Saving the Surplus
Wednesday, January 31, 2001
by Dr. Liqun Liu, Dr. Andrew J. Rettenmaier, and Thomas R. Saving
Table of Contents
"Beginning in 2022 the government must either raise taxes or issue debt to balance the budget."
8Under the pay-down-the-debt option the government is debt free by 2013 and runs a surplus until 2022. Beginning in 2022 it must either raise taxes or issue debt to balance the budget. By 2029 the debt levels are the same under the two alternatives. Beyond 2029 we assume that taxes rise to balance the budget. By 2029 we will have the same debt that we have today. At this point, we have to make some assumptions about how the government will meet its obligations. We consider two options:
- Under Scenario One, the government maintains the same debt as it has under the PRA plan and increases taxes to meet its spending obligations.
- Under Scenario Two, the government raises taxes to match the PRA tax burden and borrows to fund any additional obligations.
"By 2029, the debt levels are the same under two alternatives."
Scenario I: Both Alternatives Hold the Same Long-Term Debt. As noted above, under the personal retirement account option Social Security surpluses are invested rather than used to pay down debt. As a result, we assume the nominal debt stays at its 2000 level. This debt as a percent of GDP is depicted by the solid line in Figure IV. The dashed line identifies the debt in the case in which the Social Security surpluses are used to retire debt. As illustrated in the figure, we allow the debt to rise to the same level as in the case in which the surpluses are used to fund PRAs.
The tax schedules for the two scenarios are presented in Figure V. With PRAs, beginning in 2013 taxes must rise to balance the budget. Taxes will be higher under the PRA option until 2028, but beginning in 2029 and thereafter the pay-down-the-debt tax rates are higher. The abrupt increase in the pay-down-the-debt tax level in 2029 is the result of allowing the government to borrow between 2022 and 2029 to fund its fiscal deficit, but then requiring a balanced budget thereafter. The tax rates under the debt retirement option are higher because of treating Social Security separately. We can do this as long as the system is made solvent by taking the surpluses and investing them in private securities. Based on the CBO's forecasts of expenditures and our estimates of revenues including the constant interest payment, a real rate of return of 5.37 percent is required to make the system solvent.9 Given that this rate of return is close to the long-term market return, it is feasible to treat Social Security separately without need for tax collections above projected levels.
"If the surpluses are used to retire debts, the tax rate on payroll will rise to 18.8 percent."
As Figure VI shows, with the PRA option - assuming a real market rate of return average of 5.4 percent - tax revenues as a percent of payroll will be roughly equal to the income rates reported by the Social Security trustees. In 2050 that rate is 13.3 percent. However, if the surpluses are used to retire debt, no savings are available to offset some of the expenses of the system, and the tax rate on payroll will rise to 18.8 percent. Furthermore, if payroll taxes are used to pay the interest on the debt, the tax rate will have to be 19.6 percent.
"With the pay-down-the-debt option, by 2050 the country will have four times as much debt as with the personal retirement account option."
Scenario II: Both Alternatives Have the Same Long-Term Tax Rate Figure VII illustrates the second comparison of alternatives. This comparison treats the establishment of PRAs in the same way as in Scenario I. However, for the pay-down-the-debt option we assume that taxes are allowed to rise to the same levels as under the PRA option. Deficit financing is then used when the required revenues under the pay-down-the-debt option exceed those under the PRA option. As depicted in the figure, the debt under the PRA option follows the same schedule as before. The debt under the pay-down-the-debt option is identical to the debt shown in Figure IV until 2020, but in this case, rather than letting the debt rise to cover the shortfall, we let taxes rise until they are the same as taxes in the PRA option. Beginning in 2029 debt rises to cover the differential. From 2000 to 2040 the debt level is lower under the pay-down-the-debt option, but it is higher in subsequent years. By 2050 debt is 20 percent of GDP, compared to only 5 percent with the PRA option.
Figure VIII depicts the tax rates under the two options. From 2000 to 2029 taxes under the pay-down-the-debt option are less than or equal to taxes in the PRA option. From 2029 on, the tax schedules are the same, with deficit financing funding the shortfall between the two schedules of required taxes.
"The higher market rates of return and the sheer ability to save account for the superiority of the personal retirement account option."
As both comparisons indicate, in the long run prepaying Social Security benefits using the current Social Security surpluses has advantages over paying down the debt. The differences arise because individuals use their PRAs to help fund their Social Security benefits. The higher market rates of return and the sheer ability to save, as opposed to the government's inability to save, account for the superiority of the PRA option.