Prefunding Social Security Benefits to Achieve Intergenerational Fairness: Can It Be Done in the Social Security Trust Fund?

Abstract

Being fair to future generations requires that Social Security be reformed in a manner that prefunds a significant share of future Social Security benefit payments. All serious reform plans have this property. Prefunding is done exclusively in the Social Security trust fund in some plans, and it is done partly in personal retirement accounts (PRAs) in others. The consequences of prefunding Social Security in the trust fund are controversial and not well understood. The key question is whether Social Security surpluses are offset by smaller non-Social Security surpluses; if they are, and if the offset is 100 percent, then Social Security surpluses are not truly saved and prefunding intended to make Social Security fair to future generations is neutralized by a non-Social Security fiscal policy that is less fair to future generations. This paper makes this important point concrete by simulating the response of non-Social Security fiscal policy to two alternative Social Security reforms that differ only with regard to the breakdown of prefunding in the trust fund and prefunding in PRAs. The reforms simulated are the Nonpartisan Reform Plan proposed by Jeffrey Liebman, Maya McGuineas, and Andrew Samwick, and a version of that plan that prefunds exclusively in the trust fund. If Social Security surpluses are not saved, it is found that NRP's PRAs increase the net benefits of government to future generations by about 0.6 percent of GDP; that is, future generations enjoy some combination of lower non-Social Security taxes and higher non-Social Security government spending that amounts to about 0.6 percent of GDP in every year. The paper also reviews budget politics over the past 30 years and concludes that there is a substantial probability that trust fund accumulations are largely offset by reduced non-Social Security surpluses.The implications of these findings for Social Security reform are explored. If budget politics precludes the possibility that Social Security surpluses are saved, then large dividends would be paid if an alternative means of effectively prefunding Social Security could be found. If politics also precludes that possibility, then it would be rational to compromise other Social Security reform objectives so as to reduce trust fund accumulations. Specifically, relative to a first-best reform with effective prefunding, smaller benefit levels would be appropriate.