President Bush Resurrects Concept of Personal Accounts
The idea of personal or private accounts in Social Security, that is allowing workers to control at least part of the funds they pay in taxes, is a cornerstone of President Bush's domestic agenda for his second term. The reform is philosophically part of an "ownership society" that enables Americans to keep more of their money through tax cuts and improve their child's education by making schools accountable.

"I like the idea of encouraging more people to say, I own my own home, I own my own business, I own and manage my health accounts, and now I own a significant part of my retirement account," the president said at a January 2005 appearance touting Social Security reform.

"Promoting ownership in America makes sense to me to make sure people continue to have a vital stake in the future of our country," he added.

The idea of personal accounts is older than Social Security itself. When Congress debated the Social Security Act in 1935, lawmakers considered them, but in order to begin paying benefits right away, decided to create the system on a "pay-as-you-go" approach, meaning that today's contributions pay today's retirees.

In 1994, the World Bank published a report called "Averting the Old Age Crisis," which urged governments to fund pension plans and not rely on money coming in, an idea challenged by the International Labor Office of the United Nations, which argued in favor of traditional systems that provided pensions for the old and the poor.

By then, Chile had already begun moving toward private accounts, as had Britain in the 1980's under the leadership of conservative Prime Minister Margaret Thatcher.

In the fall of 1997, the Clinton administration looked at several plans to avoid a Social Security crunch. Task forces were set up in the Treasury Department to study the feasibility of private accounts. The idea of USA Accounts was floated and then abandoned. Instead, Clinton favored using the projected budget surpluses to shore up the Social Security trust fund.

When President Bush was elected in 2000, he appointed a bipartisan commission to study Social Security and come up with proposals to stabilize the system. The President's Commission to Strengthen Social Security, chaired by former Democratic Sen. Daniel Patrick Moynihan of New York and Richard Parsons of AOL-Time Warner was criticized at the time for not including anyone who opposed private accounts.

The panel released an initial report in August 2001, which was quickly forgotten in the subsequent focus on reacting to the terrorist attacks of Sept. 11. A final report was released in December of 2001.

Recently, the president has returned to the commission report to explain his proposals.

The commission report proposed three models for reform, all involving personal investment accounts and all allowing the accrued savings to be bequeathed to heirs.

In Model One, workers could voluntarily invest 2 percent of their taxable wages into a personal account. Under a "flexible framework," that amount could be carved out of current payroll deductions, or it could be an additional deduction.

In Model Two, workers could voluntarily redirect 4 percent of their payroll taxes -- up to $1,000 annually -- to a personal account.

In Model Three, workers would have the option of contributing 1 percent of taxable wages into a personal account, up to $1,000 annually, as an "add-on" beyond current payroll deductions. It would be matched by 2.5 percent of taxable wages from current payroll taxes.

Model Two is widely considered to be the plan preferred by the Bush administration. The White House's Council of Economic Advisers referenced the second model in a section on Social Security reform in its 2004 Economic Report of the President.

The commission says that Model Two "enables future retirees to receive Social Security benefits that are at least as great as today's retirees, even after adjusting for inflation, and increases Social Security benefits paid to low-income workers."

The report projects that a participating medium-wage worker who retires in 2032 would do so with 22 percent higher benefits than a current retiree, in 2001 dollars; by 2052, the increase is projected at 59 percent.

This is based on the premise that the stock market will perform well -- according to the Social Security Administration's projections, equities are expected to earn a real annual rate of return of about 6.5 percent; Treasury bonds are expected to yield about 3 percent.

But critics point to 401(k) disasters at places like Enron, as well as less spectacular (but pervasive) examples of workers who do poorly in 401(k) investing, to question the wisdom of allowing workers to invest in the stock market.

The president's commission, in its report, relies on the historic long-term growth of the stock market. But as investors know from their mutual fund statements, "past performance does not guarantee future results." The commission hedged when it came to recommending any guaranteed minimum set of benefits, pointing to the potential cost.

One possibility is something adopted in Germany and Japan called a "principal guarantee," in which a worker is guaranteed at least the amount of money he or she contributed to the system.

The president's commission envisioned a two-tier system for personal accounts. In the first tier, participants would choose a default balanced fund or any combination of five index funds and an inflation-protected bond fund. When the fund reaches a threshold amount ($5,000 or $7,500 have been suggested), the commission proposed, participants could move to a private-sector provider.

The range of available investments would still be tightly regulated, however.

"There will be guidelines. There will be certain -- you won't be allowed just to take that money and dump it somewhere. In other words, there will be a safe way to invest, to be able to realize the compounding rate of interest," President Bush said.

"You wouldn't be able to buy a single company stock," said Olivia Mitchell, a professor of insurance and risk management at Wharton who served on the commission. "It was not a vehicle intended for day-trading or anything like that."

As an example of how the system could work, the president points to Thrift Savings Plan, which currently serves 3.3 million civilians who are employed by the U.S. government and members of the uniformed services. The Federal Retirement Thrift Investment Board, which runs the TSP, contracts out the investing to mutual fund managers who compete for the contract. Much of the money has gone into a special money-market account operated by the U.S. Treasury and an S&P 500 Index fund, which invests in the companies of the S&P 500.

Of course, the TSP functions under a single employer with automated payroll systems; how the model would work with hundreds of thousands of businesses is an open question. If the funds are taken out of pay checks, they would have to be sorted from the aggregate taxes that employers pay to the government, which could lead to a gap in the time it takes from money to get from pay checks into accounts.

Opt-in is likely to be a paper process, much like the current W-4 form you fill out when you start a new job. All three models forwarded by the president's commission are voluntary -- workers who don't sign up stay within the current system.

Currently, employees and employers each pay 6.2 percent of a worker's pay, a total of 12.4 percent of gross income. Withholding stops at $90,000 in 2005, capping an individual's deduction at $5,580. Under the commission's Model Two, 4 percent of gross income could go into a private account. The remaining 8.4 percent would go into the existing Social Security system to pay the benefits of current retirees.

No matter what plan he chooses, any privatization would also come with so-called transition costs, the initial increase in the gap between worker contributions and retiree benefits that would result as workers send part of the 12.4 precent payroll taxes into private accounts.

Estimates of the gap vary -- it's the "$2 trillion hole" that Democratic presidential candidate Sen. John Kerry of Massachusetts referred to in his speeches -- but there's no question that money would have to be moved into the system to make up for the money moved into private accounts.

Assuming no tax increase or spending cut would be enacted to offset the shortfall, the government would have to borrow more -- issuing extra bonds over the next generation or so.

Supporters argue that the transition cost would generate an equal and opposing transition benefit. The workers who divert part of their payroll tax into personal accounts would accept an offsetting cut in future Social Security payments from the government, thus reducing the nation's debt to future recipients.

However in a Jan. 10, 2005 New York Times editorial, the writers argue that the president has not endorsed the benefit cuts necessary to make it work. Quoting a memo leaked to the press by Peter Wehner, the president's director of strategic initiatives and a top aide to Karl Rove, the president's political strategist, the Times contends that under a privatized system, only drastic benefit cuts -- not borrowing -- will relieve Social Security's financial problem.

"If we borrow $1-2 trillion to cover transition costs for personal savings accounts" without making benefit cuts, Wehner wrote, "we will have borrowed trillions and will still confront more than $10 trillion in unfunded liabilities. This could easily cause an economic chain reaction: the markets go south, interest rates go up, and the economy stalls out."

Although the president was able to get most of his proposals through Congress in his first term, the volatility of Social Security reform means the final plan will most likely be modified as representatives hear from their constituents, young and old, business and labor.

-- Compiled by Leah Clapman for the Online NewsHour