From the February 2005 issue of Investment Advisor • Subscribe!

What's Next in the Capital

Expect debate on Social Security, the tax code, and pensions, and that's just for a start in year one of Bush Two Redux

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Expect debate on Social Security, the tax code, and pensions, and that's just for a start in year one of Bush Two Redux

Reforming Social Security is the biggest issue Congress will have to grapple with this year, and every American citizen is anxiously awaiting a decision. For financial planners and investment advisors, revamping Social Security--whatever the outcome may be--will affect all of their clients' financial plans. But a heated debate is all we're likely to see out of Congress this year, as no one in Washington, or across the country, expects lawmakers to settle on a solution. We can likely count on a tax bill and a pension reform bill this year, however.

A decision on Social Security won't come easy because Republicans remain deeply divided on President Bush's plan to revamp the federal program. Most Democrats, as might be expected, oppose outright the President's plan to turn Social Security into a program where taxpayers' benefits rely on personal retirement accounts--Lifetime Savings Accounts (LSAs), Retirement Savings Accounts (RSAs), and Employer Retirements Savings Accounts (ERSAs). Two bills were introduced last year promoting the adoption of LSAs and RSAs, but neither went anywhere. ERSAs were included in Bush's 2004 and 2005 budgets, and industry sources expect the plans to be included in the 2006 budget, which is due out February 7. But one source says Bush may not even include Social Security reform in the 2006 budget, instead deciding to deal with the issue "in an off-budget manner."

I participated in a recent conference call held by three Democrats--Rep. Sander Levin (D-Michigan), ranking member on the House Ways and Means Committee; former Rep. Barbara Kennelly (D-Connecticut), who was a member of the Ways and Means Committee and is now president of the National Committee to Preserve Social Security and Medi-care; and Roger Hickey, co-director of the Campaign for America's Future. They told reporters that the administration's proposed personal retirement accounts are a bad idea. Rep. Levin said Democrats' mission is to "prevent the Bush Administration from wrecking what is the bedrock of income security protection," noting that Social Security provides cash to 48 million people--retirees, the disabled, widows, and children who've lost a parent. The majority of people aren't aware that 30% of Social Security benefits are going to the disabled, widows, and children, he said. Said Hickey: "The biggest crisis facing Social Security today is the President's plan to privatize [it]. We welcome the fact that many Republicans now say they won't vote for privatization."

Democrats argue there is a surplus in the Social Security fund until 2018, and that the projected $2 trillion that would finance the transition to personal accounts, which is basically U.S. debt, "doesn't address the Social Security challenge" 40 to 50 years from now when the funds are projected to dry up. Diverting such a large sum of money from Social Security to fund personal accounts would actually increase "the gap in the Social Security budget 20 years earlier than projected," Levin said.

Bush has said he would not raise Social Security taxes in order to fund private accounts. Josh Bolten, the administration's budget director, reasserted that position in a recent speech, stating that the government would borrow to fund the accounts. Social Security now faces a more than $10 trillion shortfall, and Bolten said that if nothing is done to fix Social Security now, the government will need "to raise Social Security payroll taxes on Americans by about 50%." He added that in 2018, the Social Security system "will begin to pay out more in benefits than it takes in in revenue." (Medicare is now $67 trillion in the hole, by the way). Putting off rescuing Social Security, he said, "increases the size of the problem by $600 billion a year." Bolten also stressed that setting up a personal account would be voluntary, and those citizens who chose not to do so would still receive full Social Security benefits.

In January, the Administration floated the idea of indexing Social Security benefits based to the consumer price index (CPI), instead of on changes in wage rates. This type of system would "cut back dramatically" on a person's Social Security benefits, argued Kennelly. True, benefits would be cut using a CPI calculation, sources say. But at least one source says using this type of calculation may actually "put Social Security on a sustainable basis, because the wage rate is much higher than the CPI--usually 1% higher."

President Bush established his advisory panel on federal tax reform last month, which is co-chaired by Senator Connie Mack (R-Florida) and ex-Senator John Breaux, a Louisiana Democrat. The President has given the committee until July 31 to figure out how to reform the tax code. What's likely to occur, says the source, is that the tax reform committee will recommend including LSAs, RSAs, and ERSAs as part of the tax code remedy. With these plans, "you would move to a consumption tax, where 99% of Americans' public savings aren't taxed," the source says.

Congress will likely make some decisions on taxes this year. For instance, lawmakers will make the previously enacted tax cuts permanent in the areas of contribution limits on IRAs and 401(k)s, which both expire by the end of the decade. The capital gains tax cuts as well as the dividend tax cuts expire in 2010. So, too, do tax-free distributions from 529 college savings plans. The government also has to come up with a substitute interest rate for the 30-year Treasury bond. Finally, the alternative minimum tax (AMT) exemption amount expires at the end of 2005.

Washington Bureau Chief Melanie Waddell can be reached at mwaddell@ia-mag.com.

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