Wednesday, January 19, 2005

Modernizing Social Security's returns

Commentary by David Reinhard


David Reinhard is the Associate Editor of The Oregonian in Portland, Oregon.

Commentary by David Reinhard

We don't know the particulars of President Bush's Social Security plan yet, but critics already have come up with two arguments. One, Social Security isn't really in the bad shape Bush says it is. Two, there's nothing wrong that benefits cuts or tax increases won't cure.

In 2009, of course, the Social Security "surplus" will start to shrink. By 2018, it will vanish and the system will start to run deficits. Between then and 2041, Uncle Sam will have to find $10.4 trillion to meet Social Security obligations, according to Donald Luskin, chief investment officer of Trend Macrolytics LLC. If that's not a crisis, why did President Clinton and Democratic leaders spend the late 1990s talking about "saving" Social Security?

Maybe your idea of "saving" Social Security only means benefits cuts or tax increases—or cutting other government programs to fill this gap—but look where that leaves you. You still have a system with a low rate of return. Indeed, the returns will be lower after benefit cuts and tax increases.

Go to the interim report of the President's Commission to Strengthen Social Security, the so-called Moynihan Report. The late Sen. Daniel Patrick Moynihan and his fellow commissioners include a chart with rates of return for various workers. A single, medium-wage male worker born in 1970 will receive a 1.13- percent rate of return. A same worker born in 1980 will receive a 0.91 percent return. The same worker born in 1990? A 0.86 percent return.

A two-earner medium-low wage couple with 1970 birth dates will realize a 2.24 rate of return. The same couple with 1980 birth dates will receive 2.08 percent return. A couple with 1990 birth dates? A 1.88 return.

And that's not the worst of it. The Moynihan final report notes that for workers born in 2000 who earn the maximum amount taxed (currently $80,400, indexed to wages), "the real annual return is minus 0.72 percent."

Another chart looks at the age workers get back what they've put into Social Security. For a worker born in 1945, that age is 85.2. (Life expectancy for males who live to 65 is 81.9, for females it's 85.) For a worker born in 1965, payback age is 91.9 (Life expectancy is 83 for males, 86.1 for females).

Even if the current system weren't facing a $10.4 trillion reckoning down the road, you might think younger workers would want a better return on their savings, and a system that allows them to own and control a part of their Social Security investment. The commission clearly thought so.

The second of its three proposed plans--the one that's won most attention--would allow workers to voluntarily redirect 4 percentage points of their payroll taxes up to $1,000 to a personal account. In exchange, traditional Social Security benefits are offset by the worker's personal account contributions compounded at an interest rate of 2 percent above inflation. "Expected benefits payable to a medium earner electing a retirement account," the Moynihan report states, "would be 59 percent above benefits currently paid to today's retirees by 2052."

Again, it's voluntary. Workers can remain in the old system if they like. And it won't affect current retirees or those near retirement.

The personal account investment options that commission envisions would be broadly diversified portfolios of corporate stocks and bonds to achieve the best returns with a reasonable amount of risk. Participants would choose from a selection of government-regulated funds similar to those in the Thrift Savings Plan for federal workers. The compound rates of return for the three funds for the closing decade of the last century were 6.7, 7.9 and 17.4 percent.

Are administrative expenses for these funds eating into federal workers' returns? Are Wall Street moneychangers making some kind of killing? "Actual trading is contracted out and administrative expenses are minimal," the Moynihan report states, noting they ranged from 50 cents to 70 cents for every $1,000 invested.

Now, personal savings accounts won't, in Bill Clinton's one-time words, "save Social Security." No one fix will. And they do pose the issue of transition costs, since money diverted into these accounts can't go to pay current benefits. (More on that another day.) But they certainly should be part of any solution. Or 17.4 percent--or 6.7 or 7.9 percent--isn't greater than minus 0.72 percent.

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