personal accounts while making no changes either to the 

traditional Social Security system’s benefit formula or to its dedicated revenue stream. 

Under this framework, further actions would eventually be required to bring Social 

Security to long-term sustainability. If no individuals elected to participate in personal 

accounts, the measures required would be exactly those necessitated under current 

law. If individuals participated in personal accounts, there would be a small 

improvement in the system’s long-term sustainability. 

This option would be relevant if Congress decided to act separately on the issues of 

creating personal accounts and restoring fiscal sustainability. In the particular example 

scored here, individuals would be given the opportunity to invest 2 percent of their 

taxable payroll in a personal account. This framework, however, could be adapted to 

allow for accounts that are of different size or construction. The accounts could be made 

larger, or smaller. They could be funded in a progressive fashion (with a higher 

contribution rate based on the first dollars of earnings than on higher earnings 

amounts). Some have proposed that such accounts be supplemented with extra 

contributions for younger workers. (One approach to this might be the idea proposed by 

former Senators Moynihan and Kerrey, which they denoted “Kidsave.”) Others have 

suggested that the accounts be made larger, with the requirement that a certain amount 

be invested in federal securities as a means of limiting the total size of the transition 

investment. Though the plan scored here envisions a 2 percent account for all wage 

earners, any of the above variations could be fit within this framework. 

In exchange for the benefits generated by the personal account, traditional Social 

Security benefits would be offset by the amount of personal account contributions, 

compounded at a real interest rate of 3.5 percent. This offset rate is higher than under 

Reform Models 2 and 3, reflecting the trade-off between the attractiveness of the 

account and the challenge of taking action to restore balance to the traditional system. 

Although the Commission projections show that individuals are likely to see increased 

benefits if they elect to participate in personal accounts, the gains will be more modest 

than under Reform Models 2 and 3. 

Another variation on this framework would be to supplement traditional Social Security 

benefits with voluntary personal accounts, established and funded by the mechanism 

described by the co-chairs in their introduction to this report. Under this option, workers 

would be given the opportunity to invest an additional one percent of their pay in a 
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personal account, and to receive a one percent match from general revenues. Such 

accounts may or may not interact directly with the Social Security system, depending on 

the design of the personal account. Structured purely as a supplementary “add-on” 

account, the accounts would produce additional income for participants, without 

affecting the underlying finances of Social Security. It would also be possible to design 

such accounts to play a role in funding a portion of existing Social Security benefit 

promises, and thereby to use the accounts to help shore up the finances of traditional 

Social Security. 
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Implications of Reform Model 1: 

 Reform Model 1 would permit policy makers to separate the issues of permanent 

fiscal sustainability and personal accounts. Specifically, it would provide policy 

makers with an opportunity to establish personal accounts in a manner that 

simultaneously makes a modest contribution to long-term sustainability, and also 

offers improved treatment of beneficiaries. 

 Total benefits under Model 1 would be higher than under the current system, to the 

extent that participants exceed a 3.5 percent real rate of return on their personal 

accounts. 

 

 Under Model 1, further actions would be required in order to ensure a fiscally 

sustainable system. Accordingly, projections of total benefits are less certain than 

would be the case under Models 2 and 3. If future action to restore sustainability to 

Social Security affects the growth of benefit levels in the traditional system, this 

would affect participants in personal accounts with respect to their benefits provided 

from the traditional system. 

 Model 1 is a flexible framework. It can be molded to fit the particular desires of policy 

makers with respect to such factors as the size of the accounts, and whether to 

establish a progressive funding mechanism for the accounts. 

 Model 1 does not change the qualitative financing challenge within the valuation 

period. It devotes a transition investment to the system in the first four decades, and 

would improve the program’s annual cash flows from 2043 onward. 
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Scorecard for Reform Model 1 

Model 1 is a flexible framework that is adaptable to various ways of financing the 

accounts. Within the basic framework of a two percent account with a 3.5 interest rate 

offset, many basic measures below show the same results whether the Model is scored 

as a two percent contribution from payroll taxes (with a larger commitment of general 

revenues to the Trust Fund) or a one percent contribution from payroll taxes in 

combination with a one percent contribution from general revenues (with a somewhat 

smaller commitment of general revenues to the Trust Fund.) Only for the solvency and 

actuarial balance measures are these treated differently, so both constructions are 

shown in these measures for purposes of illustration. 

New Saving and Benefits due to Personal Accounts: When fully phased in, expected 

benefits for a medium earner would be approximately 12 percent higher for individuals 

who opt to participate in accounts relative to the current system. By 2017, more than $1 

trillion (present value) are projected to have been accumulated in the personal 

accounts. This figure would surpass $2 trillion in 2035. 

Positive Annual System Cash Flow Within Valuation Period: Reform Model 1 would not 

return to positive annual cash flow within the 75-year valuation period. Assuming 100 

percent participation in personal accounts, cash deficits by the end of the valuation 

period would be reduced by 36 percent relative to current law. Under 67 percent 

participation, they would be reduced by 24 percent. 

Improvement in System Solvency: Despite improving long-term fiscal pressures, Reform 

Model 1 would increase short-term revenue requirements to maintain Trust Fund 

liquidity. If structured as a 1 percent payroll tax contribution matched by a 1 percent 

contribution from general revenues, these additional revenue requirements to maintain 

Trust Fund liquidity would begin in 2023, assuming 100% participation. Assuming 67 

percent participation, they would begin in 2026. (Note again that revenues required to 

retain liquidity in the Trust Fund, an issue that would not arise for decades, are a 

different concept than the “transition investment” that is explained in the Methodology 

section.) 

Reduce Rate of Growth in Long-Term System Costs as a Percent of GDP: 

Assuming 100 percent participation in the accounts, total growth in system costs relative 

to GDP would be reduced by 30 percent through the end of the valuation period. 

Assuming 67 percent participaton, they would be reduced by 20 percent. 

Improvements in 75-Year Actuarial Balance: If structured as a 1 percent payroll tax 

contribution matched by a 1 percent contribution from general revenues, the net 

actuarial imbalance, assuming 100% participation, would be approximately –1.34 

percent of payroll over 75 years, an improvement of approximately 28 percent relative 

to current law. Assuming 67 percent participation, the improvement would be 

approximately 16 percent. If structured as a two percent contribution from payroll taxes, 

improvements in actuarial balance would occur only after the 75-year valuation period. It 
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is important to note, however, that this is an artifact of the method of computing 

solvency and that the two methods of construction are identical in terms of their fiscal 

effects on beneficiaries and taxpayers. Either way, the total revenues required to 

achieve solvency would be exactly the same. 

Actuarial Balance not Deteriorating at the End of Valuation Period: 

Because this reform model does not attain 75-year solvency, there would be no positive 

actuarial balance at the end of the valuation period. 

Reduction in Unfunded Benefit Obligations: At the end of 75 years, assuming 100 

percent participation in accounts, future unfunded obligations of the Social Security 

system would be reduced by approximately $1.3 trillion (in present value) relative to 

current law. For 67 percent participation, the reduction in unfunded obligations would 

be approximately $891 billion. 
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Benefit Projections for Model 1 

Expected benefits for Reform Model 1 would be higher than those in the traditional 

system, although the program’s fiscal challenges would remain qualitatively similar to 

current law. 

Expected benefit projections for Model 1 are more uncertain than for Models 2 and 3, 

because only under the latter Models is the program fiscally sustainable throughout the 

valuation period. Under current law, additional revenue would be required in order to 

sustain full scheduled benefits, or else benefits would be suddenly reduced by 27 

percent in 2038. 

Accordingly, benefit projections for Model 1, both for individuals who take the accounts 

and for those who do not, are subject to continued uncertainty. If all individuals opted to 

stay in the traditional Social Security system, full benefit promises would be met as 

scheduled through 2038, and then reduced. Accordingly, benefits for those who do not 

take the personal accounts under Model 1 are shown on the accompanying chart with 

recognition of this uncertainty. After 2038, two lines are shown – the level of current 

benefit promises, as well as the level of benefits that would actually be paid under 

current law. 

Model 1 is a flexible framework in which the accounts could be financed in a manner 

that either shortens or extends the period of systemic solvency. Accordingly, benefit 

levels for those who take the accounts are shown with the same uncertainty as shown 

for the current system. 

Plan 1: Two percent personal account, no changes to underlying system 

Year 

Relative 

Earnings 

Today's 

benefit 

levels 

Current Law 

benefit 

Expected 

benefit with 

account 

Increase 

relative to 

today's 

benefit 

Additional 

increase 

due to 

account 

Low $7,644 $9,756 $10,140 $2,496 $384 

Medium $12,624 $16,116 $16,944 $4,320 $828 

2032 High $16,392 $21,288 $22,620 $6,228 $1,332 

 

Low $7,644 $8,568* $9,624* $1,980 $1,056 

Medium $12,624 $14,148* $16,476* $3,852 $2,328 

2052 High $16,392 $18,696* $22,428* $6,036 $3,732 

* $11,832, $19,536 and $25,812 are currently scheduled monthly for low, medium, and 

high earners respectively but the system is projected to be 27.6% underfunded in 2052. 

Under the assumption that currently scheduled benefits are met, then the total 

expected benefit with personal accounts would be $12,888, $21,864 and $29,544 

respectively. 

** Expected benefits with accounts assume individual invests in a 50/50 stock/bond 

portfolio earning an annual real rate of return, net of administrative expenses, of 4.6%. 

Upon retirement, the individual is assumed to have converted to a variable annuity 

invested in the same portfolio. Actual benefits may be higher or lower than those 

reported here depending on realized investment returns. 
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Under current law, Social Security’s annual costs will 

exceed its income in 2016, with perpetually increasing 

deficits thereafter. 

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(COMMISSION DECISION: SHOW 100% or 2/3 PARTICIPATION RATE?)

Under Reform Model 1, Long-Term Cash Deficits Would Be 

Reduced By Approximately 36 Percent, if All Individuals 

Participate in Accounts. 

Cost and Income Rates for the Defined Benefit portion of 

Social Security Reform Model 1 Assuming 100% participation in accounts.* 

*Investments in accounts counted as revenue lost to the federal government. 

*Total Social Security system, including investments in and outlays from accounts. 

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Under Model 1, Long-Term Cash Deficits Would Be Reduced 

By Approximately 24 Percent, if Two-Thirds of Individuals 

Participate in Accounts. 

Cost and Income Rates for DB part of Social Security Reform Model 1 

Assuming 100% participation in accounts.* 

(Need footnote here) 

*Total social security system, including investments in and outlays from accounts. 

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Under Reform Model 1, Gains for Beneficiaries Would 

Be Accompanied By Long-Term Fiscal Improvements. 

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Improvement in 

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Solving the Fiscal Problem: Reducing Future Cash Deficits 

 Under Reform Model 1, the present value of the program’s cash deficits over the 

next 75 years would remain qualitatively the same as under current law -- $5.4 trillion,

assuming 100 percent participation in the accounts. For 67 percent participation, the 

figure would be $5.3 trillon. Outside the valuation window, the picture would improve 

substantially relative to current law. Reform Model 1 would increase expected benefits 

for participants but without significantly altering the size of Social Security’s fiscal 

imbalances within the valuation period. It would, however, distribute the financing 

burdens more equitably across generations, with some of the mounting outyear cash 

burdens moved closer in time. 

 Earlier, it was noted that the long-term picture would be improved from 2043 

onward under Reform Model 1. At the same time, however, the short-term financing 

challenge would be greater than under current law. The figures above demonstrate that 

through 2075, these effects have roughly canceled each other out. 

 If Reform Model 1 were structured as a 1 percent investment of payroll taxes 

accompanied by a 1 percent match from general revenues, the present value of the 

cash deficits within Social Security would be measured as $4.0 trillion for 100% 

participation, and $4.3 trillion for 67 percent participation. This, however, could give a 

misleading impression that such a method of financing would diminish the total costs of 

Reform Model 1. It would not. Counting the cost of a 1 percent match from general 

revenues would bring the total cost of Reform Model 1 up to the same figures given 

above. 
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Transition Investment under Reform Model 1 

 For Reform Model 1, even under 100 percent participation, no new “transition” 

cash would be needed before 2009, when the investment in personal accounts for the 

first time exceeds current-law surpluses. The “transition” financing requirements begin 

comparatively small – $6 billion in present-value terms in 2009 – and would grow to a 

maximum of $59 billion (present-value) terms in each of 2015 and 2016.. Thereafter the 

amount of new cash requirements for the new system would diminish, until in 2043, the 

new system would be permanently less expensive than the old. For 67 percent 

participation, the first new transition money would be needed in 2012, would grow to a 

maximum of $40 billion in 2016, and would be permanently less expensive than the old 

system in 2043. 

 The accompanying 

charts also show the total 

amount of new transition 

financing, including that which 

can be financed from existing 

Social Security surpluses. For 

Reform Model 1, however, 

current Social Security 

surpluses would be sufficient 

to finance all transition costs 

at least through 2009. 

All of the figures above 

presume that only Social 

Security cash surpluses are 

available to provide transition 

financing. Were Congress to 

“lockbox” both cash and 

interest surpluses as 

previously intended, transition 

financing needs would be 

postponed by additional 

years. 

(COMMISSION DECISION: 

SHOW 100% or 2/3 

PARTICIPATION RATE?)
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Impact of Reform Model 1 on the Unified Federal Budget 

Reform Model 1 would take the longest of the three plans to have a net positive 

impact on the annual federal cash budget, doing so only after 2042, assuming 100 

participation. By 2075, the net positive effect would be $240 billion annually in 2001 

dollars. The largest annual negative effect that this Reform Model would have on federal 

cash operations would be approximately $96 billion in 2001 dollars, annually, from 

2014-2018. This is considerably less than the current Social Security surplus, if interest 

is included. 

Assuming 100% Participation in Accounts, Reform Model 1 Would Have a 

Positive Impact on the Federal Cash Budget from 2043 Onwards

(COMMISSION DECISION: SHOW 100% or 2/3 PARTICIPATION RATE?)
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Reform Model 2: Voluntary Progressive Investment of Payroll Taxes in 

Accounts Combined with an Inflation-Indexed Traditional System 

Individuals would be given the opportunity to invest 4 percent of their taxable wages in a 

personal account, up to an annual maximum of $1,000. The amount of the maximum 

annual contribution would be indexed annually to wage growth. 

In exchange for the benefits generated by the personal account, traditional Social 

Security benefits would be offset by the amount of personal account contributions 

compounded at a real interest rate of 2 percent. So long as personal account returns 

averaged more than 2 percent, a worker would receive higher total retirement benefits. 

Even the most conservative portfolio available, consisting only of government bonds 

returning 3 percent annually, would exceed the offset rate and result in higher total 

benefits. 

Benefit growth for lower-wage workers would be accelerated and increased relative to 

current law. By 2018, a 30-year minimum wage worker would receive benefits in an 

amount at least 20 percent above the poverty line, a protection that does not exist in the 

current system. 

Benefits in the traditional Social Security system would be indexed to price inflation 

rather than national wage growth beginning in 2009. In practice, this would be 

accomplished by multiplying the PIA bend point factors (the bend points would remain 

indexed to wages) by the ratio of the Consumer Price Index to the Average Wage Index 

in successive years. 

Benefits for widows would be increased to 75 percent of the combined benefits that 

would be received by the couple if both were still alive, versus 50-66 percent under 

current law. To target this benefit increase to widows most in need, benefits cannot be 

increased under this provision to a level higher than the benefit received by a survivor of 

an average-wage earner. 

Pressures on general revenues would be reduced during the valuation period relative to 

current law. Regardless of participation rates for the accounts, the Trust Fund would 

never become insolvent. For the traditional system, exact actuarial balance would be 

attained without any additional general revenues. That is, no additional revenues would 

be required assuming 0 percent participation in accounts. For 100 and 67 percent 

participation, transition investment in the accounts would be followed by improvement in 

long-term sustainability. To ensure that the use of general revenues for transition 

financing does not undermine the program’s self-financing ethic, funds would be 

transferred to the Trust Fund on a temporary basis to ensure liquidity. Subsequent 

permanent cash surpluses within Social Security would permit these transfers to be 

repaid to non-Social Security budget accounts. Although policy makers can think of this 

money as a “transition loan” to Social Security, the Office of the Social Security Actuary 

draws a technical distinction between transfers and loans in its determinations of 
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solvency, and the Commission has thus structured the temporary transfers to meet 

OACT’s standard of solvency. 
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Advantages of Reform Model 2: 

 All workers would expect to benefit from personal accounts (due to the low 2% offset 

rate), but lower-wage workers would benefit the most, because of the progressive 

formula for funding the accounts. 

 Those who opt for personal accounts would not be required to pay any additional 

money. 

 Reform Model 2 would significantly raise low-wage workers’ benefits relative to 

current law. The bill would establish a new poverty protection so that no lifetime lowwage participant would face poverty in old age. Benefits for minimum wage workers 

with at least 30 years of labor force attachment would be raised to 120 percent of the 

poverty line, even if they do not opt for personal accounts. A low-wage workforce 

entrant today who opts for personal accounts can expect to receive combined Social 

Security benefits equal to those received by an average retiree today, even after 

adjusting for inflation. 

 Social Security’s permanent deficits would be eliminated without reliance on 

permanent general revenue transfers. 

 Reform Model 2 would significantly increase benefits for widows, who are among the 

elderly at greatest risk of poverty. 

 Social Security’s burden on future generations would be significantly reduced, 

returning to today’s levels within the valuation period. 

 Cash deficits under this model are manageable in size. Even in the peak years of 

cash deficits, they never rise to more than 1.4 percent of GDP. Under current law 

scheduled benefits, Social Security deficits would reach 2.5 percent of GDP. 

 
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Scorecard for Reform Model 2 

New Saving and Benefits due to Personal Accounts: When fully phased in, expected 

benefits for a medium earner would be approximately 52 percent higher for individuals 

opting for relative to benefits payable from the current system. By 2015, more than $1 

trillion (present value) are projected to have been accumulated in the personal 

accounts. This figure would surpass $2 trillion in 2028. 

Additional Protections against Poverty: Under Reform Model 2, low-income earners, 

widows, and women and minorities generally would receive substantially higher benefits 

than are payable from the current Social Security system. The new minimum benefit 

provision would increase benefits for a 30-year minimum wage earner by approximately 

40 percent by 2018 relative to today, even without the additional gains from the 

personal account. Benefits for widows in low-income households would be increased by 

as much as 50 percent through a change in the widows’ benefit formula. 

Positive Annual System Cash Flow Within Valuation Period: Under all participation rates 

for personal accounts, Social Security would be restored to permanent annual cash flow 

surpluses within the 75-year valuation period. Cash surpluses would resume in 2058 

assuming 100 percent participation in the accounts and in 2062 assuming 0 percent 

participation. Assuming 67 percent participation, they would resume in 2059. As 

personal accounts would be highly attractive under this framework, providing 

significantly higher benefits without additional taxes, participation rates are expected to 

be high, thus accelerating the return to permanent cash surpluses. 

 

Improvement in System Solvency: Social Security would be made permanently solvent 

under all participation rates for personal accounts. Assuming 0 percent participation, no 

additional revenues would be required. Assuming 100 percent participation in the 

accounts, temporary transfers would be required from the years 2025 through 2054. 

The total present value of these temporary transfers would be approximately 41 percent 

less than the additional revenue required under current law. Social Security’s annual 

cash surpluses would permit repayment of this money beginning in 2057. (Note again 

that revenues required to retain liquidity in the Trust Fund, an issue that would not arise 

for decades, are a different concept than the “transition investment” referred to in the 

Methodology section, which simply measures the period of time that the new system is 

more expensiev than the old.) 

Reductions in the Rate of Growth in Long-Term System Costs as a Percent of GDP: 

Under all participation rates, total system costs would grow no faster than the economy 

as a whole through the end of the valuation period, rendering the system wholly 

sustainable by this measure. 

Improvements in 75-Year Actuarial Balance: The system would be made permanently 

solvent under all participation rates for personal accounts, with financing requirements 

as indicated above. It should be noted that the general revenue transfers required under 
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higher account participation rates would be temporary and are outweighed (in present 

value terms) by savings created over the longer-term by this model. 

Actuarial Balance Stable or Improving at the End of Valuation Period: Under all 

participation rates, actuarial balance would be increasing at the end of the valuation 

period, indicating permanent sustainability. 

Reduction in Unfunded Benefit Obligations: Total unfunded obligations would have been 

reduced by $1.1 trillion (in present value) due to the personal accounts, in addition to 

the savings resulting from balancing the traditional system. For 67 percent participation, 

the progress due to the personal accounts alone would be approximately $750 billion, 

in present value terms. 
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Benefit Projections for Reform Model 2 

Reform Model 2 illustrates how it is possible to significantly increase total benefits 

relative to the current system. 

Under Reform Model 2, benefits for those who do not opt for personal accounts would 

grow at exactly the rate that is affordable under the current system without tax 

increases. Accordingly, the accompanying charts provide a direct comparison between 

the benefits payable through a personal account system vs. the current system. 

Under the current system, a rate of initial benefit growth slightly higher than inflation is 

affordable within current tax rates. Reform Model 2 would target this growth above 

inflation on low-income workers and widows, for those who stay wholly in the traditional 

system. 

For those who opt for personal accounts, considerably higher benefits would be 

obtainable. All workers would expect significantly higher benefits, either than are paid 

today, or that the existing system can afford in the future. 

Plan 2: Price indexed system

Year 

Relative 

Earnings 

Today's 

benefit 

levels 

Current 

Law 

benefit 

Expected 

benefit 

with 

account 

Increase 

relative to 

today's 

benefit 

Additional 

increase due 

to account 

Low $7,644 $9,756 $11,160 $3,516 $1,488 

Medium $12,624 $16,116 $15,444 $2,820 $2,256 

2032 High $16,392 $21,288 $19,680 $3,288 $2,268 

 

Low $7,644 $8,568* $13,608 $5,964 $3,936 

Medium $12,624 $14,148* $20,016 $7,392 $6,828 

2052 High $16,392 $18,696* $24,684 $8,292 $7,272 

* $11,832, $19,536 and $25,812 are currently scheduled monthly for low, medium, 

and high earners respectively but the system is projected to be 27.6% underfunded 

in 2052. 

** Expected benefits with accounts assume individual invests in a 50/50 stock/bond 

portfolio earning an annual real rate of return, net of administrative expenses, of

4.6%. Upon retirement, the individual is assumed to have converted to a variable 

annuity invested in the same portfolio. Actual benefits may be higher or lower than 

those reported here depending on realized investment returns. 
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Under Current Law, Social Security’s Annual Costs Will 

Exceed Its Income In 2016, With Perpetually Increasing 

Deficits Thereafter. 

Under Reform Model 2, Social Security Would Be Actuarially Balanced Even With Zero 

Percent Participation In Personal Accounts. 

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(COMMISSION DECISION: SHOW 100% or 2/3 PARTICIPATION RATE?)

Reform Model 2 Would Restore Social Security To Permanent 

Surpluses Within The Valuation Period, Assuming 100 

Percent Participation in Accounts. 

Social Security Cost And Income Rates* 

*Investments in accounts counted as revenue lost to the federal government. 

Reform Model 2 Would Restore Social Security To Permanent Surpluses Within The 

Valuation Period. 

*Investments in accounts treated as collection and outlay. 

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Reform Model 2 Would Restore Social Security To Permanent Surpluses Within 

The Valuation Period, Assuming Two-Thirds Participation in Accounts.

(COMMISSION DECISION: SHOW 100% or 2/3 PARTICIPATION RATE?)

*Investments in accounts counted as revenue lost to the federal government. 

*Investments in accounts treated as collection and outlay. 

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Reform Model 2 Would Vastly Improve System Finances 

Relative To Current Law. 

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Reform Model 2: Reducing Programmatic Cash Deficits 

Under Reform Model 2, Social Security’s cash deficits would be reduced 

significantly relative to current law. 

The present value of Social Security’s cash deficits under current law is projected 

to be $5.1 trillion over the next 75 years. 

Assuming 0 percent participation in personal accounts over the next 75 years 

under Reform Model 2, the present value of the system’s cash deficits would be 

reduced to $1.8 trillion, an improvement of 64 percent relative to current law. 

Because the personal accounts are highly attractive under Reform Model 2, it is 

likely that participation rates would be high. Beneficiaries would expect significantly 

higher benefits if they opted for personal accounts. Assuming 100 percent participation 

in the personal accounts, the present value of the system’s cash deficits would be $3.4 

trillion over the next 75 years, an improvement of 34 percent relative to current law. 

Assuming 67 percent participation, the figure would be $2.8 trillion, an improvement of 

46 percent. 

Although short-term cash deficits would be larger than if no individuals 

participated in accounts, higher participation rates in the personal accounts would return 

the system to cash surpluses more rapidly and result in larger surpluses outside the 

valuation window. 

By any measure, Reform Model 2 would significantly reduce fiscal pressures on 

the rest of the federal government relative to current law. Any transition investment 

would be more than repaid during the long-range valuation window, reducing overall 

system cash gaps by anywhere from 34 percent to 64 percent. 
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Transition Financing Under Reform Model 2 

For Reform Model 2, no new “transition” cash would be needed before 2006, even with 

100% participation in the accounts, when the investment in personal accounts for the 

first time exceeds current-law surpluses. The “transition” financing requirements begin 

comparatively small – $1.3 billion in present-value terms in 2006 – and would grow to a 

maximum of $71 billion in present-value terms in 2015. Thereafter the amount of new 

cash requirements for the new system would diminish, until in 2032, the new system 

would be permanently less expensive than the old. For 67 percent participation, the first 

transition cash needs would be in 2010, would grow to a maximum of $46 billion in 

2015, and the new system would 

be less expensive than the old 

starting in 2029. 

Again, all of the figures above 

presume that only Social Security 

cash surpluses are available to 

provide transition financing. 

Were Congress to “lockbox” both 

cash and interest surpluses as 

previously intended, transition 

financing needs would be 

postponed by additional years. 

(COMMISSION DECISION: 

SHOW 100% or 2/3 

PARTICIPATION RATE?)
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Impact of Reform Model 2 on the Unified Federal Budget 

 Assuming 100 percent participation in the personal accounts, Reform Model 2 

would have a net positive impact on the federal cash operations by 2032, with positive 

gains increasing throughout the valuation period and reaching $838 Billion annually (in 

2001 dollars) by 2075. The largest negative impacts on the federal budget would be 

$116 Billion (in 2001 dollars) in year 2013. 

 Assuming no participation in personal accounts, eventual improvements in the 

net annual cash budget would not grow quite as large ($772 billion annually in 2075) by 

the end of the valuation period, but net effects on total federal budget balance would be 

positive throughout almost the entirety of the valuation period.

(COMMISSION DECISION: SHOW 100% or 2/3 PARTICIPATION RATE?)
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Reform Model 3: Voluntary Add-On Accounts with Matches from 

Payroll Taxes Overlaying a Traditional System Balanced with a Blend 

of Revenue and Outlay Changes 

Reform Model 3 is based on the premise that restoring Social Security to solvency is 

essential, but maintaining scheduled benefits and existing wage replacement rates is 

also important. To reconcile these two objectives requires additional revenues.

Individuals would be given the opportunity to invest in voluntary personal accounts. The 

deposit in personal accounts would be triggered by a voluntary contribution of an 

additional 1 percent of the participant’s wages, matched by a 2.5 percent contribution 

(up to an annual maximum of $1,000) from their current payroll taxes. For low-income 

workers, the voluntary contribution would be subsidized by rebating the amount through 

a refundable tax credit. 

In exchange for the benefits generated by the personal account, traditional Social 

Security benefits would be offset by the amount of personal account contributions 

compounded at a real interest rate of 2.5 percent. Accordingly, even if individuals 

invested only in government bonds returning 3 percent, the most conservative portfolio 

available, their total retirement benefits will increase due to the accounts. 

The initial formula for the traditional Social Security benefits would grow at a rate that is 

approximately halfway between wage indexing and price indexing. The rationale for this 

rate of growth is to adjust the rate of growth in benefits for future changes in life 

expectancy, without changing the retirement age. 

Work would be rewarded and early retirement penalized by changing the actuarial 

adjustments for early and late retirement to reflect additional payroll taxes contributed.

This change would be phased in from 2009 through 2013. 

The 15 percent bend point factor, affecting the participants with the highest incomes, 

would be gradually reduced to 10 percent from 2009 through 2028.

Growth in traditional Social Security benefits for lower-wage workers would be 

accelerated and increased relative to current law. By 2018, a worker who works for 30 

years at the minimum wage would receive a benefit at least as high as the poverty level, 

a protection that does not exist under the current system. 

Traditional Social Security benefits for widows would be increased to 75 percent of the 

combined benefits that would be received by the couple if both were still alive, versus 

50-66 percent under current law. To target this benefit increase to widows most in need, 

benefits cannot be increased under this provision to a level higher than the benefit 

received by a survivor of an average-wage earner. 

Additional revenues would be committed to the Social Security system.

As scored in the accompanying presentation, these revenues would take the form of 

dedicated revenue transfers, starting at 0.34 percent of national taxable payroll and 
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averaging 0.63 percent throughout the 75-year valuation period. Congress would be 

able to choose from a variety of sources for making such revenues available to the 

Social Security system. 

Maintenance of scheduled benefits and replacement rates. 

These benefit and revenue changes would have the effect of maintaining or exceeding 

scheduled benefit levels and wage replacement rates from a combination of the 

traditional Social Security benefit and the personal retirement account. 

Solvency would be maintained through a combination of permanent and temporary 

commitments of general revenues. For the traditional system, exact actuarial balance 

would be attained through the use of targeted general revenues as above. To ensure 

that the use of general revenues for transition financing does not undermine the 

program’s self-financing ethic, funds would be transferred to the Trust Fund on a 

temporary basis to ensure liquidity. Subsequent permanent cash surpluses within 

Social Security would permit these transfers to be repaid to non-Social Security budget 

accounts. Although policy makers can think of this money as a “transition loan” to 

Social Security, the Office of the Social Security Actuary draws a technical distinction 

between transfers and loans in its determinations of solvency, and the Commission has 

thus structured the temporary transfers to meet OACT’s standard of solvency. 
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Advantages of Model 3: 

1. Workers who opt for PRAs can reasonably expect to receive total Social Security 

benefits (including their PRA) exceeding current law promised benefits. 

 

2. Revenues to the social security system are enhanced, in order to maintain current 

replacement rates (ratio of average benefits to average wages) for those who opt to 

participate in the accounts. 

 

3. The primary source of additional revenue is a voluntary 1% add-on to the new PRAs. 

The add-on is matched by a redirection of part of the payroll tax—2.5% up to an 

annual maximum of $1000--to the PRA. 

 

4. The add-on directly increases household saving and national saving, to the extent 

that add-on contributions do not displace other pre-existing saving. If saving 

increases, productivity and output would be increased. 

 

5. Some permanent transfers of new revenues are added from dedicated sources to 

the pay-as-you-go Social Security system 

6. Intergenerational equity is maintained by holding constant the present value of 

lifetime benefits from Social Security as longevity increases. 

 

7. Work incentives are augmented by rewarding delayed retirement and by steeper 

actuarial penalties for early retirement. 

 

8. The obligations of future generations to pay unfunded obligations are dramatically 

reduced. 

 

9. The transition burden is kept manageable by the fact that some of the PRA comes 

from an add-on and by charging a 2.5% offset interest rate. 

 

10. Progressivity is enhanced and poverty reduced: The pay-as-you-go benefit is 

“flattened out” for higher earners, a new minimum benefit increases pensions of low 

earners and a higher survivors benefit helps alleviate poverty among the very old. 
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Scorecard for Reform Model 3 

New Saving and Benefits due to Personal Accounts: When fully phased in, expected 

benefits for a medium earner would be approximately 56 percent higher for individuals 

who opt to participate in accounts relative to those payable from the current system. By 

2013, more than $1 trillion (present value) are projected to have been accumulated in 

the personal accounts. This figure would surpass $2 trillion in 2023. The extent to which 

this is new saving would depend on the amount of pre-existing saving displaced for addon contributions to the accounts. 

Additional Protections against Poverty: Under Reform Model 3: low-income earners, 

widows, and women and minorities generally would receive substantially higher benefits 

than are payable from the current Social Security system. The new minimum benefit 

provision would increase benefits for a 30-year minimum wager earner by 

approximately 17% by 2018, even without the additional gains from the personal 

account, and this amount would grow over time faster than inflation. This minimum 

benefit would be even more generous for individuals with the same career earnings but 

more years of work. Benefits for widows in low-income households would be increased 

by as much as 50% through a change in the widows’ benefit formula. 

Positive Annual System Cash Flow Within Valuation Period: Under all participation 

rates, projected cash deficits would be reduced relative to current law. Under 100 

percent participation, the system would return to positive cash flow by 2062, providing 

that additional revenue has been collected to fund this framework’s general revenue 

transfers. For 67 percent participation this would occur in 2072. Net of the obligation to 

fund the transfers, the system would return to cash surpluses only outside the valuation 

period. Under 0 percent participation, the system would not return to positive cash flow 

within the valuation period. 

Improvement in System Solvency: The system would be made permanently solvent 

under all participation rates for personal accounts. Assuming 100 percent participation 

in the accounts, temporary transfers would be required from the years 2028-2056 in 

addition to the general revenues tapped to sustain the traditional Social Security 

system. The total present value of these would be approximately 69 percent less than 

the revenue requirements under current law. Repayment of this money could 

commence in 2058 within the financing of this particular Reform Model. Total general 

revenue requirements, including permanent and temporary transfers, would be 

approximately 33% less than current law. (Note again that revenues required to retain 

liquidity in the Trust Fund, an issue that would not arise for decades, are a different 

concept than the “transition investment” referred to in the Methodology section, which 

simply measures the period of time that the new system is more expensive than the 

old.) 

Reduce Rate of Growth in Long-Term System Costs as a Percent of GDP: 

Total system costs would grow slower than GDP through the end of the valuation 

period, rendering the system wholly sustainable by this measure. 
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Improvements in 75-Year Actuarial Balance: The system would be made permanently 

solvent under all participation rates for personal accounts, with financing requirements 

as indicated above. 

Actuarial Balance not Deteriorating at the End of Valuation Period: Under all 

participation rates, the system would experience either increasing surpluses or 

decreasing annual cash deficits by the end of the valuation period. Under 0 percent 

participation, continuing cash deficits would mean that the actuarial balance would not 

yet be increasing. For 100 percent participation, actuarial balance would be improving 

providing that revenues have been made available to fund general revenue transfers. 

Reduction in Unfunded Benefit Obligations: Total unfunded obligations would have been 

reduced $1 trillion (in present value) from the personal accounts, in addition to the 

savings resulting from balancing the traditional system. For 67 percent participation, 

this figure would be approximately $700 billion. 
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Benefit Projections for Reform Model 3 

Reform Model 3 illustrates how it is possible to exceed currently scheduled benefit 

promises through personal accounts without recourse to the large tax increases that the 

current system would require. 

Under Reform Model 3, benefits for those who opt for the personal accounts would be 

significantly higher than those who do not, even without the 1% add-on contribution, but 

the 1% add-on would bring total benefits to a higher level than currently scheduled 

promises. 

These gains would still exist, although to a lesser extent, under the more conservative 

assumption of a fixed annuity upon retirement. 

Like Reform Model 2, Reform Model 3 would provide for benefit growth, among those 

who do not opt for personal accounts, for low-wage workers and widows. 

Plan 3: 1% "Add-on" contribution allows for benefit growth exceeding currently

scheduled benefits

Year 

Relative 

Earnings 

Today's 

benefit 

levels 

Current 

Law 

benefit 

Expected 

benefit 

with 

account 

Increase 

relative to 

today's 

benefit 

Additional 

increase due 

to account 

Low $7,644 $9,756 $10,932 $3,288 $1,560 

Medium $12,624 $16,116 $17,412 $4,788 $3,456 

2032 High $16,392 $21,288 $22,620 $6,228 $4,632 

 

Low $7,644 $8,568* $14,112 $6,468 $3,828 

Medium $12,624 $14,148* $23,796 $11,172 $8,496 

2052 High $16,392 $18,696* $31,668 $15,276 $11,952 

* $986, $1,628 and $2,151 are currently scheduled monthly for low, medium, and

high earners respectively but the system is projected to be 27.6% underfunded in

2052. 

** Expected benefits with accounts assume individual invests in a 50/50 stock/bond

portfolio earning an annual real rate of return, net of administrative expenses, of

4.6%. Upon retirement, the individual is assumed to have converted to a variable

annuity invested in the same portfolio. Actual benefits may be higher or lower than

those reported here depending on realized investment returns. 
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[1] The adjustment would be based on actual changes in period tables 10 years prior. 

For example, the increased life expectancy between 2010 and 2015 would be used to 

adjust (carryover of footnote) the annual DB downward over 2020-2025. This gradual 

adjustment process would give people ample time to compensate by planning to work 

longer or save more privately. 
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Income And Cost Rates Under Current Law 

Under Reform Model 3, Social Security Would Be Actuarially Balanced Even With Zero 

Percent Participation In Personal Accounts. 

5

6

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Cost Rate

Income Rate

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Cost Rate

Income Rate
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Social Security Cost and Income Rates * 

*Investments in accounts counted as revenue lost to the federal government. 

(COMMISSION DECISION: SHOW 100% or 2/3 PARTICIPATION RATE?)

Reform Model 3 Would Restore Social Security To Permanent Surpluses Within The 

Valuation Period, Assuming 100% Participation in Accounts. 

Social Security Cost and Income Rates* 

*Investments in accounts treated as collection and outlay. 

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Reform Model 3 Cost Rate

Reform Model 3 Income Rate

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Reform Model 3 Total Cost Rate

Reform Model 3 Total Income Rate
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Reform Model 3 Would Vastly Improve Systemic Finances 

Relative To Current Law
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*Investments in accounts counted as revenue lost to the federal government. 

*Investments in accounts treated as collection and outlay. 

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Reform Model 3 Cost Rate

Reform Model 3 Income Rate

Reform Model 3 with 66% Participation

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Reform Model 3 Cost Rate

Reform Model 3 Income Rate

Reform Model 3 with 66% Participation
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Reform Model 3: Reducing Programmatic Cash Deficits 

Under Reform Model 3, Social Security’s cash deficits would be reduced 

significantly relative to current law. 

 The present value of Social Security’s cash deficits under current law projects to 

be $5.1 trillion over the next 75 years. 

Assuming 0 percent participation in personal accounts over the next 75 years 

under Reform Model 3, the present value of the system’s cash deficits would be 

reduced to $2.7 trillion, an improvement of 48 percent relative to current law. 

Because the personal accounts are attractive under Reform Model 3, it is likely 

that participation rates would be high. Beneficiaries would expect significantly higher 

benefits if they opted for personal accounts. Assuming 100 percent participation in the 

personal accounts, the present value of the system’s cash deficits would be $3.4 trillion 

over the next 75 years, an improvement of 32 percent relative to current law. For 67 

percent participation in the accounts, the figure would be $3.1 trillion, an improvement of 

38 percent. 

By any measure, Reform Model 3 would significantly reduce pressures on the 

rest of the federal government, relative to current law. Any “transition investment” would 

be more than repaid during the long-range valuation window, reducing overall system 

cash gaps by anywhere from 32 percent to 48 percent. 

Relative to Reform Model 2, Reform Model 3 would make less progress in 

reducing cash gaps if 0 percent participation in the accounts is assumed. This reflects 

the fact that Reform Model 2 takes stronger measures to bring the traditional system to 

solvency. For 100 percent participation in the accounts, however, the two systems have 

roughly similar effects in reducing cash deficits. This is because Reform Model 3 has a 

somewhat steeper offset rate for participation in the personal accounts than does 

Reform Model 2. 
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Transition Financing Under Reform Model 3 

 Reform Model 3 employs infusions of general revenues, with effects on the 

unified federal budget as described on the following page. Beyond these infusions, no 

new “transition” cash would be needed before 2009, even assuming 100 percent 

participation, when the investment in personal accounts for the first time exceeds 

current-law surpluses (must revise for new effective dates.) The “transition” financing 

requirements begin comparatively small – $8 billion in present-value terms in 2009 – 

and would grow to a maximum of $55 billion in present-value terms in 2015. Thereafter 

the amount of new cash requirements for the new system would diminish, until in 2031, 

the new system would be no longer requires additional temporary transition financing. 

The system, however, would 

continue to rely on permanent 

infusions of general revenues 

throughout the valuation 

period, and the model’s net 

impact on the federal budget 

would turn positive in 2035, as 

shown on the following page. 

Again, all of the figures above 

presume that only Social 

Security cash surpluses are 

available to provide transition 

financing. Were Congress to 

“lockbox” both cash and 

interest surpluses as 

previously intended, transition 

financing needs would be 

postponed by additional 

years. 
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Impact of Reform Model 3 on the Unified Federal Budget 

 Assuming 100 percent participation in the personal accounts, Reform Model 3 

would have a net positive impact on the federal cash operations by 2032, with positive 

gains increasing throughout the valuation period, and reaching $588 Billion annually (in 

2001 dollars) by 2075. The largest negative impacts on the federal budget would be 

$100 Billion in in 2012-2013. 

 Assuming 0 percent 

participation in personal 

accounts, eventual 

improvements in the net 

annual cash budget would 

grow to approximately $499 

billion (in 2001 dollars) by 

2075. Though eventual 

improvements would be 

smaller by the end of the 

valuation period, such 

improvements would exist 

throughout the valuation 

period. 

Assuming 67 percent 

participation, the gain would 

be $558 billion (in 2001 

dollars) by 2075 with 

positive gains beginning in 

2029. 

(COMMISSION DECISION: 

SHOW 100% or 2/3 

PARTICIPATION RATE?)
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The Role of Guarantees 

Finding: The Commission has chosen not to include guarantees in any of the three 

plans presented here. Advocates of guarantees in a voluntary personal accounts 

retirement system should carefully assess both the costs and the benefits of any such 

guarantee to holders of personal accounts, taxpayers, and retirement security over the 

long term. 

Every public and private retirement system must continually balance the risks and 

rewards of alternative approaches to structuring and financing benefits for retirees. For 

example, unfunded systems, including the current U.S. Social Security system, are 

sensitive to demographic change, economic fluctuations, and political risk. The aging of 

the population and the declining ratio of workers to retirees places fiscal pressure on 

unfunded systems, leading to the risk to beneficiaries that benefits may be reduced in 

order to balance system finances. 

Personal accounts holding real financial assets reduce the risk that participants face 

under an unfunded Social Security system. Personal accounts are owned by workers, 

and they provide an opportunity to diversify pension investments. However, investing in 

capital markets may expose participants to fluctuations in the value of their pension 

assets. 

Concern about market volatility has prompted some analysts and policy makers to 

explore the possibility of “guarantees” of pension accumulations. In many cases, the 

desire for a “guarantee” is premised on the mistaken notion that the current Social 

Security system provides a guaranteed benefit. This is untrue. While the defined benefit 

formula does not subject individuals to financial market uncertainty, the formula itself 

can be changed and has been changed in the US numerous times in the past. This 

political risk to benefits is all the more real because the Social Security system faces 

perpetual financing deficits starting in the middle of the next decade, such that currently 

scheduled benefits cannot be paid. 

With personal accounts, the simplest way for individuals to protect their retirement 

accumulations is to select low volatility investments in their portfolio. For example, an 

extremely risk averse individual will have the opportunity to invest in a conservative 

portfolio of bonds if he or she wishes. In fact, one of the great advantages of personal 

accounts is that individuals have the freedom to choose a portfolio that is best suited to 

their individual preferences over risk and return. 

There are also other forms of personal account guarantees that policymakers could 

include in a reformed system. One approach promises that participants would receive 

no less than their lifetime contributions to the personal account, also known as a 

“principal guarantee”. This type of format was recently adopted in Germany and Japan, 

where retiring plan members must at least be paid back their contributions at retirement. 

Depending on the exact format of a principal guarantee, it might be relatively 

inexpensive to provide. Another guarantee could promise that a retiree would receive 
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his or her contributions plus the rate of inflation at retirement. As long as assets such as 

inflation-indexed bonds were available to back these promises, it is clear that such 

promises could be met relatively inexpensively. 

A different form of guarantee might promise participants they will receive their 

contributions plus some minimum rate of return. For example, the design might promise 

participants that they will receive their contributions plus a return on government bonds 

(e.g. the returns on a 10-year Treasury bond index fund). 

Alternative forms of guarantees might be structured such as a return on a corporate or 

diversified index bond fund. Some would argue that such a guarantee would be 

inexpensive inasmuch as US stock returns have historically been higher than bond 

returns. That is, over the past century, long-term investors in the United States have 

consistently earned a higher rate of return on a stock market index than they would 

have earned on a bond market index. Nevertheless, stocks are more volatile than 

bonds, so a guarantee would still have some cost. 

Providing a guarantee of this sort is clearly valuable to plan participants, since investors 

receive a floor of protection against the chance of a market loss. These benefits derive 

from risk-sharing across cohorts and eliminating negative outcomes for particular 

cohorts. However, it follows that more valuable guarantees must also represent a larger 

liability to the sponsoring entity, be it a private sector group (such as a plan sponsor, 

insurer, or financial services firm), or a government entity. Over the last decade, the 

Congressional Budget Office (CBO) and the General Accounting Office (GAO) have 

both taken the position that government guarantees should be evaluated and their 

budgetary impact made clear. If a pension guarantee were to be included in a Personal 

Account plan proposal, it is necessary to estimate and recognize the financial cost of 

such a proposal. 

The Commission agrees that both the benefits and costs of any explicit guarantee must 

be clearly identified in all proposals, whether or not these costs would be explicitly 

charged to participants in the Social Security program. Modern finance theory provides 

a number of option pricing modes that can be used to compute the “price” of a financial 

guarantee. This cost will depend on the amount that a worker contributes over his 

lifetime, the portfolio in which the assets are invested, and the nature of the guarantee 

benchmark. For example, the value and the price of a guarantee will be higher for 

portfolios that are more heavily weighted towards equities. 

There are also several ways that Personal Account guarantees could be paid for. One 

option would be for private companies to offer participants the option to elect a selffinanced guaranteed investment account. The financial services provider might offer a 

“guaranteed return account” as one investment choice people could elect in their 

accumulation portfolios if they were willing to pay a “guarantee premium.” In this case, 

people who desired a guaranteed investment product would pay a premium reflective of 

the value of the guarantee. There is also the concept of “financial collars,” where 

individuals give up some portion of their upside returns to the provider in exchange for 
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protection from downside returns below an agreed-upon level. Personal accounts are 

likely to spawn new financial products to fit the needs of each individual. 

Alternatively, the cost of guarantees might be passed on to future taxpayers. In 

essence, this approach finances the guarantee through borrowing or future taxes “as 

needed,” i.e., whenever the revenue is required to fulfill the guarantee. This approach 

imposes an unfunded obligation on future generations, which reverses some of the 

salutary aspects of advance funding through personal accounts. 

If guarantee costs were passed on to future taxpayers, instead of having participants 

self-finance them, it would mean that future taxes would be needed when guarantees 

were “in the money.” One concern is that the guarantor may be asked to pay out 

precisely when economic conditions times are bleak. Then taxpayers might be unable 

or unwilling to raise taxes on themselves to cover the guarantees, even if promises had 

been made in the past. 
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The Role of Supplemental Security Income In Social Security Reform 

Several of the Social Security reform plans described in this report include minimum 

benefit provisions designed to ensure that lifetime low-earning workers may still count 

on a Social Security defined benefit that will keep them out of poverty. The current 

Social Security system does not provide this protection. 

In addition, Commission members remain concerned that some people may reach old 

age without having worked in paid employment over their lifetimes. They might have 

engaged in unpaid work such as child rearing, or they may have experienced illness or 

other life events preventing them from engaging in paid employment for many years. 

Social Security does provide some protection through spousal benefits, survivor 

benefits, and benefits for disabled workers and their families. Nevertheless, because it 

is an earnings-based program, Social Security was not designed to provide universal 

income protection for every conceivable set of life circumstances. It is the judgment of 

the Commission that this role should be handled by a revised and updated 

Supplemental Security Income (SSI) program. 

Enacted in 1972, SSI today is a means-tested income assistance program that provides 

monthly cash payments to needy aged, blind and disabled persons, in accordance with 

uniform, nationwide, eligibility requirements. Congress conceived of SSI as a 

guaranteed minimum income to supplement Social Security. SSI provides a safety net 

for those who reach old age with little or no Social Security entitlement. The maximum 

federal SSI benefit for individuals is $531 in 2001. This is equivalent to about threequarters of the elderly individual poverty threshold.36 States supplement the maximum 

federal benefit to varying degrees. The average payment across all states was $110 in 

1999. SSI recipients are also generally eligible for Medicaid and are also eligible for 

food stamps. Total federal benefit outlays for SSI in fiscal year 2001 were $28 billion. 

A fully thought-out plan for reforming Social Security would do well to take account of 

how the defined benefit and personal retirement account components of Social Security 

interact with SSI. This Commission believes that changes in the SSI program should be 

devised to create a more cohesive retirement income security system, one that 

achieves an optimal balance of rewarding work, promoting individual saving, and 

providing an adequate retirement income safety net. It is the position of this 

Commission that a comprehensive retirement security system should provide improved 

poverty protection for the aged, either through SSI or some combination of Social 

Security and SSI. 

This Commission recommends that Social Security reform plans should also 

encompass reforms in SSI policy, to improve retirement incomes for those persons who 

might not otherwise attain poverty-level income in old age. While the Commission did 

not have sufficient time to review the SSI program in detail, members believe that SSI 

program parameters should be re-examined to ensure that these provisions remain 

 

36 Couples in which both members are eligible for SSI receive a maximum federal benefit equivalent to 

about 90 percent of the elderly couple poverty threshold. 
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consistent both with the original objectives of the SSI program and with the objectives of 

a reformed Social Security system. For example, the income and resource tests used to 

determine SSI eligibility and benefit amounts should be reassessed. The program 

currently allows individual recipients to receive up to $20 of general monthly income 

such as Social Security benefits, and $2,000 in resources without affecting their SSI 

eligibility or benefit amounts.37 The income exclusion has not changed since SSI was 

implemented in 1974. The resource exclusion was increased in 1984 from its original 

level of $1,500 but has not changed since. Additionally, today some 60 percent of aged 

SSI beneficiaries receive some Social Security income. Under a Social Security reform 

plan that involves personal retirement accounts, it would be necessary to examine 

whether these income and resource limits remain appropriate. 

 

37 Couples in which both members are eligible for SSI can exclude $30 in income and $3,000 in 

resources. For individuals and couples, a more generous income disregard applies to earned income, but 

very few aged SSI beneficiaries have earned income. 
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Treatment Of Disability Insurance In Social Security Reform 

The primary objective of this Commission has been to reform the Social Security 

retirement program. Although the Disability Insurance (DI) program faces financial 

problems similar to the Old-Age and Survivors Insurance (OASI) program, the nature of 

the issues facing the DI program are far more complex. As a practical matter, 

determining whether an individual is disabled for DI purposes is often a complicated and 

subjective process. Moreover, some basic features of the DI program are at odds with 

current thinking on disability policy, which emphasizes the importance of supporting 

disabled individuals’ efforts to be self-sufficient when possible. The Commission’s short 

life span has not allowed time for the careful deliberation necessary to develop sound 

reform plans for the disability program. Because of the complexity and sensitivity of the 

issues involved, we recommend that the President address the DI program through a 

separate policy development process. 

In lieu of specific DI policy recommendations, this Commission has applied changes in 

defined benefits to DI recipients as well as OASI recipients in the reform plans 

presented in this report. This action recognizes the close integration between the two 

programs and is consistent with the historical relationship between DI and OASI defined 

benefits. Nevertheless, the Commission recognizes that changes in Social Security’s 

defined benefit structure and the role of personal accounts may have different 

implications for DI and OASI beneficiaries. The Commission urges the Congress to 

consider the full range of options available for addressing these implications. 

The DI and OASI programs are closely linked because they serve a unified purpose: to 

provide protection against the loss of earnings due to retirement, death, or disability. As 

such, the Primary Insurance Amount formula used to calculate benefits is the same for 

both programs. These two programs are also linked in that their finances are affected in 

similar ways by demographic changes. The Baby Boom generation is entering the age 

brackets that experience relatively high rates of disability. As a result, DI program 

outlays are projected to increase as a percent of payroll by 45 percent over the next 15 

years, and DI costs will exceed DI tax revenue starting in 2009. 

Nevertheless, a reformed Social Security system must take into account the fact that a 

planned retirement is a very different life event from an unplanned onset of disability. 

Personal retirement accounts are intended to partially replace the defined benefit 

component in Social Security. DI beneficiaries with abbreviated work histories might 

have relatively low account balances. Some may argue that this justifies isolating the DI 

defined benefit structure from any changes that would affect OASI defined benefits. On 

the other hand, testimony provided to the Commission indicated that many DI 

beneficiaries feel strongly that a parallel program structure should be maintained across 

both DI and OASI. Also, if the gap between OASI and DI benefits payable at a given 

age were to become large, incentives would increase for workers nearing retirement to 

seek to qualify for DI as a way to maximize income. This would put further pressure on 

DI program finances and could also raise equity concerns, if DI beneficiaries were able 

to receive higher total Social Security income than OASI beneficiaries. Further analysis 
STAFF PRESENTATION TO COMMISSION; DO NOT QUOTE WITHOUT 

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is needed to determine the optimal approach to balancing these adequacy and equity 

concerns. 

While both OASI and DI face financial shortfalls due to demographic changes, other 

factors affect the DI program that are more complex and may require a unique set of 

solutions. It has been decades since a comprehensive review of the DI program has 

occurred. There are indications that the standards used to determine disability vary 

across geographic regions and across different levels of the adjudicative process, which 

raises questions about the overall consistency and fairness of the program for 

claimants. In addition, fundamental questions exist as to whether the program 

adequately reflects Congressional intent and current thinking on disability policy. 

Technology, the economy, and social attitudes about disability have changed 

dramatically in the past 50 years. The law has only begun to respond to these changes. 

In 1999, for example, Congress passed the Ticket to Work and Work Incentives 

Improvement Act, a bill that provides improved access to return-to-work services for 

disabled beneficiaries and expands access to federally funded medical care for a period 

of time after they return to work. The philosophy behind this law is that some disabled 

beneficiaries can work and want to work, but they are discouraged from doing so 

because they lack access to rehabilitative services and medical care. While this law 

was a step in the right direction, further analysis is necessary to determine what more 

could be done to help DI applicants and beneficiaries who want to remain in, or return 

to, the workforce.