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Today's Commentary: 04.01.05
A Simple Solution to Social Security

It is good to hear American politicians, accountants, actuaries and wordsmiths coming together to offer so many solutions to what might be a real problem - or maybe not. The President launched the opening salvos across the bow of Social Security well in advance of his inaugural address and is currently stumping his "political capital" on a state by state basis.

Since that moment, virtually everyone who writes about money, politics and the goings-on on the Beltway, and quite a few who are just concerned about the financial state of the program have weighed in on the topic. In fact, I received a call from Tommy Lasorda early this afternoon using baseball euphemisms describing Mr. Bush's efforts at reforming the program and telling me they were worth supporting. Baseball managers calling during the day was common when the kids were still playing ball. They were usually looking for an umpire to call a game. But former managers calling in support of Social Security was just odd. But this is an odd undertaking.

In spite of those who have launched their own platforms to "reform the program", which from an accounting and actuarial perspective does not seem to be as broken as many claim, there is a growing body of facts supporting the fact that there is still life in Social Security.

Rep. Clay Shaw (FL-R) proposes an aggressive savings credit that acts much like a payroll rebate offering a 4% credit or $1,000 a year to create a personal account. But this idea, besides its immediate belt tightening effect on federal spending - read: more borrowing to make ends meet - would still fall short of the goal of helping people become more solvent in their golden years.

Even that term has become anachronistic referring to an age when people actually had money to enjoy themselves after their career. To hear some tell it, we are all headed for the poor house! While Mr. Shaw has a good idea, it fails to address the psyche of the average baby boomer.

Paul O'Neill, former (fired) Treasury Secretary was out stumping the annuity part of the President's program. Personal/private accounts, the ones that are part of Mr. Bush's plan, would be turned into annuities at retirement. These accounts would, all things being equal and the markets cooperate with the President's math, contain at least enough savings to cover the shortfall of lost benefits.

O'Neill told a CNBC audience that a nest egg of a million dollars would leave him a very comfortable annuity of around $80,000 a year. So, for most of America, a group that is curiously underinvested to the point of concern, the average person, if we were to assume the current average retirement savings of the average 50 year old, would be looking at an annuity payment of $4,000 a year.

Even Rep. Shaw's plan would not make the average fifty year old wealthy enough to cover their needs and definitely not enough to replace those missing benefits. It should be noted that Mr. Shaw's plan is done in tandem with Social Security, leaving the program untouched in the near term.

To figure how much savings you should have amassed as of right now, use this simple multiplier. If you are 30, multiply your income by 0.1. If you are forty, use 1.8; 50 year olds should use 4.5 times your income; those at 60 should multiply their income by 8.9.

Remember those calculations when someone suggest an ownership society. A plan that suggests you save more in an account that would reduce your Social Security benefit, push the age of retirement back, and ultimately force the country to face the debt that supposedly will save the program should take into account those that did the math and realized they haven't saved enough.

Thomas Mann of the New Republic suggests the debate should use Robert Axelrod's assessment of "possible strategies in the famous Prisoner's Dilemma game, which consists of a situation where mutual cooperation produces better results than mutual refusal to cooperate". Holding hands across the aisle is not something that seems possible for this group.

Perhaps there is a simple solution. Maybe even two.

Assume, and you can do this with a fair amount of safety, that the government already has a vested interest in the welfare of the stock market. In fact, about $14 trillion of invested equities will eventually accompany the current work force, the same worrisome bunch that will break the bank on Social Security, into retirement. This money is currently stashed in an assortment of tax deferred accounts - money that has yet to be taxed. That is an enormous amount of revenue that could be used to save not only Social Security in the long term but quite possibly Medicare in the short term.

The idea behind programs such as 401(k) plans and IRAs was elegantly simple. The belief was that when a person eventually retired and began to draw on these types of investments, their retirement years would find them in a more favorable tax bracket. As waves of baby boomers retire, this retirement savings will begin to be withdrawn and taxed.

This is guaranteed income delivered to the federal government by the program-saving bucketful. Before it is added into the federal budget, a portion of the capital gains tax that will be paid, say six percent, could be diverted directly into the coffers that are supposedly headed for insolvency. Normally that would be problem solved. But these are not normal times.

That means, to really fix the program, the solution would rely on two things happening, both of which should be easy for our current band of knee jerk politicians. Creating legislation that would force the government to pay back the program with the money the President had planned on using to fix the program would go a long way in fixing Social Security. The second piece of legislation would create a lock box to keep it there. The first Mr. Bush signed such a law into effect but was quickly ignored by the body of law that created it replaced with IOUs.

This would have a distinct effects on how politicians look at budgets. Learning to become accountants instead of elected spendthrifts would change the whole political arena for the better while accomplishing what everyone thought was the Republican agenda. We would then elect officials for their leadership not their promises. A secondary effect would come with the creation of fiscal leadership that will lead this country in the direction the current administration wants.

But letıs not stop there.

Another possible solution could help millions of young people who believe the program will not be there for them. Penalize them, in a sort of fatherly way for their poor tax management and force them to save their tax refund. Last year, the average refund, according to the IRS was $854. A taxpayer living in a state like Oregon, where the average income is $42,000 according to the latest Census records, would actually pay $250 less in taxes. That is equivalent to getting a 33% return on your money even before the miracle of compounding takes effect.

Uncle Sam could then put the money in a tax deferred account. Because it would eventually get a portion of the money back in future taxes, some of which would be directed to pay for Social Security, everyone wins.

Now there will be some who balk at that last notion of deferring that precious tax refund until retirement. People use that money to pay bills, take vacations, or buy incredibly large televisions. If they wanted to opt out of this plan they could march themselves into their human resource office and adjust their W-4 to pay no more than they were obligated to pay. Or they could see a tax professional and they could do it for you.

Peter Orszag of the Brookings Institution thinks that savings could be vastly improved using the opt-out method. His research has uncovered an interesting problem. When workers are allowed to opt-in to a retirement program, far too many simply never get around to it. But if the employee is immediately enrolled with an option to stop their retirement savings, many choose to stay. Call it a quirk of our financial nature.

So before we move too fast down a road that needs not be traveled quite yet, we should consider how to be proactive without spending money, create a nation of savers without taking the economy down with our sudden change of habits, and pay off the debt that we currently own. Social Security is a program that requires some tweaking, perhaps a little belt tightening and a lot of sacrifice. These traits unfortunately are not prevalent among this generation.

Today's Commentary: 03.27.05
Choosing Default: How a Nation Picks its Best Financial No-Choice

Seven years ago, the Swedish government added personal savings accounts to their system of social security. Göran Normann, Ph.D., an associate professor of economics at the University of Lund, Sweden and Daniel J. Mitchell, Ph.D., a McKenna Senior Fellow in Political Economy at The Heritage Foundation wrote shortly after the adoption of the change to what was considered Europe's best welfare program that "there are many benefits to Sweden's new system, including greater incentives to work, increased national savings, a flexible retirement age, lower taxes and less government spending, opportunities for more reform, a fairer system that no longer redistributes income from the poor to the rich, and greater retirement income for retirees."

The Swedish model of social care was first introduced in the 1930's and was based on the book "The Middle Way" by Marquis Childs. The system that was adopted had been cherished by the Swede's largely because it was based on "low poverty levels, a low level of inequality, a high employment rate, a high level of employment among women, and a situation in which disadvantaged groups such as single mothers and people with disabilities are more likely than in other countries to live on terms that are not very different from those enjoyed by the majority of the population". During the eighties and nineties, Sweden faced an economic crisis that challenged these notions.

While the adoption of social changes is still in the early stages, some differences have emerged that should be noted as the issue is debated here in the states. The Swedes will need to face further cutbacks in public benefit levels than believed the change would require and that will force higher income wage earners to look for alternatives outside those currently offered. While on the surface this seems to be good for the system, removing the strain that these highly compensated workers would add, any loss of interest in the system as a whole will leads towards a greater chance that system will be further dismantled. These wage earners, because of increased levels of income have created a growing disparagement of pay among the country's workers, effectively moved this important tax base above the benefit ceiling.

The Swedish model accomplished this with drastic changes in the system that aimed many of the benefit cuts directly at those who needed it the most, the working poor. How did this happen?

Sweden began the 1990's with a cut in marginal tax rates and a broadening of the tax base. Part of this wide spread reform separated taxes on labor and capital gains through the elimination of what was essentially a progressive system. Deregulated wages rose and inflation increased. This led to a housing boom. The tax reform was also under financed. Growing deficits turned the government's attention to what they considered the obvious answer: a wage freeze.

This had several cascading effects. Inflation stopped rising. Instead, it headed dramatically towards deflation while the speculation in the housing market burst. This triggered a banking crisis while the ability of the country to attract buyers for their higher priced goods pushed their export trade into a recession. This led to a growth in unemployment that began in manufacturing which put increased pressure on the public system the government was trying to reform. Add to that the budget deficit reached 13% of GNP.

With the government essentially divesting themselves of the problem through reform, the goal of active employment (the unemployment rate target was 3%) which was helped by a government that was less passive, quickly put a strain on the system while eroding the tax base that was supposed to pay for the changes. When those revenues did not materialize, the government began widespread benefit cuts. It also saw the creation of private accounts to help offset the system's woes.

According to Sweden.Se who published an article by Joakim Palme, the recently appointed director of the Institute for Future Studies in Stockholm, there is "very little information is available concerning the consequences of privatisation, as regards both user experience and provider experience". Ultimately Mr. Palme notes the system will be forced away from their goal of low poverty levels and gender equality.

This social system reform also led to the creation of private accounts designed to allow workers to divert 2.5% of their taxes - currently their system is taxed at 18.5% - to private accounts. The belief that these workers would choose their destiny far better than the government would has been largely proved false. Recent studies have pointed toward a 90% participation rate in the investment that was considered the default option of the private accounts. This low fee option was considered the least likely to grow substantially and given inflation, may not keep pace with the previously paid benefits.

This type of investment savvy has also proven to be the case in the United States. The success of the 401(k) plan and participation is dramatically increased when the employee's options are eliminated forcing the worker to join the retirement savings plan. Opt-in plans showed the lowest participation rate. What had not been expected was the equally high percentage of workers who allowed this vital part of their self directed pension plan to be invested in the default investment would do so in spite of a wide array of choices in many cases. In some plans, the default option merely parks the workers money in a money market account.

If the comparison to the Swedish system seems remarkably similar, the results should also mirror how any reform to our social system might play itself out.

Increased deficits have led to growing income disparity, export difficulties, low savings rates, a housing bubble, and the belief that even in Social Security reform, the government will offer a paternalistic hand to guide us through, will all prove to be too much for the average worker to comprehend let alone chose what is best for their future. The belief that houses are real wealth, that savings do not matter because of that belief, and the changes to how employment is allocated in this country will effectively push just as many Americans toward a choice that will neither benefit them nor the reform goals of the program.

The Blue Money Report
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