Personal Accounts Are No Cure-All (How conservatives should think about Social Security reform)

National Review ^ | 08/31/2010 | Andrew Biggs

[SeekAndFind]

I don’t usually spend much time disagreeing with people I mostly agree with, but a column in National Review by the Cato Institute’s Michael Tanner — my old boss and an all-around great guy — presents a chance to talk about why Social Security reform has proved to be such a difficult task for those who believe in free markets and individual choice.

Here’s where I agree with Mike: “Given their large lead in current polls, it is perhaps understandable that Republicans don’t want to risk offending voters, particularly seniors, by wading back into the Social Security thicket. But they are making a mistake.” He’s right: If you run on nothing, you’ll receive a mandate to do just that. Voters need to hear a realistic discussion of how to fix Social Security and other entitlement programs.

But Mike also argues that conservatives shouldn’t give up on Social Security personal accounts: “By taking personal accounts off the table, Republicans may be boxing themselves into a very bad corner. There are, after all, only three options for Social Security reform: raise taxes, cut benefits, or switch to personal accounts.” These choices mimic those laid out by President Clinton in 1998, although at the time Clinton was arguing for investing in stocks through the Social Security trust fund, not personal accounts.

Here’s the problem: Personal accounts are a valid choice, and one I’ve supported in the past and continue to support. But accounts aren’t exclusive to tax increases or benefit cuts; they don’t, as I’ll explain, reduce the need for these other choices. One problem for the Bush administration’s reform drive in 2005 was that many congressional Republicans had bought into the idea that accounts reduce or eliminate the need for tax increases or benefit cuts. Finding out they don’t may have taken some wind out of their sails. Because of this, combined with some pretty shameless demagoguery from the left, Bush’s reform ideas didn’t even come up for a vote.

President Bush’s 2001 Commission to Strengthen Social Security (on which I was a staffer) wrote that once the program began to run payroll-tax deficits — something that happened this year — policymakers would face difficult choices to raise taxes, cut benefits, reduce other programs, or increase the budget deficit. All these claims are true.

Also true, however, is a statement the supercilious younger me made to one of my fellow staffers: With personal accounts, we face the same choices, only sooner. If workers invest part of their Social Security taxes in personal accounts, they could indeed earn higher returns and generate higher benefits without taking more risk. But diverting taxes to accounts leaves the program short of what is needed to pay benefits to today’s retirees. To cover these “transition costs,” we would need to generate new revenues for the program, either by raising taxes, cutting other programs, or borrowing.

But once transition costs are accounted for, the total rate of return on a personal-accounts-based program would be about the same as the current system. (If you’re willing to wade through some math, this paper by Olivia Mitchell, Stephen Zeldes, and John Geanakoplos is pretty much the canonical treatment.) Social Security’s overall rate of return stinks because (a) we paid early generations far more in benefits than they paid in taxes, meaning that later generations must make up the difference; and (b) we didn’t save the trust fund, meaning taxpayers must “repay” something that was supposed to have been an asset. These acts can’t be undone: We’re stuck with them.

Also unchanged would be the program’s financing shortfall, even assuming that account holders gave up a share of their traditional benefits. A pay-as-you-go program like Social Security is always in the hole, such that each generation honors the benefits of the preceding one while hoping their own claims will be honored by the following generation. No generation can break away from this cycle without either ponying up extra cash (tax increases) or defaulting on its promises (benefit cuts). Neither solution is costless.

Now, we could come out ahead if transition costs were funded by cutting other government spending, which at the margin certainly produces benefits below its costs. But we could reap those gains by cutting government spending in the absence of Social Security reform; in any case, few reform proposals have presented a credible way to ensure that non–Social Security outlays are reduced. The most likely path is simply increased debt.

The only way personal accounts could fix Social Security on their own is if accountholders gave up traditional benefits far in excess of the taxes they put into accounts. For instance, individuals might put half their taxes into an account but give up all their traditional benefits. This would fix Social Security, but it’s not clear that most (or even many) workers would take the deal. You might come out ahead if you got solid investment returns, but you could also fall far short. This is just asking accounts to do more than they reasonably can.

That’s why most personal-account plans have worked in two stages: First, do whatever is needed to fix the current system — cut benefits, raise the retirement age, whatever. Then, offer the option of accounts on relatively favorable terms. This approach is fine, but it’s not the easiest to defend politically. Why? First, you have to admit that the accounts themselves won’t fix the program. Second, you’ll be attacked for the extra costs — usually borrowed — that would be incurred during the transition period. Third, you’ll be criticized for putting Social Security benefits at the whims of the stock market. You can respond to these attacks credibly, but you will be spending a lot of time on the defensive. As much as I support accounts philosophically, I’m not sure the political cost-benefit analysis weighs out in their favor, given all the other difficult choices we face on entitlements and the budget.

So in the end, the choices basically do come down to lower benefits or higher taxes. No one thinks we should cut benefits for true low earners, who need the safety net that Social Security provides. But there’s no reason middle and high earners should derive so much of their retirement income from the government. The real divide over Social Security policy is that the Left wishes to charge higher taxes on higher earners in order to pay higher benefits to higher earners. The Right should respond that these Americans can, should, and will respond to lower benefits by saving more on their own.

An approach that would give many of the benefits of personal accounts with fewer downsides is to fix Social Security’s finances on the benefit side, by increasing the retirement age, reducing benefits for middle and higher earners, and potentially reducing COLA payments to account for the CPI’s overstatement of inflation. Then, to make up the difference in benefits, institute universal 401(k) or IRA accounts. Taxes wouldn’t increase, total retirement income would approach the levels promised under current law, and individual retirement wealth would be increased. Under the circumstances, I’d call that a win.

The short story is that the government should focus on those things only government can do, such as the transfers to lifetime low earners that Social Security provides. Individuals and markets should do what they do best, which includes ordinary retirement saving for middle and high earners. That’s a decent recipe for social policy to begin with, and even more so given the multi-trillion-dollar budget shortfalls we face.

— Andrew G. Biggs is a resident scholar at the American Enterprise Institute. Previously he was the principal deputy commissioner of the Social Security Administration and, in 2005, he worked at the White House National Economic Council on Social Security reform.

[Perdogg]

End the triple taxation on Social Security.

[mo]

http://www.cato.org/pubs/journal/cj15n2-3-1.html

[bestintxas]

“The only way personal accounts could fix Social Security on their own is if accountholders gave up traditional benefits far in excess of the taxes they put into accounts.”

Baloney.

If the government would have invested 100% of the funds received for Social Security into a passive indexed fund, the stock market would remain at heady heights and each of us would have comfortable retirement income for as long as we live, far greater than what we now expect.

The time value of money would preserve the financial well-being 100%. Instead, we have had politicians take our retirement money and spend in the general fund for their own reelection, seploying the mother-of-all Ponzi schemes.

[PGR88]

Declare Soc. Sec. the ponzi-scheme failure it is.

Let anyone under 45 years-old opt-out completely.

Raise retirement age to match life-expectency gains from when program first started.

Eliminate COLA’s.

Make the Fed. Govt account for unfunded liability on its books.

[abb]

I haven’t the time to read this whole mess, but what I got was that he thinks SS should be for the “poor” and private accounts should take care of those who actually saved on their own.

IOW, welfare. Another wealth transfer scheme.

Fuggidaboutit.

[SeekAndFind]

RE: If the government would have invested 100% of the funds received for Social Security into a passive indexed fund,

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That’s all water-under-the-bridge-now. We all know that they haven’t invested the money and are raiding SS to pay for current expenses and padding SS with IOU’s.

We also know that it works with present workers paying for present retirees and the ratio of the former to the latter is shrinking.

GIVEN THIS — what can we do about it FROM NOW ON ?

I say we can follow the Chilean model designed for them with the help of the Chicago School of Economics ( when Milton Friedman was still alive ).

[taildragger]

If the government would have invested 100% of the funds received for Social Security into a passive indexed fund, the stock market would remain at heady heights and each of us would have comfortable retirement income for as long as we live, far greater than what we now expect.

Not advice, but the ultimate experiment vehicle to compare SSI and self-directed accounts is right under everyone's noses...

The Roth IRA.

Roth max contributions are $6000, not that far from max SSI taxes.

It would be fun to do a what if senario spread sheet using max Roth contributions with a 50-50 passive stock and or all asset classes and bonds and compare the growth/potential draw downs vs. your SSI Benefit....

[SeekAndFind]

RE: Eliminate COLA’s.

What would retiree’s do when inflation strikes with a vengeance ? ( Note — I said when, not if. The Fed has been printing money like crazy and it’s sure to come to a head in the near future ).

[kingu]

Public employee wages, benefits and pensions. It doesn’t matter what is done to Social Security so long as public employee compensation continues at insane levels. Whatever is created will be drained with taxes to pay for public employee pensions. If they can not get that under control, we are simply Greece waiting for the riots and Chinese bailouts.

[Marty62]

You know , not to diagree but to bring up a point.

WHY does EVERYONE like to focus on SSA?

As I have repeatedly mentioned. To not even mention the elimination of such depts as EPA, EDU, Interior and the millions of other tit sucking orgs funded by the taxpayers, indicates to me that NO ONE is serious about “fixing” the problem. Yes I know it will unemploy hundreds of thousands of OVERPAID union Government workers (shirley Sherrod types)

But hey I know it’s mor important to slam the retirees.(Useless eater?)

[Sgt_Schultze]

Republicans could easily get around the democrat bogeyman of "social security in stocks" by starting off mandating investment in Treasuries. At least individuals would have ownership in a marketable security instead of in a proprietary one on which the government could default. The benefit, of course would be that in the event of death, it would become a part of an estate and not forfeited as is currently the case. No voter could want to approve of continued forfeiture of "earned benefits." After approval, the allowable investment pool could be broadened.

Republicans need to start planning like libdems. The have to take baby steps and build upon those new baselines. That's how we arrived at the health care bull. Libdems built upon union deals that provided insurance. Government started wrecking the industry when Kennedy invented HMO's and that in turn impelled further meddling to further complicate free-market dynamics.

The author is correct. If Republicans don't start laying out an affirmative agenda, their mandate will be only to obstruct POSCIC's agenda.

[Non-Sequitur]

Do away with Social Security and don't you also do away with the disability programs and the parts that provide financial support for widows and orphans? Are they to be left with nothing?

What do you do with the person who spends his entire life and saves nothing? Is there anyone who honestly thinks that politicians would refuse to provide a government safety net for people voters who do that?

[PGR88]

What would retiree’s do when inflation strikes with a vengeance ? ( Note — I said when, not if. The Fed has been printing money like crazy and it’s sure to come to a head in the near future ).

I expect that before too long, Soc. Sec. (as well as much Gov;t expenditure) is going to be paid with increasingly worthless printed money anyway. My goal would be to get the US Gov't out of the Soc. Sec. business starting ASAP. It won't be easy, esp. with the baby-boomers facing retirement, but the truth must be faced. I know that ending Soc. Sec. is a political impossibility, but major adjustments must be made now.

[Norman Bates]

Interesting. Can you explain the Chilean model?

[Marty62]

And will you get behind eliminating the EDU,EPA ETC.

[SeekAndFind]

RE: Interesting. Can you explain the Chilean model?

---

I refer you to this article by Dan Mitchell (Senior Fellow at CATO Institute) as an example :

http://danieljmitchell.wordpress.com/2010/08/25/chiles-private-social-security-system-a-big-success/

---

Unlike the United States and most European nations, Chile does not face a long-term Social Security crisis. This is because lawmakers shifted to a system of personal accounts almost 30 years ago. As a result, Chile’s economy is much stronger, the financial system is healthy, workers are better off, and taxpayers are protected.

It also turns out that a system of personal accounts has a positive impact on the labor supply of older workers. Instead of getting lured into retirement by a punitive tax-and-transfer government system, they remain active to reap the rewards of a system that rewards them (rather than tax collectors) for continued work. A former World Bank expert has the details in a new report from the National Center for Policy Analysis.

American workers live longer each decade but they continue to retire early. They often begin receiving Social Security benefits, quit working and stop contributing to national output well before age 65. Reversing these trends must be an important objective when designing long-term reforms to balance revenues and expenditures on elderly entitlements. Chile faced similar problems prior to 1981. It had a traditional pay-as-you-go defined benefit system, like Social Security in the United States. Workers had strong incentives to start their retirement benefits as soon as possible, because postponing pensions and adding contributions did not increase benefits commensurately. Labor force participation dropped dramatically when workers became eligible for pensions.

This changed with reforms in 1981 that replaced the defined benefit system with a defined contribution system. All new workers were required to join the defined contribution system while existing workers had a choice.

Most workers are now in the new system and are required to contribute 10 percent of their wages to an individual account.

Contributions are invested in a pension fund chosen by the worker and accumulate a market rate of return.

Payouts take the form of inflation-protected annuities or gradual withdrawals during retirement.

The new system increased incentives for older workers to postpone retirement and continue working.

The response was dramatic….Following the 1981 policy changes and reforms, and after controlling for other sources of change in retirement behavior, the percentage of individuals receiving early benefits fell significantly:

* The proportion who received benefits before age 65 decreased by about 8 percentage points.

* The proportion of individuals who started receiving retirement benefits by their early 60s fell by about a quarter.

* The proportion who started receiving benefits by their 50s was cut in half.

* Postponing the commencement of benefits could be due to market returns on additional contributions, which made workers more willing to continue working in order to save more money for retirement. Or it could be due to tighter preconditions on early retirement, which required more individuals to continue working until age 65.

* Tighter preconditions seem to dominate, as the percentage of individuals who receive benefits after 65 has not changed.

* More older workers kept working following the reform, after controlling for other factors:

* Labor force participation rates for individuals in their 50s rose 12 percentage points.

* Labor force rates rose 13 percentage points for those aged 65-70.

* Individuals aged 60-64 increased their labor force participation the most – by 19 percentage points.

* The biggest change in labor force participation was for individuals who had started receiving benefits from their retirement accounts:

* Participation rates rose by 15 percentage points for pension recipients in their late 60s.

* Rates rose by 28 percentage points for those in their 50s and early 60s.

* Among all pension recipients under age 70, the proportion who continued working more than doubled.

[Nick Danger]

The problem with Social Security, and indeed all retirement plans of whatever kind, is one of demographics, not money.

People cannot eat money. They cannot wear money. They can't live in huts made of money. No matter how much money they might have saved up, their actual income in old age must consist of food, shelter, clothing, and other goods and services produced by the people who are then working. Whatever the retired consume will not be available for consumption by the people then working, or by their children.

Throughout most of human history this issue was not a problem for two reasons: populations grew, and life expectancy wasn't much longer than the average working life.

What "breaks" Social Security, and will break any other so-called 'retirement savings plan,' is the arrival of near-zero population growth combined with life expectancies that are ten to thirty years longer than the average working life.

Human societies have never seen a situation where the average adult worker had his or her own personal retiree to support, for roughly as long as they will also have to support children. Put another way, the dependent old represent a larger burden than they ever have in all of human history.

Saving money doesn't solve this problem because the real issue is the quantity of goods and services consumed by the retired, and virtually all of that has to come from then-current production. Loaves of bread "saved" in the 1980's are not going to be edible in 2020. Televisions built in 1980 won't work in 2020. We can't 'save' or 'bank' goods and services the way we do money.

There are only two ways out of this that do not involve euthanasia: we either need much higher population growth, such that the ratio of retirees to workers goes back down to some manageable number, or people need to work for more years than they do now... perhaps to age 70 or more. The question is where the jobs will come from to allow that without freezing the generation that is raising the young out of the jobs and promotions market.

This is not a simple problem.

[Nip]

I am ABSOLUTELY in favor of personal social security accounts. But not for the reasons most people use.

Right now the social security “trust fund” is a large pile of money that belongs to no one. That's right the trust fund belongs to no single person - it belongs to “all of us”. That being true also means it belongs to none of us.

The recent legal cases about BHOI’s constitutional qualifications brought this to the forefront. Multiple cases were thrown out for “lack of standing” because the individual plaintive couldn't prove a degree of damage.

We now have the computational capability to establish individual social security trust funds. This linked to your social security number means it is possible to have individual accounts.

If that happens and a liberal/progressive/socialist/democrat/RINO politician attempts to divert your money to a more morally better option each individual can clearly prove in a court of law a direct personal loss and have standing before any court in the land.

The ability to put a true lock on social security trust funds is the real reason why liberal/progressive people so strongly oppose the idea.

[Teacher317]

But hey I know it’s mor important to slam the retirees.(Useless eater?)

Um, positing ways to secure Social Security benefits is not "slamming on retirees"... it is an attempt to rein in an out-of-control government, as well as to increase the returns Americans can make on their invested retirement dollars. Where is there "slamming"?

And why you think seniors are "useless eaters", I'll never know. (You raised the phrase, in an attempt to smear others. It properly belongs to you.)

You spin worse than MSNBC.