The Public Pension Reform Debate in the United States and International Experience

ABSTRACT This article describes the recent debate on Social Security in the United States. To provide some perspectives on the U.S. system, comparisons with public pension systems in other countries are made throughout the article. The article is organized as follows. The first section discusses financing problems in the U.S. Social Security system. Following this, the U.S. Social Security system is described. Options for fixing public pension systems are discussed next. The topic of individual accounts appears in its own section. FINANCING PROBLEMS Public retirement pension programs reflect two concerns. One is to relieve poverty among the elderly (and reduce the use of means-tested programs). The second is to ensure an income replacement ratio in retirement that is not too low for a much wider swath of the work force than just those in danger of poverty. Both goals are important, and there is a natural debate concerning how many resources should be devoted to achieving one goal versus the other. This issue arises in a number of countries, not just the United States. Pensions are long-term commitments, and pension rules should be changed infrequently and with adequate lead-time. Hence the importance of projections of future finances of pension systems, and actuaries and economists play an active role in these projections. To see where the United States stands, refer to Figure 1, which is a stochastic projection of the Social Security Trust Fund published in the Annual Report of the Trustees of Social security. Under the projection the Trust Fund is almost sure to run out of money within the traditional 75-year horizon that Social Security has long worked with.1 This traditional horizon is shorter than the infinite time horizon preferred by some economists. Analysts looking at pension systems need to look at the future, when considering public pension systems or corporate pension systems (that are required by regulations to be adequately funded). Analysts approaching this process naturally recognize great uncertainty about all of the economic and demographic variables that come into play to produce a picture of the future. Analysts are comfortable working with the stochastic projections, which serve usefully as the starting place and the heart of the analysis. On the other hand, the political process cannot really deal with a picture like Figure 1. You cannot go to your average Congressman and say, "here is the future of Social security and, as you can readily see, probabilistically you ought to be passing some legislation about this." The legislative process needs bright lines and clear pictures. The reports of the Trustees of Social Security contain three deterministic projections, which are developed by the Office of the Actuary (OACT). The intermediate one (shown in Figure 2) plays a critical role in the political process.2 An important question, which I have never seen anyone try to address, is, "Assume your view of the world is the stochastic projection as in Figure 1. If your view of the legislative process is that the process is going to be influenced by some deterministic projection, what should be the relationship between the deterministic projection put forward and the underlying stochastic projection?" In practice, the intermediate deterministic projection is roughly the median in the stochastic picture. Deterministic projections play two different roles. One is to indicate whether the system should be changed because it is either projected to run out of money (as in the U.S. case) or because it is projected to run up such a big surplus that benefits might be raised or taxes cut. In the former, the role of the actuary in convincing the public there is a need for politicians to take painful steps is critically important. (The latter is not a problem-politicians do not need much prodding to move in that direction.) The second role is to evaluate reform proposals-to show their properties and particularly to see whether the deterministic projection of a reform proposal restores the traditional condition of actuarial balance. …