Personal Accounts for Social Security: Facts and Fantasies

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Personal Accounts for Social SecurityFacts and
Fantasies
Social Security University February 20,
2003 Presented by Andrew G. Biggs, Social
Security Analyst The Cato Institute, Washington,
D.C. www.socialsecurity.org
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Challenges Facing Social Security

• Its going broke Social Security will begin
  running payroll tax deficits within 15 years. By
  2041, it will be legally and financially unable
  to pay full promised benefits, resulting in cuts
  of 25 percent or more.
• Its unfair Social Security often discriminates
  against working women divorcees African
  Americans and younger Americans.
• It hurts wealth creation asset ownership brings
  a host of economic and social benefits. Social
  Security discourages saving by the poor, reducing
  wealth accumulation and increasing economic
  inequality.
• Its risky workers have no legal right to their
  benefits, even after a lifetime of contributions.
  The lack of a legal obligation encourages the
  government to make promises it cannot keep, and
  to delay action on reform.

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Social Security reform should

• Increase economic growth In the future, smaller
  numbers of workers will support larger
  populations of retirees. Social Security reform
  can help make each worker more productive by
  raising national saving, thereby increasing
  worker productivity and boosting economic growth.
  
• Increase personal control Reform should give
  workers true legal ownership of their retirement
  savings, prevent the government from raiding
  Social Security for other purposes, and give all
  Americans the opportunity to build wealth and
  pass it on.
• Increase fairness The current system can be
  unfair to African Americans, who often do not
  survive to retirement age to working women, who
  often do not receive spousal benefits and the
  young, who must pay high taxes into a system that
  will be insolvent by the time they retire. Reform
  should correct these flaws so all Social Security
  participants feel they are treated fairly.

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A solution personal accounts

• Workers could invest part or all of their payroll
  taxes in accounts holding diversified stock and
  bond mutual funds. In return, they would give up
  part of their traditional benefits.
• At retirement, workers could purchase an annuity
  or take gradual withdrawals of their money.
• If the worker died before the account was
  exhausted, the remainder would pass onto his
  spouse, children or a chosen charity.
• Many plans exist Congressional proposals, the
  Presidents reform commission, think tanks and
  other interested groups.
• Nevertheless, many people have doubts. Others
  seeks to play on the publics fears

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The tough questions about Social Security reform
Is there really a crisis? Wouldnt personal
accounts cut benefits? Isnt it cheaper just to
fix the current system? Arent personal accounts
too risky? Wont accounts reduce Social
Securitys progressivity? Wont personal accounts
would drain money from the system? Isnt reform
too expensive? The trust fund will keep Social
Security solvent for decades. Whats the
hurry? Would personal accounts Enron Social
Security? Would personal account shred the
safety net? Can ordinary workers invest
wisely? Will stocks continue to pay high returns
in the future? Wont personal accounts increase
the retirement age?
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What do these questions show?
None of the questions are deal-breakers Some are
simply wrong on the facts. Others highlight the
costs of reform, while ignoring the costs of
inaction. Others show legitimate difficulties
with personal accounts, which reform supporters
must work to overcome. But even legitimate
difficulties must be weighed against the
advantages of reform.
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Is there really a Social Security crisis?
Some people say Social Securitys financing
problems are just a function of pessimistic
economic projections. Some even accuse Social
Securitys trustees of rigging the numbers to
make the program look bad. If the economy grows
faster, they say, Social Security wont go broke.
Why make big changes now for a problem that may
never occur?? This is a very interesting view at
first. Unfortunately, it is wrong.
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Both sides acknowledge need for reform

• ButPoliticians from both parties have stressed
  the need for reform and sooner rather than
  later. President Clinton spent a year
  highlighting Social Securitys problems.
• Two independent panels of experts examined the
  trustees projections. They found them to be
  reasonable or maybe even a little optimistic
  regarding Social Securitys financing.
• In other words, instead of a phony crisis, we
  might have something even worse than expected.

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Heres why the crisis is real

• Social Securitys trustees believe the economy
  will slow tomorrow because birth rates are low
  today fewer new workers equals slower economic
  growth.
• Faster economic growth wont help much. Tax
  revenues will increase, but so will the amount
  that Social Security must pay in benefits.
  Economic growth could double and Social Security
  would still go broke.
• The trustees low cost projections do show
  Social Security solvent for 75 years, but this
  assumes higher economic growth, increased birth
  rates, reduced improvements in life expectancies,
  lower unemployment, higher inflation, higher
  interest rates, a one-third increase in
  immigration, and lower incidence of disability.
  No one seriously believes this will happen.
• Many demographers believe life expectancies will
  increase faster than the trustees project. If so,
  Social Securitys deficits will be bigger MUCH
  bigger.

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Faster growth increases short-term surpluses and
long-term deficits
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Would personal accounts cut benefits?
President Bush's own Social Security commission
has developed privatization plans that would
require drastic reductions in future Social
Security benefits. For some seniors, these cuts
could exceed 25 percent. In the future, seniors
could face far deeper cuts in benefits, up to 45
percent." (Sen. Jon Corzine, D-NJ). Is this true?
The short answer NO! Heres the proof One plan
from the Presidents Commission did nothing other
than add personal accounts. Social Securitys
actuaries certify that a low-wage worker retiring
in 2052 could expect 5 percent higher benefits
than he is promised by the current
program. Moreover, beginning in 2042, it would
always be cheaper than the current system, while
paying higher benefits to everyone. We must do
more to fix Social Security than just add
personal accounts, and those steps could be
painful. If changes arent made, retirees face
cuts of over 25 percent when Social Security
becomes insolvent. But by raising benefits,
accounts make whatever combination of steps we
choose to restore solvency less painful. In other
words, personal accounts dont cause cuts, they
actually make them smaller.
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So why all the talk of cuts?
Anatomy of a benefit cut Critics compare the
current programs promised benefits to the
traditional benefit paid by the Commissions Plan
2.
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Benefit comparisons are fundamentally flawed
and misleading.
Comparing a proposals projected benefits to
those resulting from the rules of current law can
be misleading, since the full amount of benefits
promised under current law would not be payable
under the trustees projections. For example, a
proposal that is shown to result in benefits that
are 10 or 20 lower than under current law may
at first glance appear politically unattractive,
but may appear less so if compared to the 27
reduction in benefits that would have to occur
if policymakers were to take no action.
(Congressional Research Service). Theres a lot
of people that want to compare Social Security
reform proposals just to promised benefits. That
is fundamentally flawed and unfair because all of
promised benefits are not funded. There is a huge
shortfall between what's been promised and what's
been funded, and youve got to figure out how
you're going to close that shortfall. So, any
analyses, including the Diamond-Orszag study,
that compare the benefit cuts based upon promised
benefits solely rather than funded and promised,
is unfair, unbalanced, in my opinion
inappropriate. (General Accounting Office head
David Walker).
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Social Security cant meet its promises
Compared to what Social Security can actually
pay, the reform plans traditional benefit is
often much higher.
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Including the account, its game over
A low-wage worker retiring in 2052 can expect
benefits 45 percent higher than Social Security
can afford to pay, and 5 percent higher than the
current system even promises.
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Heres the proof

• A 25-year-old low-wage woman retiring in 2042 is
  promised 896 per month (in 2001) from Social
  Security.
• However, because Social Security will be
  insolvent in 2042, by law the program can pay her
  only 655 per month (with larger cuts in future
  years).
• Under one proposal from the Presidents
  Commission, this same woman could expect to
  receive 611 in benefits from the traditional
  system plus 375 from her account, for a total of
  986 per month.
• Her benefits would be 331 per month more than
  Social Security will by law be able to pay, and
  90 more than Social Security even promises.
• This is what reform opponents consider a deep
  cut in benefits.

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Isnt it cheaper just to fix the current system?
All personal account plans use a certain amount
of general tax revenue to cover temporary
transition costs. The National Committee to
Preserve Social Security and Medicare says, It
would be less expensive to extend the solvency of
the program using the structure we have in
place. Peter Orszag (Brookings) and Peter
Diamond (MIT) make the same argument, that if we
put those same resources into the current system,
it could pay higher benefits than personal
account plans. But is this true? To find out,
Rep. Charlie Stenholm (D-TX) asked Social
Securitys actuaries to determine what benefits
the current system could pay if it received the
same 1.3 trillion in general revenues used in
the Presidents Commissions Model 2.
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SSA Confirms Personal Account Plans Give More
Bang for the Buck
Social Security's actuaries found that even if
the current system received the same general
revenue transfers as Commission Model 2,
virtually all low- and average-wage account
holders under Model 2 would receive higher
retirement benefits. By 2075, a low-wage account
holder could expect 30 percent higher benefits
under the personal account plan than the current
system. This provides the best head-to-head,
apples-to-apples comparison of personal accounts
to the current system, as measured by Social
Securitys non-partisan actuaries. Reps. Jim
Kolbe (R-AZ) and Stenholm concluded, "The new
analysis by the nonpartisan Social Security
Administration Office of the Chief Actuary (OACT)
shows that a Social Security reform plan with
personal accounts can provide more 'bang for the
buck' than simply pumping more money into the
current Social Security system."
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Detailed Results Dollar for Dollar, Personal
Accounts Pay More
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Isnt the stock market too risky?
After whats happened in the stock market the
last few weeks, we think its a terrible idea.
Imagine if you were retiring this week, with most
major stock indexes hitting five-year lows.
(Sen. Tom Daschle, D-SD, July 12) A worker with a
personal account invested only in the SP 500 and
retiring today would have received around a 6
percent real return even after the market
decline. A single male worker retiring today can
expect a 1.74 percent real return from Social
Security. Married couples can expect around 2.5
percent. Recent market drops dont show personal
accounts are too risky in fact, they show just
the opposite. Even in the biggest bear market
since the Great Depression, a worker would have
more than doubled his money with a personal
account holding stocks.
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Even a big crash wouldnt leave account holders
worse than Social Security.
Assumptions single male, average wage, retiring
2002. Employee share of payroll tax (6.2 percent)
paid into account, versus same tax paid into
current program.
22
Even stocks worst returns beat Social Security.
Stocks lowest annualized returns over various
holding periods
23
Social Securitys Progressivity

• Private accounts ... would eliminate the
  progressive aspects of the current system that
  provide more help for low-income people." (Maya
  Rockeymore, National Urban League).
• Social Security seems progressive, since low-wage
  workers receive relatively higher monthly
  benefits than those with higher wages. But many
  economists now conclude it is barely progressive
  at all. Why?
• Life expectancies The rich live longer than the
  poor, collecting benefits for more years.
  Progressivity reduction 16 percent.
• Spousal benefits spouses of high-wage earners
  receive higher spousal benefits. Progressivity
  reduction 30 percent.
• Intra-household redistribution Social Security
  often redistributes from a richer member of a
  household to a poorer member, not from rich
  households to poor households. Progressivity
  reduction 14 percent.
• Potential earnings many people appear poor not
  because of low wages, but because they work short
  hours or leave the workforce. This is
  particularly true when the persons spouse has
  high wages. Progressivity reduction 20 percent.

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Progressivity Greatly Exaggerated.
Result Only about 2.5 percent of total benefits
redistributed from rich to poor. Economists Alan
Gustman (Dartmouth) and Thomas Steinmeier (Texas
Tech) state It is clear from these results that
the general perception that a great deal of
redistribution from the rich to the poor is
accomplished by the progressive Social Security
benefit formula is greatly exaggerated. As a
result, adoption of a Social Security scheme with
individual accounts designed to be neutral with
regard to redistribution would make much less
difference to the distribution of Social Security
benefits and taxes among families with different
earnings capacities than is commonly believed.
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Actual Social Security redistribution one-fifth
of what basic benefit formula implies
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Personal accounts can substantially increase
progressivity.
Progressive personal accounts low-income workers
make larger contributions. Since accounts are a
better deal than the current program, the more
you can contribute the better you are. Enhanced
safety net new minimum benefits, increases for
widows. More progressivity in traditional
program low-wage workers most protections
against reductions in traditional benefits to
restore solvency. General tax revenues would pay
the transition wow-wage workers, who pay
little income taxes, would receive a pure shift
from low pay-as-you-go returns to market
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Heres the proof

• Under the current program, a low-wage retiree
  receives benefits equal to 46 percent of a
  high-wage retirees benefits. (Even though the
  low-wage retiree earned just 28 percent as much
  as the high-wage individual.)
• Under the Presidents Commissions two
  comprehensive reform plans, benefits to low-wage
  workers would rise to 50 and 56 percent of those
  paid to high-wage workers.
• These plans are clearly more progressive than the
  current program.
• And because account balances could be passed on
  at death and would be split evenly at divorce,
  true progressivity is likely higher than these
  numbers show.

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Would personal accounts drain money from the
system?

• Today, Social Securitys surpluses are used to
  cover deficits in the rest of the budget. Reform
  opponents call this saving the money.
• Personal accounts would save those surpluses only
  for paying benefits. Yet this supposedly drains
  money from the system.
• If we do nothing, by 2075 Social Security would
  run debts of 3.2 trillion (in present value
  dollars). Under two plans from the Presidents
  Commission, by 2075 the system as a whole
  (including accounts) would have assets exceeding
  1.7 trillion.
• Without reform Social Security will go broke.
  With reform, it would be solvent and hold 1.7
  trillion in assets. Its hard to see that as
  draining the system.

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Would reform be too expensive?
Plans from the Presidents commission are
dependent upon large, multi-trillion dollar
transfers from the rest of the budget. (Peter
Diamond and Peter Orszag.) But large compared to
what? Not compared to paying full promised
benefits under the current program (which is what
reform critics assume when they talk about
benefit cuts). Most major reform plans reduce
the need for general revenue transfers relative
to maintaining the current system. The only thing
cheaper than reform is doing nothing but that
implies over 25 percent benefit cuts.
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Plans from Presidents Commission cut general
revenue costsby a LOT.
31
Do we have the money?
Reform is cheaper over the long run current
system would demand 23 billion in general
revenues over the next 75 years. Reform plans cut
that by half or more. Moneys tight today so
Congress should cut corporate welfare and pork to
help finance reform. Are those things more
important than Social Security? The budget
balance will only decline in the future. Social
Securitys surpluses will fall after 2005. The
rest of the budget will be squeezed as the baby
boomers begin retiring in 2008. The budget may
not be flush today, but will it be better
tomorrow? Social Security reform is not a luxury
to be undertaken when times are good. We have no
choice but to reform Social Security, and acting
sooner will always be less painful than leaving
it for later.
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The trust fund will keep Social Security solvent
for decades. Whats the hurry?
The assertion that Social Security is going bust
in 2016 flies in the face of all reality. The
facts are Social Security has enough reserves in
the trust fund to last until at least 2038.
(Rep. Richard Gephardt, D-MO) The trust fund
cannot delay the need for tax increases or
spending cuts by a day or reduce them by a
dollar. The reason the trust fund holds
government bonds, and when Social Security
redeems them the government must raise taxes or
cut other spending to repay those bonds. Example
in 2020 Social Security will run a payroll tax
deficit of 74 billion (in todays dollars).
Without a trust fund, wed need to raise taxes or
cut other spending by 74 billion to pay full
benefits. With a trust fund, we need to raise
taxes or cut other spending by 74 billion to
repay the funds bonds. For the taxpayer, its
all the same.
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What the experts say
Although government trust funds arguably have
some value as an accounting mechanism, their
projected solvency does nothing to ensure that
economic resources are available to cover program
costs. (Congressional Budget Office.) While
the trust funds have an important role in
monitoring the finances of the program and
maintaining its fiscal discipline, they are
basically accounting devices. The federal
securities they hold are not assets for the
government. When an individual buys a government
bond, he or she has established a claim against
the government. When the government issues a bond
to one of its own accounts, it hasnt purchased
anything or established a claim against some
other entity or person. It is simply creating a
form of IOU from one of its accounts to another.
Those claims are not resources the government has
at its disposal to pay for future Social Security
claims. Simply put, the trust funds do not
reflect an independent store of money for the
program or the government (Congressional
Research Service) The changes to Social
Security enacted in 1983 are not producing the
result of lessening the burden of paying for the
retirement benefits of the baby boom generation.
The budgetary reality is that the payroll taxes
are being used to finance the current operations
of government and are masking the size of the
on-budget deficit. The economic reality is that
the Trust Fund reserves consisting of Treasury
securities that are financing current consumption
rather than productive investment are illusory.
They will remain so until the rest of the
government achieves approximate balance between
revenues and outlays. (General Accounting
Office.)
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Would personal accounts Enron Social Security?

• Sen. Tom Daschle said "I don't want to 'Enron'
  the people of the United States,. I don't want to
  see them holding the bag at the end of the day,
  just like Enron employees have held the bag. I
  don't want to destroy their Social Security
  system."
• Personal accounts are nothing like Enron. Workers
  could invest only in diversified, approved mutual
  funds, not in single stocks. What happened at
  Enron simply couldnt happen under any existing
  personal account plan.
• The current system is actually more like Enron.
  Like Enron, Social Security
• Uses murky trust fund accounting that
  exaggerates its assets and hides its liabilities.
• Gives workers little control over their savings.
• Doesnt allow workers to diversify. Low-wage
  workers have nothing but Social Security.
• Is going broke. Not as fast as Enron, but that
  wont matter to workers who are affected.

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The real message of Enron

• In a July 2002 Cato Institute/Zogby International
  poll, likely voters were asked, Which statement
  to you more agree with?
• The Enron scandal shows the dangers of the stock
  market and why we must maintain Social Security
  as it is and not allow individuals to invest
  their payroll taxes in personal retirement
  accounts.
• The Enron scandal shows that people need more
  choice and more control over their retirement
  savings, including allowing workers the option to
  invest part of their payroll taxes in a personal
  retirement account.
• By a more than 2-to-1 margin, likely voters said
  the Enron scandal was a reason to favor personal
  accounts not a reason to oppose market investment
  by workers.

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Would personal accounts shred Social Securitys
safety net?

• People like Sen. Jon Corzine (D-NJ) worry that
  personal accounts would shred the safety net.
  But
• Today, a low-wage worker could pay an eighth of
  his wages into Social Security all his life and
  still retire below the poverty line.
• Today, Social Security allows 12 percent of women
  to retire into poverty, versus only 7 percent of
  men. Among widows, divorcées or never-married
  women, poverty rates can approach 25 percent.
• Today, one-third of black men entering the
  workforce will not live to collect a penny in
  retirement benefits.
• Tomorrow, Social Security will become insolvent,
  forcing benefit cuts of 25 percent or more.
• The poor will be hit the hardest when Social
  Security goes broke.

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An enhanced safety net

• Personal account plans like those from the
  Presidents commission include provisions to
• Increase the programs progressivity
• Guarantee that low-wage workers dont retire into
  poverty
• Increase benefits for lower-income widows
• Give divorced women a right to half their
  husbands account balance.
• Could we take these steps without personal
  accounts? Sure, but an insolvent system cant
  afford to improve the safety net. Personal
  account plans that restore solvency can build a
  stronger net.
• A solvent system is the best safety net.

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Can ordinary workers invest wisely?
Millions of ordinary workers have already begun
investing successfully through IRA and 401(k)
plans. Will low-wage workers take too much risk?
Not likely the average worker aged 60-65 and
earning 15-25k has just 23 percent of his 401(k)
account in stocks, and the rest in bonds. He
would have made money in the market last year.
Workers in dozens of countries around the world
already invest in personal accounts. Are workers
in Chile, Australia or Mexico smarter than
Americans? Personal accounts would be modeled
after the federal Thrift Saving Plan simple,
cheap and easy to use. What the opposition is
REALLY saying is low-income workers are too
stupid to invest. This is patronizing and
demeaning particularly since opponents usually
have investment accounts of their own!
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Will stocks pay the same returns in the future?

• Some argue that because the economy will slow in
  the future, stock returns must also fall. No one
  knows for sure, but
• Stock returns which have averaged 7 percent --
  would have fall a lot to be below Social
  Securitys 2 percent returns.
• Social Securitys independent actuaries forecast
  6.5 percent real annual returns.
• Much of the argument for lower future returns
  hinged on an overvalued market and thats no
  longer true.
• Historically, long-term stock returns have no
  correlation to growth of the total economy.
  Instead, returns correlate to economic growth per
  worker. GDP growth per worker will remain strong,
  even if slow labor force growth reduces total
  economic growth.

40
Wont personal accounts increase the retirement
age?
You can call any change in benefits a change in
the retirement age, since by working longer you
would earn higher benefits.
41
Personal accounts could make earlier retirement
possible.
The normal retirement age currently 65,
gradually rising to 67 is entirely separate
from personal accounts. None of the plans from
the Presidents Commission raise the retirement
age. You could still retire as early as 62, and
the normal age would remain the same as in
current law. Moreover, workers retiring at any
given age would receive higher benefits than
under the insolvent current program. For
instance, a 25-year-old low-wage woman would have
to work past age 70 under the current program to
receive the same benefits she could receive at
age 65 under the Presidents Commissions Plan 2.