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  • Social Security Reform and National Saving in an Era of Budget Surpluses
  • Douglas W. Elmendorf and Jeffrey B. Liebman

The unexpected emergence of federal budget surpluses during the late 1990s, combined with official projections that these surpluses will continue for decades to come, has significantly altered fiscal policymaking. Congressional and administration budget proposals now aim to balance the budget exclusive of Social Security, or exclusive of Social Security and Medicare, rather than on an overall, or unified, basis. Some proposals state the goal of paying off the entire stock of federal debt held by the public within a decade and a half. This fiscal bounty has also altered the likely avenues for Social Security and Medicare reform. Traditional options for ensuring the programs’ financial stability—benefit cuts and tax increases—have largely given way to new options focused on using the expected surpluses to prefund future obligations.

The future obligations of Social Security and Medicare under current law are large. The projected aging of the population and rising health care spending imply that federal outlays on these programs will nearly double as a share of GDP over the next seventy-five years, from 6.3 percent in [End Page 1] 2000 to 12.2 percent in 2075.1 Increased federal spending on Medicaid, which pays for long-term care for low-income seniors, will accentuate this jump. From the perspective of the programs, prefunding these obligations requires a buildup of assets that can be redeemed to pay future benefits. From the perspective of the nation, however, such programmatic prefunding does not necessarily imply that the obligations have been prefunded in an economically meaningful sense. For example, Congress could simply legislate that $3 trillion of additional government bonds be placed in the Social Security trust fund immediately. This action would nearly eliminate Social Security’s seventy-five-year actuarial imbalance but would, by itself, have no direct economic effects.

Economic prefunding of Social Security and Medicare requires incremental national saving, which is the only way to increase future resources. In this paper we estimate the effect on national saving of a range of Social Security reform plans designed to capture and contrast the main features of existing proposals. The plans we examine specify the income and outlays of—and thus saving within—the Social Security trust fund and any new individual retirement saving accounts that the plans would create. Yet national saving also includes the saving of the non–Social Security part of the federal budget and the non–individual accounts part of the private sector. Hence the overall impact of Social Security reform depends crucially on the response of these other sectors. Our analysis focuses on these responses. We mostly leave aside other critical issues for Social Security reform such as the distribution of benefits, the allocation of risk, and administrative costs, important though these are.

We begin by reviewing the dramatic recent improvement in the federal budget and then discuss the appropriate roles of national saving and programmatic prefunding in response to population aging. Next we explore the relationship of Social Security to the rest of the federal budget, with an emphasis on alternative characterizations of the political economy of budget policy. Then we present our methodology for estimating the effect of Social Security reform on national saving and apply this methodology to a representative set of reform proposals.

Our analysis yields four primary conclusions about the effect of Social Security reform on national saving. First, budget policy matters: some [End Page 2] elements of reform raise saving if the political process tends to balance the budget excluding Social Security but have no effect on saving if the political process tends to balance the unified budget. In contrast, other elements raise saving only if the political process tends to balance the unified budget. Second, dissimilar plans can have similar effects on capital accumulation, in part because the plans pay out similar total retirement benefits (although often with a different division between traditional benefits and payouts from individual accounts) and in part because responses elsewhere in the budget offset any differences. Third, if policymakers aim to balance the budget excluding Social Security, then all reforms that generate programmatic prefunding...


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pp. 53-66
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