Promises to keep.

A fair agreement makes all parties to it grumble equally, people say--so get ready to grumble.

Proposals on how best to modify Social Security to ensure its long-term viability but not betray soon-to-retire baby boomers or overburden the young, proportionately smaller workforce are now front and center, thanks to President George W. Bush's push for a reform plan. The good news is the funding shortfall finally is being discussed seriously. The bad news lies in the considerable uncertainty about the best way to solve it. Some ideas to strengthen Social Security have been working their way through Congress, and there are several alternatives to consider in the public debate.

To convey information about the reform ideas in progress, the New York State Society of CPAs (NYSSCPA) held a March 2005 press briefing. Its panel consisted of Louis Grumet, NYSSCPA executive director; Laurence Keiser, CPA, JD, a tax and estate planning specialist; and David Lifson, CPA, a past chairman of the AICPA tax executive committee. The centerpiece of the session was Understanding Social Security Reform: The Issues and Alternatives, a newly updated AICPA report prepared by the Tax Division and the Social Security Reform Task Force (see www.aicpa.org/mem bers/socsec.htm). Grumet, who praised the AICPA for doing an outstanding job of synthesizing important information, says, "The dialogue about Social Security reform is a great opportunity for CPAs to increase the public's confidence in the profession." This article gives practitioners of all types a thumbnail comparison of the plans and issues covered in Understanding Social Security Reform.

SOCIAL SECURITY SNAPSHOT

Social insurance. Reducing poverty among the elderly has been Social Security's major accomplishment and remains critical to future plans. Without Social Security almost half (48%) of elderly Americans would live in poverty. Although the demographics of those who contribute to the program and receive its benefits have changed since the system was created, all Americans expect, and many rely upon, the benefits promised in return for their contributions into the system.

Projected deficit. A problem with deciding how to strengthen Social Security is that its looming shortfall can only be estimated. Projections over 75-year periods start and end at different points and use varying assumptions, making comparison difficult. Under the Social Security Administration's "best guess" scenario the trust fund surplus will peak in 2028, decline thereafter, and finally be exhausted in 2042. If nothing changes, beneficiaries could receive full benefits through 2042, after which benefits would have to be reduced by 27%. In 2078 benefits would have to be reduced by 32%. An immediate infusion of $3.54 trillion, increasing the payroll tax rate from its current level of 12.4% to 14.3% or reducing current scheduled benefits by 12.6% could prevent the projected deficit.

While those assumptions are "reasonable," many others are as well. Under some projections the trust fund will peak in 2021 and be entirely depleted by 2031. Under other assumptions the trust fund would not be depleted in the immediate future and there is no long-term financing problem.

Potential fixes. Whatever the actual extent of the shortfall, three general ways to improve the financial condition of the Social Security Trust Fund are to

* Reduce benefits. Across-the-board cuts, means-testing, raising the retirement age and/or changing the inflation adjustments to benefits are methods to lower them.

* Increase revenues or turn to other revenue sources. Raising the payroll tax rate, raising the cap on taxable income, extending the payroll tax to all government workers, raising income taxes on Social Security benefits and/ or diverting general tax revenues to the trust fund would increase revenues. Several plans suggest using Treasury general funds to shore up the Social Security Trust Fund.

* Improve the rate of return on trust fund assets. Social Security's trust fund rate of return--even fully funded--can improve significantly only if the restriction to invest exclusively in U.S. government securities is lifted. But investing in private securities adds risk and administrative costs, and large-scale government investment in private equities could distort markets.

PERSONAL SAVINGS ACCOUNTS?

Creating personal savings accounts or private accounts within the Social Security system would change it from a pay-as-you-go social insurance program to a hybrid with a defined-contribution pension plan component. Proposals suggest putting part of each under-55 worker's payroll taxes into a voluntary personal account, with investment and payout restrictions. Personal accounts wouldn't eliminate all traditional Social Security retirement benefits, but less money would be redistributed from high- to low-income earners.

In a best-case scenario, workers could earn a higher return than under the traditional benefits plan. In a worst-case scenario, workers could lose some amount of their retirement nest egg. Under most proposals reviewed for the report, traditional benefits would go down regardless of whether an individual participated in the voluntary account program. All personal account proposals in the report require an infusion of money such as transfers from the Treasury general fund to the Social Security Trust Fund.

Benefit offsets. Workers choosing to contribute to personal accounts would receive benefits from their private accounts plus traditional benefits, offset in proportion to the amount redirected to personal accounts. Large benefit offsets would make personal accounts less costly for the trust fund but riskier for the worker.

Transition costs. Over the 75-year horizon used to estimate Social Security reforms, the creation of personal accounts will worsen the financial condition of the trust fund. During the long transition to a personal account system, contributions diverted to personal accounts would shrink trust fund levels, leaving less money to pay benefits to retirees. To remain solvent the program would need funds from outside or significant savings from inside.

Personal account issues. Important issues to consider under any personal account proposal are

* To what degree, and over what period, will benefits under the existing system remain in place?

* Will there be a safety net for low-income beneficiaries?

* How much choice will individuals have about

** Participating?

** Investments?

** Distributions?

* Will benefit payments be subject to tax? If so, at what rate?

* What will the plan "cost" beneficiaries in lost traditional benefits as a trade-off for a personal account?

PLANS NOW IN CONGRESS

Presently there are many proposals for reform in Congress. The AICPA study compares the basic types of plans by looking at seven proposals: Ferrara-Ryan, Reform Commission Plan 2, Diamond-Orszag, DeMint, Graham, Kolbe-Boyd and Smith. All but one involve personal accounts. The exhibit on page 42 compares them. For more detail readers are urged to consult Understanding Social Security Reform: The Issues and Alternatives.

* Ferrara-Ryan: Peter Ferrara, an Institute for Policy Innovation senior fellow, wrote a paper entitled A Progressive Proposal for Social Security Personal Accounts. Rep. Paul Ryan (R-Wis.) introduced the Social Security Personal Savings and Prosperity Act of 2004 (HR 4851), an almost identical plan to Ferrara's. Under it, all workers at least 55 in the year following enactment would receive benefits under the current system. Workers under 55 could elect to have some payroll taxes redirected to personal accounts. Funds deposited in those accounts would be automatically invested in a three-tier investment process. If market performance fell short, the federal government would make up the difference. Diverting funds to the new accounts would have a significant impact on the Social Security Trust Fund, which would become insolvent in 2015 instead of 2042.

* Reform Commission Plan 2 (Model 2): In 2001 President Bush charged a commission to come up with a plan to restore Social Security to a sound footing while making personal savings accounts available to younger workers who want them. In its report, the commission presented three alternative models. Model 2, which attracted the most interest, includes voluntary personal accounts, but on a smaller scale than Ferrara-Ryan. It includes major changes (mostly reductions) in traditional benefits even for those not opting for personal accounts. It proposes smaller personal accounts and reduces conventional benefits--and therefore needs less outside funding than Ferrara-Ryan.

* Diamond-Orszag: Peter Diamond, an economics professor at the Massachusetts Institute of Technology, and Peter Orszag, an economist and Brookings Institution senior fellow (and former special assistant to President Clinton), described their plan in Saving Social Security: a Balanced Approach (Brookings: 2004). It does not include personal accounts and does not require outside funds to remain solvent. Instead of financing a transition to personal accounts, the plan would finance approximately two-thirds of the current Social Security unfunded liability through payroll tax increases and the remaining one-third through benefit reductions targeted at higher-income workers. Over the 75-year horizon the payroll tax rate would gradually increase from the current 12.4% to 15.4%. Payments to beneficiaries would gradually increase by 16.5%, less than under current law.

* DeMint: Rep. Jim DeMint (R-S.C.) introduced the Social Security Savings Act of 2003 (HR 3177). Similar to Ferrara-Ryan, it uses large personal accounts and requires large transfers from the Treasury general fund. It does not cut traditional Social Security benefits other than redirecting payments to personal accounts. Under DeMint, no one over age 55 when the plan is implemented would be affected. All other workers would automatically be enrolled but permitted to withdraw. On average 5.1% of earnings would be redirected to personal accounts.

* Graham: Sen. Lindsey Graham (R-S.C.) introduced the Social Security Solvency and Modernization Act of 2003 (S. 1878), which would reduce scheduled benefits, largely by changing from wage indexing to price indexing. Under this plan, current retirees, workers 55 and older and persons with disabilities would remain in today's system with no changes. Workers 54 and younger would have the option of putting 4% of wages into personal accounts, up to $1,300 annually. The government would guarantee currently scheduled benefits to workers not electing personal accounts in return for their paying an additional 2% tax on their wages into Social Security. The additional tax would increase over time.

* Kolbe-Boyd: Peps. Jim Kolbe (R-Ariz.) and Allen Boyd (D-Fla.) introduced the Bipartisan Retirement Security Act of 2004 (HR 3821). This plan reduces Social Security benefits by changing the method of adjusting for inflation, gradually increasing the normal retirement age and increasing the income cap on Social Security payroll taxes. In 2006, workers under age 55 could redirect 3% of their first $10,000 of earnings and 2% of their remaining earnings below the wage cap (currently $90,000, but it is indexed for inflation) to individual accounts. Contributions would be invested, under each worker's direction, in federally administered individual security accounts, similar to the Federal Employees' Thrift Savings Plan.

* Smith: Rep. Nick Smith (R-Mich.) introduced the Social Security Solvency Act of 2003 (HR 3055), which would permit workers to elect to redirect 2.5% of their pay to personal accounts in each year until 2025, and 2.75% from 2026 to 2038. The contribution rate would increase from 2.75% in 2038 to 8% in 2068. Workers could choose options with stock-to-bond ratios of 40/60 or 80/20, or the money would otherwise go into a default portfolio of 60% common stock and 40% corporate bonds. Once an account balance reached $2,500, the worker could invest in a range of mutual funds that replicated several broad-based indices of securities and did not involve high investor risks. Certain low-income earners could receive a subsidy credit of up to $300 to their personal accounts.

IT'S TIME TO GET INVOLVED

President Bush has presented a rigorous case for Social Security reform, and Republicans have introduced reform plans featuring personal accounts. Grumet admonishes more Democrats to join the public discourse about this issue. "Being in a fetal position isn't what leadership is all about," he notes.

A May 3, 2005, New York Times editorial proposed adjustments to Social Security based on Americans' longer life expectancy and income levels. Raising the payroll tax by three-tenths of a percent in 10 years and in increments over 20 years thereafter and raising the cap on wages subject to Social Security tax to about $150,000 from the current $90,000 are less expensive ways to obtain the necessary funding. "Social Security can be strengthened without cuts as blunt and inflexible as the ones Mr. Bush proposes," it said. Americans are trying to tell President Bush "there are better ways to go. He obviously can't hear them, but we hope Congress can." Concerned citizens should write to Congress and make it clear they want a solution that works, "not window dressing" Grumet says.

The preface to Understanding Social Security Reform urges policymakers and the public to gain a clear understanding of the issues involved before modifying a program as important as Social Security. It cautions: "Although care and deliberation are called for ... we must move toward a solution in the near future. The longer we delay, the more difficult and painful reaching a solution will become." Practitioners are in a great position to help the public understand the plans before us and perhaps help shape even better ones.

AICPA RESOURCE

Understanding Social Security Reform: The Issues and Alternatives, a newly updated AICPA report prepared by the Tax Division and the Social Security Reform Task Force, www.aicpa.org/members/ socsec.htm.

Progress

In 2000 the poverty rate for elderly Americans was 10%, down from 35.2% in 1959.

Source: Understanding social Security Reform: The Issues and Alternatives, AICPA, www.aicpa. org/members/socsec.htm, 2005.

MICHAEL HAYES is a senior editor on the JofA. Ms. Hayes is an employee of the AICPA and her views, as expressed in this article, do not necessarily reflect the views of the Institute. Official positions are determined through certain specific committee procedures, due process and deliberation.