SOCIAL SECURITY

| MEMORANDUM |
|------------|
| Date:      | February 11, 2004 |   | TCA |
| To:        | Representative Jim KolbeRepresentative Charles Stenholm |
| From:      | Stephen C. Goss, Chief Actuary Alice H. Wade, Deputy Chief ActuaryChris Chaplain, Actuary |
| Subject:   | Estimated OASDI Financial Effects of the "Retirement Security Act"--INFORMATION |

This memorandum provides long-range estimates of the financial effects on the Social Security (OASDI) program assuming enactment of the "Bipartisan Retirement Security Act", which you have indicated will be introduced in the near future. Specifications and intent for of the provisions in the bill were provided by Ed Lorenzen and Trent Wright from your staffs.  A description of these specifications, reflecting our understanding of the intent of this bill, is given below.  All estimates are based on the intermediate assumptions of the 2003 Trustees Report, as well as additional assumptions described below.  The comprehensive proposal described in this memorandum would:

Modify the computation of OASDI benefit levels in several ways,

Transfer specified amounts from the General Fund of the Treasury to the OASDI Trust Funds,

Credit all revenue from taxation of OASDI benefits (including disbursements from individual accounts (IAs)) to the OASDI Trust Funds,

Change the indexing of the benefit and contribution base, and

Establish individual accounts for workers who are under age 55 at the beginning of in 2006 by redirecting a portion of their payroll tax. 

Enactment of the comprehensive proposal described in this memorandum would improve the long-range OASDI actuarial balance by an estimated 2.05 percent of taxable payroll, changing the present-law actuarial deficit of 1.92 percent to a positive actuarial balance of +0.14 percent of taxable payroll.  The trust fund ratio for the combined OASDI program would increase to a peak of 425 percent in 2016, then decline to 192 percent in 2053.  After 2053, the trust fund ratio would begin to rise, reaching 257 percent at the end of the long-range period, at which time the ratio would be rising by about 4 percentage points per year.  OASDI Trust Fund levels under this proposal are thus projected to be (1) positive throughout the long-range (75-year) period and (2) stable or rising as a percentage of the annual cost of the program at the end of the period.  Thus, the proposal meets the criteria for "sustainable solvency" for the foreseeable future.

It should be noted that the actual yield attained on individual accounts would have an effect on the financial status of the OASDI Trust Funds, because disbursements from the accounts would be taxed, with the proceeds transferred to the trust funds.  The sensitivity of the financial status to variation in individual account yields would, however, be relatively small, as indicated later.  

The remainder of this memorandum provides the following:

Description of the provisions of this bill (with modifications to reflect intent) as they would affect the Social Security program; 

Assumptions used for estimates provided in this memorandum;

Description of the expected financial effects of enactment of the bill, reflecting stated intent; and

Tables providing detailed estimates of the financial effects of the bill.

1. Description of the provisions of this bill (modified to reflect stated intent) as they would affect the Social Security program

**Provision 1a:  Redirect 3 percent of the first $10,000 of taxable earnings and 2 percent of the remaining taxable earnings to individual accounts**

Beginning in 2006, for each worker who is under age 55 at the beginning of 2006, redirect 3 percent of his/her first $10,000 of taxable earnings and 2 percent of taxable earnings in excess of $10,000 to individual accounts. This amount redirected to fund individual accounts is taken from the employee's share of the FICA payroll tax.  A similar redirection would occur for taxable self-employment earnings, with 3 percentage points of the first $10,000 of taxable self-employment income and 2 percent of taxable self-employment income in excess of $10,000 redirected to individual accounts. The $10,000 threshold is increased after 2006 by the increase in the Average Wage Index.  The Federal Government would collect all redirected amounts in the same manner that payroll taxes are collected currently.  Accounts would be managed and invested, under the direction of the worker, in a federally administered individual security account, similar to the government employee Thrift Savings Plan.  However, when the balance of an individual's federally administered individual security account is at least equal to the minimum deposit amount ($7,500 for 2006 and increased by COLA adjustments thereafter), the individual would be eligible to designate one of a range of several individual security accounts, still centrally managed.   For both "tiers," the central authority would maintain individual account records and would combine account transactions in aggregate amounts when dealing with the private investment firms. 

This provision taken alone, with the redirection of payroll tax only and without the effect of taxation of benefits considered in provision 1b below, would reduce the long-range OASDI actuarial balance by an estimated 2.16 percent of taxable payroll.

**Provision 1b:  Disbursements from individual accounts are considered OASDI benefits for income tax purposes**

Disbursements to individuals after retirement or to their estates at death from the portion of the individual accounts arising from the redirection of the payroll taxes would be considered Social Security benefits when determining income taxes.  Thus, the revenue from taxing these disbursements would be transferred to the OASI Trust Fund.  

This provision would increase the long-range actuarial balance relative to present law because revenues from taxation of individual account proceeds would be an additional source of income to the Trust Funds, in addition to taxes on OASDI scheduled benefits.  Taken alone, this provision would increase the long-range OASDI actuarial balance by an estimated 0.09 percent of taxable payroll. 

**Provision 2:  Modification of PIA Formula during 2012-2060**

*Provision 2* would reduce the upper two factors of the PIA benefit formula (32 and 15) by 2.5 percent per year (multiply by 0.975) for 2012 through 2030.  Then, for years 2031-2060, the 90, 32, and 15 percent factors would all be reduced by 1.5 percent per year (multiply by .985).   The PIA benefit factors applicable for beneficiaries newly eligible in 2060 and later would be 57.2, 12.6, and 5.9 percent, respectively.   This provision would not apply to disabled worker beneficiaries. 

*Adjustment to benefits for disabled workers or retired workers with disability periods*

The intent of this provision is to limit in two ways the amount of benefit reductions that would apply to workers who have had periods of disability.   First, because the annuity derived from a disabled worker's individual account is first payable at disability conversion age, no reduction due to this provision would apply to benefits received as a disabled worker.  Second, once the disabled worker reaches disability conversion age, the reduction due to this provision would be limited, reflecting only the portion of potential working years (years from age 22 through age 61) that the individual was not entitled to a disabled-worker benefit.

For example, a worker who becomes disabled at age 32 and is thereafter continuously receiving disability benefits would receive no reduction in his/her benefit level due to this provision until disability conversion age (age 67).  At conversion, monthly benefits would be paid from the individual account, and a portion of the reduction due to the formula factor adjustment would begin to apply to the PIA.  Of the 40 potential working years, 10 years (ages 22 though 31) were years that the worker did not receive a disability-worker benefit. Thus, for this worker, one-fourth of the reduction due to the formula factor adjustment would apply to his/her PIA level.

This provision, taken alone, would increase the long-range OASDI actuarial balance by an estimated 2.24 percent of taxable payroll.

**Provision 3:  Reduce the COLA by 0.22 percentage point**

This provision would base the present-law OASDI annual cost-of-living adjustment (COLA) for monthly OASDI benefits on a new CPI-W series that would reflect a superlative formula, of the type currently used for the new "chained" CCPI-U.  This provision is assumed to reduce the annual COLA by an average 0.22 percentage point from the level currently anticipated under the assumptions of the 2003 Trustees Report.  The reduction would start with the COLA scheduled for December 2004 and continue indefinitely thereafter.  

This provision, taken alone, would increase the long-range OASDI actuarial balance by an estimated 0.35 percent of taxable payroll.

**Provision 4:  Transfer revenue from the General Fund to the OASI Trust Fund**

This provision provides a transfer to the OASI Trust Fund from the General Fund of the Treasury. The amounts would be transferred beginning in 2005 and are specified as an increasing percentage of OASDI taxable payroll.  These amounts are as follows: 

| Calendar Year | Percent ofTaxablePayroll |   | Calendar Year | Percent ofTaxablePayroll |   | CalendarYears | Percent ofTaxablePayroll |
|---------------|--------------------------|--------|---------------|--------------------------|--------|---------------|--------------------------|
| 2005          | 0.02                     |   | 2009          | 0.13                     |   | 2013-2018     | 0.33                     |
| 2006          | 0.04                     |   | 2010          | 0.20                     |   | 2019-2042     | 0.39                     |
| 2007          | 0.10                     |   | 2011          | 0.24                     |   | 2043-2062     | 0.47                     |
| 2008          | 0.12                     |   | 2012          | 0.29                     |   | 2063+         | 0.57                     |

Taken alone, this provision would increase the long-range OASDI actuarial balance by an estimated 0.38 percent of taxable payroll.

**Provision 5:  Eliminate the hiatus in the currently scheduled increase in normal retirement age (NRA)**

Under current law, the NRA increases from age 65 by two months a year beginning with individuals attaining age 62 in the year 2000, until it reaches 66 for individuals attaining age 62 in the year 2005.  While current law then leaves the NRA at 66 for several years, this provision would continue to phase the NRA upwards by two months a year until it reaches 67 for individuals reaching age 62 in 2011.  The NRA would remain at age 67 for all individuals reaching age 62 after 2011.  This provision, taken alone, would increase the long-range OASDI actuarial balance by an estimated 0.14 percent of taxable payroll.

**Provision 6:  Modify actuarial reduction and increment factors**

Under this provision, the early retirement reduction factors and delayed retirement credits would be changed in an attempt to reflect the fact that the marginal increase in the full benefit level (i.e., the PIA) for earnings after reaching retirement eligibility age is, generally, relatively small. (Reduction and increment factors provided under current law are intended to provide actuarially equivalent lifetime benefits for a fixed earnings history regardless of the age at which retirement benefits start.)  This relatively small marginal increase results from both the AIME formula, which uses 35 years of earnings, and the weighted PIA benefit formula.  Together, these provide a larger marginal amount of benefit per dollar of additional earnings for low earners and for earnings earned early in a worker's career.  This provision is intended to provide a greater marginal incentive to work past the retirement earliest eligibility age (EEA).  Because the degree of this marginal effect depends upon the extent and level of earnings a worker has had in earlier years, no absolute adjustment can be provided that would be appropriate for all workers.  Rough estimates of adjustments to the reduction and increment factors have thus been developed.

The chart below displays the proposed monthly early retirement reductions that would be applicable for retired worker beneficiaries for the first 36 months for which benefits are received prior to NRA under both current law and the provision.  (Different factors apply to aged spouse beneficiaries and aged widow beneficiaries.)

| Age 62 in:  | 2003   | 2004   | 2005   | 2006   | 2007   | 2008+  |
|-------------|--------|--------|--------|--------|--------|--------|
| Present Law | 20/36% | 20/36% | 20/36% | 20/36% | 20/36% | 20/36% |
| Proposal    | 20/36% | 21/36% | 22/36% | 23/36% | 24/36% | 25/36% |

Similar increases for aged spouse beneficiaries would be applied, increasing the monthly reduction for the first 36 months of entitlement before NRA from 25/36 percent under present law to 30/36 percent under the provision.

The reductions that are proposed for the fourth and fifth year of benefit entitlement before NRA are 12/24% per month (current law reductions are 10/24% per month) for both retired worker and aged spouse beneficiaries.  The reductions for the fourth and fifth year of entitlement before NRA are applicable to all new eligibles who reach age 62 after 2005 and are phased in for those newly eligible in 2002 through 2005.

The ultimate percentages of PIA payable for retired workers by age at initial benefit entitlement are shown in the table below. 

| Age at InitialEntitlement: | NRA-5 | NRA-4 | NRA-3 | NRA-2 | NRA-1 | NRA  |
|----------------------------|-------|-------|-------|-------|-------|------|
| Present Law                | 70%   | 75%   | 80%   | 86.7% | 93.3% | 100% |
| Proposal                   | 63%   | 69%   | 75%   | 83.3% | 91.7% | 100% |

The percentage of PIA payable for non-disabled aged widow beneficiaries newly eligible at age 60 would remain at 71.5 percent.  The percentages payable for those newly eligible at ages between 60 and the NRA would scale linearly between 71.5 and 100 percent, as under present law.  

The delayed retirement credit (DRC) under present law is scheduled to increase to 8% per year for workers attaining age 65 after 2007.  Under this provision, the DRC would continue to increase at the rate of 0.5 percentage point every two years, with the first new increase applied to those attaining age 65 in 2010.  An ultimate factor of 10 percentage points per year would be reached for workers reaching 65 after 2015.  The delayed retirement credit applies for those months between NRA and age 70 in which no retired worker benefit is received. 

Taken alone, this provision (increasing the early retirement factors and delayed retirement credits) would increase the long-range OASDI actuarial balance by an estimated 0.32 percent of taxable payroll.

**Provision 7: Adjust the PIA levels to reflect changes in life expectancy for persons newly eligible after 2011**

Adjust the PIA levels of retired worker beneficiaries newly eligible after 2011 to reflect changes in life expectancy at age 62, based on period life tables produced by the Office of the Chief Actuary in the Social Security Administration.  This provision does not apply to disabled worker beneficiaries.   In addition, only a portion of the amount of reduction due to this provision would apply to the benefits of retired worker beneficiaries who convert from disabled worker beneficiary status. 

*Adjustment to benefits of retired workers with no disability periods*

The intent of this provision is to adjust benefit levels to reflect actual measured changes in longevity.  The adjustment would be applied beginning with workers turning age 62 in 2012, the first year after the year in which the NRA under this proposal reaches its maximum of 67 years.  The adjustment would be a ratio of:

The life expectancy at age 62 from the period life table for the calendar year 2008 to 

The life expectancy at age 62 from the period life table for the calendar year that is three years prior to the year in which the retiree turns age 62.

For example, the benefit of a worker reaching retirement eligibility age, age 62, in 2012 would be reduced based on the increase in period life expectancy at age 62 between 2008 and 2009.  The two years would generally be the two most recent years of complete data.   If the life expectancy at age 62 increased from 20.20 to 20.27 between 2008 and 2009, then the benefit level of the worker would be multiplied by 0.997 (=20.20/20.27), for a reduction of 0.3 percent.  For a worker retiring at age 62 in 2013, the reduction in benefit level would be based on the increase in life expectancy at age 62 between 2008 and 2010.  The chart below provides the expected life-expectancy adjustment factors and the benefit reduction percentages that would apply to selected retired-worker beneficiaries using the intermediate assumptions of the 2003 Trustees Report.

| (1)                              | (2)                        | (3)                                | (4)                          |
|----------------------------------|----------------------------|------------------------------------|------------------------------|
| Year retired worker turns age 62 | Life expectancy at age 621 | Life-expectancy adjustment factor2 | Percent reduction in benefit |
| 2011                             | 20.20                      | NA                                 | NA                           |
| 2012                             | 20.27                      | 0.9970                             |  0.30%                  |
| 2015                             | 20.46                      | 0.9785                             | 2.15                         |
| 2020                             | 20.79                      | 0.9630                             | 3.70                         |
| 2030                             | 21.45                      | 0.9333                             | 6.67                         |
| 2050                             | 22.67                      | 0.8831                             | 11.69                        |
| 2070                             | 23.78                      | 0.8419                             | 15.81                        |
| 1The life expectancies used for this table are based on projections and are for the year 3 years prior to the year the worker turns age 62.  Reductions applied would be based on actual data.2Calculations are based on life expectancy values expressed in more decimal places than are shown in the table. |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

This provision would not apply to disabled worker beneficiaries.   In addition, only a proportion of the amount of reduction due to this provision would apply to the benefits of retired worker beneficiaries who convert from disabled worker beneficiary status.  The application of this provision to the benefits of disabled worker beneficiaries and beneficiaries who convert from disabled worker beneficiary status is the same as described under *provision 2* in the section *adjustment to benefits of disabled workers or retired workers with disability periods*.

Provision 7, taken alone, would increase the long-range OASDI actuarial balance by an estimated 0.59 percent of taxable payroll.

**Provision 8: Change in calculation of AIME**

This provision would apply in determining benefits for retired workers and their dependents and for survivors of deceased workers.  This provision does not apply in determining benefits for disabled workers and their dependents.

In calculating the AIME for a retired worker under present law, the highest 35 years of indexed earnings are used in determining the numerator of the AIME and a benefit computation period of 35 years is used in determining the denominator.  Under this provision, the following changes would be made in the calculation of the AIME for someone newly eligible for retirement benefits after 2004.

The number of years of earnings used in calculating the numerator of the AIME is gradually increased, reaching all years for individuals becoming newly eligible in 2013.

The benefit computation period, used in determining the denominator of the AIME, is gradually increased, reaching 40 years (5 additional years), except for the "lower earner" of a married couple. Specifically, in the case of a two-earner couple, the benefit computation period used in the denominator for the earner with the lower PIA is retained at 35 years.

The chart below indicates the phase-in schedule of the above changes.

| Newly Eligible in Years: | 2005 - 2006             | 2007 - 2008 | 2009 - 2010 | 2011 - 2012 | 2013+ |
|--------------------------|-------------------------|-------------|-------------|-------------|-------|
| **Present Law**          |
|                     | Years in Numerator1     | 35          | 35          | 35          | 35    | 35 |
|                     | Denominator (in years)2 | 35          | 35          | 35          | 35    | 35 |
| **Proposal**             |
|                     | Years in Numerator1     | 37          | 39          | 41          | 43    | all |
|                     | Denominator (in years)2 | 36          | 37          | 38          | 39    | 40 |
| 1Years in Numerator: Refers to the number of years of earnings used in calculating the numerator of the AIME.2Denominator (in years): Refers to the benefit computation period (in years) used in calculating the denominator of the AIME. |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

Under this provision, the number of benefit computation years used for the denominator of the AIME for a retired worker turning age 62 after 2012 would be 40.  Under current law, the number of benefit computation years is determined by subtracting 5 *dropout* years from the number of *elapsed* years (years age 22 through the year prior to reaching EEA).  Under this proposed provision, the increase in the number of benefit computation years would be accomplished by reducing the number of *dropout* years, ultimately to zero.   

This provision, taken alone, would increase the long-range OASDI actuarial balance by an estimated 0.21 percent of taxable payroll.

**Provision 9:  Credit all revenue from taxation of HI benefits to OASDI by 2019**

This provision would redirect revenue collected by the IRS from Federal income taxes payable on OASDI benefits, in excess of the tax on 50 percent of such benefits, from the Medicare HI trust fund to the OASDI Trust Funds.  The provision would redirect 10 percent of this revenue for 2010, 20 percent for 2011, ... , and 100 percent for 2019 and later.   It should be noted that disbursements from individual accounts established under this bill would be included as OASDI benefits for the purpose of income taxation. 

Taken alone, this provision would increase the long-range OASDI actuarial balance by an estimated 0.41 percent of taxable payroll.

**Provision 10:  Establish a minimum PIA level**

For beneficiaries newly eligible in 2013 and later, establish a minimum PIA amount as described below:

**For Retired Workers:**  The minimum PIA would apply to such retired workers who have at least 80 quarters of coverage (QCs) (reduced by 2 for each year of disabled-worker entitlement).  It would equal 0% of the *Monthly Applicable Poverty Level* (see below for definition) for individuals with 40 QCs, 80% of the *Monthly Applicable Poverty Level* for workers with 80 QCs (reduced by 2 for each year of disabled-worker entitlement), and 120% of the *Monthly Applicable Poverty Level* for workers with at least 160 QCs (reduced by 4 for each year of disabled-worker entitlement).  The percentage of the *Monthly Applicable Poverty Level* would be prorated between 0% and 80% for individuals with more than 40 QCs but less than 80 QCs.  A similar proration would occur between 80% and 120% of the *Monthly Applicable Poverty Level*, for workers with more than 80 QCs but less than 160 QCs.  These criteria would also apply in determining PIA levels used for auxiliary benefits for survivors of workers who died after reaching age 62. 

**For Disabled Workers and Survivors of Workers Who Die Before Age 62:**   A minimum PIA for disabled worker beneficiaries and for auxiliary benefits for survivors of workers who die before age 62 would be similar, except that the quarters-of-coverage requirement would be scaled to the number of elapsed years.  Thus, the minimum PIA would equal 0% of the *Monthly Applicable Poverty Level* (see below for definition) for individuals with QCs less than or equal to the number of elapsed years, 80% of the *Monthly Applicable Poverty Level* for workers with QCs equal to twice the number of elapsed years, and 120% of the *Monthly Applicable Poverty Level* for workers with QCs equal to or greater than 4 times the number of elapsed years.  The percentage of the *Monthly Applicable Poverty Level* would be prorated in a fashion similar to that of retired workers, for individuals with QCs between the 0% and 80% thresholds, and between the 80% and 120% thresholds.  Elapsed years are defined as years between attaining age 22 and the earliest of disability benefit entitlement, death, or age 61.

The minimum PIA is phased in during the years 2009 through 2012.  For new eligibles in 2009, the percentage of the *Monthly Applicable Poverty Level* is one-fifth of the fully phased in percentage in 2013.  This fraction increases by an additional one-fifth for each year during the phase in period, reaching four-fifths for 2012.

The *Annual Applicable Poverty Level* for 2002 is $8,628 (*Monthly Applicable Poverty Level* would equal 1/12 of this amount). The *Annual Applicable Poverty Level* that applies to an individual in their year of initial eligibility is determined by increasing the 2002 level by:

the 
COLA
 for 2002 through the earlier of (1) the year prior to the year of initial benefit eligibility and (2) 2012; and 

increases in the 
average wage index
 between 2011 and the second year prior to initial benefit eligibility.

Minimum PIA levels would increase by the COLA after benefit eligibility in all cases. 

This provision, taken alone relative to present law, would reduce the long-range OASDI actuarial balance by an estimated 0.06 percent of taxable payroll.  The incremental effect of this provision, after all other provisions in the package are taken into consideration, is a decrease in the long-range OASDI actuarial balance by an estimated 0.50 percent of taxable payroll.  

**Provision 11: Gradually increase the benefit and contribution base so that 87 percent of all covered earnings is taxable**

Under current law the *contribution and benefit base* ($87,000 in 2003) is automatically increased each year based on increases in the SSA average wage index. The ratio of OASDI effective taxable payroll to covered earnings is estimated to be about 84.8 percent in 2003 and is projected to be about 83.5 percent in 2013. 

This provision would gradually increase the *contribution and benefit base* over the period 2004-2008, so that by the end of this period 87 percent of all covered earnings would be taxable. After 2008, the *contribution and benefit base* would be determined so that this level of 87 percent is maintained.  The actual levels of the base for a given year would be set by looking at actual earnings distribution data for two years prior (the most recent data that would be available), determining the *contribution and benefit base* for that year which yields the desired ratio of covered earnings that would be taxable, and bringing forward this level 2 years by changes in SSA's average wage index.  

Taken alone, this provision would increase the long-range OASDI actuarial balance by an estimated 0.41 percent of taxable payroll. 

**Provision 12:  Redesign the PIA formula**

Establish a new bend point in the PIA formula equal to 183.8% of the present-law first bend point. PIA formula factors would be initially set at 90, 32, 32, and 15 percent (yielding the same benefit as current law). Beginning with new eligibles in 2006, the PIA formula factors would be adjusted until reaching factors of 90, 70, 20, and 15 for newly eligible beneficiaries in 2015 and later. The yearly adjustments to the formula factors over the 10-year period (2006 through 2015) are:

The second formula factor would be increased each year by 3.8 percentage points; and 

The third formula factor would be decreased each year by 1.2 percentage points. 

This provision alone has a negligible effect on the long-range OASDI actuarial balance (i.e., a change of less than 0.005 percent of taxable payroll).  

**Provision 13:  Increased Benefits for Widow(er)s**

Under this provision, starting in 2006, all aged surviving spouses (aged 62 or older) would receive 75 percent of the benefit that would be received by the couple if both were still alive (including all applicable actuarial reductions and delayed retirement credits), if this is higher than their current benefit.  The benefit provided by this option would be limited to what the survivor would receive as a retired worker beneficiary with a PIA equal to the average PIA of all retired worker beneficiaries for December of the year prior to becoming eligible for this option.  Actuarial reduction for this limitation would be computed as if the survivor had begun receiving a retired worker benefit on the earliest of the actual ages upon which benefits began as an aged spouse, an aged surviving spouse, or a retired worker beneficiary, but not before 62.   The provision would only apply to those individuals who would qualify for a widow(er)'s benefit under Social Security; that is, individuals whose deceased spouses are not fully insured would not be eligible for potential increased benefits.  

This provision alone would reduce the long-range OASDI actuarial balance by an estimated 0.08 percent of taxable payroll.

**Provision 14:  Limit Spousal Benefits Based on Maximum Worker Benefits**

Under current law, aged spouses receive a base benefit of 50 percent of the retired worker's PIA, with reductions for age if the spouse becomes entitled to benefits before normal retirement age.  Under this provision, beginning with all months of benefit eligibility after December 2004, aged spouse benefits are limited so that the combined benefit of a married couple does not exceed the PIA of a hypothetical single worker who earns the taxable maximum at ages 22 through 61, and who has the same eligibility year as the retired worker's PIA.  For the purpose of this estimate, we assume that the hypothetical single worker has earnings at the taxable maximum at ages 22 through 61, and retires at age 62.   

Taken alone, this provision would increase the long-range OASDI actuarial balance by an estimated 0.16 percent of taxable payroll.

2. Assumptions used for estimates provided in this memorandum 

As indicated above, estimates provided in this memorandum are based on the intermediate assumptions of the 2003 Trustees Report.  In addition, the long-term ultimate average annual real yield assumed for equities is assumed to be 6.5 percent.  An assumed yield on equities is needed because income taxes on individual account disbursements are directed to the OASI Trust Fund.

A consensus is forming among economists that equity pricing as indicated by price-to-earnings ratios may average somewhat higher in the long-term future than in the long-term past.  This is consistent with broader access to equity markets and the belief that equities may be viewed as somewhat less "risky" in the future than in the past.  Equity pricing will vary in the future as in the past.  Price-to-earnings ratios were very high through 1999, and are now lower.    The ultimate average real equity yield assumed for estimates in this memorandum is consistent with an average ultimate level of equity pricing somewhat above the average level of the past.

The assumption for an ultimate real equity yield of 7 percent that was used until 2001 was developed in 1995 with the 1994-96 Advisory Council.  At the time, the Trustees assumption for the ultimate average real yield on long-term Treasury bonds was 2.3 percent.  Real yields on corporate bonds are believed to bear a close relationship to Treasury bond yields of similar duration.  The 2003 Trustees Report includes the assumption that the ultimate real yield on long-term Treasury bonds will average 3 percent, or 0.7 percentage point higher than in 1995.  This increase in the assumed bond yield is consistent with a reduction in the perceived risk associated with equity investments.  

In order to estimate the income to the OASDI Trust Fund from taxing the disbursements from individual accounts, individual accounts are assumed to be managed by a central administrative authority, and, for the purpose of these estimates, used to purchase indexed life annuities at retirement through this authority.  The following assumptions were made:

During the accumulation period, individual accounts would be, on average, invested 50% in equities and 50% in long-term Treasury bonds. 

The charge for annual administrative expenses would average 30 basis points during the accumulation period.

During the disbursement period (after retirement), the net real yield on annuities is assumed to be 3 percent annually, net of administrative expenses.

Therefore, during the accumulation period, the assumed annual real yield on individual accounts would be 4.45 percent (net of administrative expense), as follows:

(0.5*6.5% + 0.5*3.0% - 0.3%) = 4.45%.

3. Estimates of the Financial Effects of Enacting the Bill 

Estimates by Provision

Table A provides a brief listing of the individual provisions of the proposal, including the effect of each provision, separately, on the long-range OASDI actuarial balance.  

OASDI Trust Fund Operations:  Annual and Summarized

Table 1 shows estimated annual and summarized income rates, cost rates, balances, and trust fund ratios under the proposal.  In addition, the table shows the general revenue transfers under provision 4 of the proposal, expressed as a percentage of taxable payroll.  The last two columns display the payroll tax rate deposited in the OASDI Trust Funds (net OASDI contribution rate) and the amount deposited in individual accounts (IA contribution rate).  As shown in the table, sustainable solvency is indicated for the foreseeable future, because the Trust Fund ratio is steadily rising at the end of the projection period.  

Additional Aggregate Values for Trust Funds and Personal Accounts

Table 1a shows estimated OASDI Trust Fund balances at the end of each year under current law and under the proposal.  In addition, the "IA/Annuity Assets End Of Year" column shows the total individual accounts (personal accounts) at the end of each year. The next two columns show annual aggregate contributions to and disbursements from the individual accounts .  All of the amounts in this table appear on a present value basis as of January 1, 2003.

The estimates of annual dollar flows and accumulations of the personal accounts are based on very specific assumptions that all personal account assets are converted to CPI-indexed life annuities at retirement (see assumption description in the section describing *provision 1b*).  In practice, many individuals would likely annuitize only part of their personal account accumulation so estimated annuity assets are overstated to some degree.  In addition, if death occurs prior to benefit entitlement, the accounts are assumed to be distributed to the estate.  Total personal account and annuity assets (referred to as "IA/Annuity Assets EOY" in the tables) include both the assets of personal accounts held prior to retirement, and the assets held by the annuity provider after retirement.   If the personal accounts are considered as a part of "Social Security", it is reasonable to combine the amounts of trust fund assets and personal accounts for a representation of total system assets. 

Effects on Annual Federal Unified Budget Balances 

Table 1b provides a rough estimate of the effects of the proposal on the annual Federal unified budget balance for each calendar year through 2078.  All amounts in this table appear in constant 2003 dollars (that is, dollar amounts that are indexed back to 2003 based on the consumer price index (CPI)).  The first three columns in these tables include sources of changes to the unified budget balance, as follows:

Annual aggregate OASDI payroll taxes that are redirected to individual accounts (IAs) --these amounts result in a reduction to the unified budget balance because the monies leave the government and are deposited in personal accounts;

Estimated annual amounts of OASDI benefit offset based on hypothetical accumulations of earlier deposits to personal accounts--an increase to the unified budget balance because these proceeds reduce Social Security benefit payments (not applicable for this proposal); and

Other changes in OASDI cash flow (as compared to present law) from the other benefit provisions (but not from transfers between the General Fund and the Trust Fund, which have no unified budget effect).

The last three columns present the aggregate effects on the unified budget:

Change in the annual unified budget cash flow, which is simply the sum of the sources of unified budget balance changes identified above;

Change in debt held by the public, as of the end of each year, which represents the cumulative change in the unified budget cash flows, with interest (at the assumed rates earned by the Trust Funds); and

Change in annual unified budget balance, which includes changes in both unified budget cash flow and in interest on the publicly held debt.

These unified-budget estimates are based on the intermediate assumptions of the 2003 Trustees Report, including the trust-fund interest assumption, and thus are not consistent with projections made by CBO and OMB (which use different assumptions).  However, differences in payroll and benefit estimates are not large during the first 10 projection years so these values can be viewed as very rough approximations of the magnitude of effects on the unified budget balances through this period. 

Annual Cash Flows from the OASDI Trust Funds to the General Fund of the Treasury

Table 1c provides estimates of the net cash flow from the OASDI Trust Funds to the General Fund of the Treasury.  Values in Table 1c are shown as a percent of taxable payroll, in current dollars, in present value dollars as of 1/1/2003, and in constant 2003 dollars (discounted to 2003 with the projected growth in the CPI).  For comparison purposes, net cash flow is also shown for a theoretical Social Security program where transfers from the General Fund of the Treasury to the OASDI Trust Funds are assumed to occur as needed to assure full payment of scheduled benefits in 2042 and later.  

Taxable Payroll and General Fund Transfer Information

Table 1d provides taxable payroll in current (nominal) dollars both under the proposal and under present law.  The table also provides the present value (as of January 1, 2003) of general fund transfers under provision 4, described above, on a year-by-year basis and for the 75-year period from 2003-2077. 

Sensitivity analysis

It must be noted that the uncertainties associated with equity investments, bond yields, and mortality improvement, as well as with a number of additional variables means that actual experience could vary substantially from the estimates provided in this memorandum.   In particular, there is a potential that long-range ultimate equity yields could average less than the 3 percent, although this is not very likely. 

If actual real yields on equities held in individual accounts over the next 75 years were to average only 3 percent, the same level as assumed for long-term Treasury bonds, this comprehensive proposal would still provide for adequate financing for the OASDI program through the provisions described above.  The long-range OASDI actuarial balance would improve by an estimated 2.01 percent of taxable payroll, changing the present-law actuarial deficit of 1.92 percent to an actuarial balance of +0.09 percent of taxable payroll.  

|                 |
|-----------------|
| Stephen C. Goss |
|                 |
| Alice H. Wade   |
|                 |
| Chris Chaplain  |

Attachments: 6 

| Table **A** |         |         |         |         |
|-------------|--------------|--------------|--------------|--------------|
| Table **1** | Table **1a** | Table **1b** | Table **1c** | Table **1d** |

List of memos