US Pension Reform: Lessons from Other Countries

Drawing inspiration from the pension reform experiences of other rich nations, Baily and Kirkegaard present a set of interconnected reform proposals. To deal with the fiscal shortfall, they propose: 1.   Targeted benefit adjustments that better integrate Social Security with private, tax-advantaged pension plans: Americans in the top income quintile derive most of the economic subsidy bestowed by government to private, tax- benefited retirement plans, whereas the overwhelming majority relies almost exclusively on Social Security: More than a third of Americans have no retirement savings at all, and of those who do, more than a third have less than $10,000. The federal government spends about $120 billion (and rising) annually in tax expenditures to promote retirement saving, which goes disproportionally to high-income Americans. The authors propose to cut future Social Security benefits through some proportional formula for this group of high-income Americans (likely earning over $100,000 a year) who take advantage of government provided tax breaks for their private retirement saving.

Given the $120 billion in annual tax expenditures toward retirement saving and at least $80 billion in Social Security benefits to recipients in the top income quintile, the authors believe a reduction in annual benefits of about $30 billion to $40 billion is possible by targeting those who take advantage of tax-preferred pensions. Thus their pension integration proposal would save upto 50 percent of the Social Security benefits paid to recipients in the top income quintile.

Pension integration addresses only part of the benefit reduction that would be needed, along with some revenue enhancements, to generate fiscal balance for the program into the future. The second part is to adjust the age of retirement.

2.   Continued adjustments of the normal retirement age after 2027:The age of  retirement has a huge impact on the retirement pension budget. While expected lifespan has increased in all advanced countries, the age of retirement has declined since around 1970, and the combination of these two effects has sharply increased the number of years spent in retirement and put tremendous strain on pension budgets. The authors propose to link the eligi- bility ages for early (currently 62) and full (rising gradually to 67 by 2027) Social Security benefits to changes in life expectancies after 2027 in a way that keeps constant the ratio between expected years spent in retirement and the rest of an individual’s lifetime. This would mean that the earliest age (now 62) of reduced Social Security benefit eligibility would also rise with life  expectancy. To respond to the low saving rate in the United States, Baily and Kirkegaard propose:

3.   Asystem of add-on individual accounts: The idea of replacing the existing Social Security retirement program with individual accounts did not find support in Congress or with voters. Nevertheless, the concept of low- and middle-income workers having additional individual retirement savings, over and above their Social Security benefits, is a good one. Moreover, the government can play a legitimate role in making it easier and cheaper for lower-income families to save. Under the plan, workers would be automatically enrolled in a 401(k)-style indi- vidual account managed by the Social Security Administration but with the funds invested privately. Participants could opt out of the program without penalty. The plan would add not only to the retirement resources of future generations of elderly but also marginally to national saving. US policymakers who push Social Security reform into the future impose an unnecessarily large and intergenera- tionally unfair burden on future generations. Social Security reform is a political challenge but, in the words of Abraham Lincoln, “You cannot escape the responsibility of tomorrow by evading it today.”