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Today's Commentary: 12.14.04
Six Questions about Social Security
Of the hundred or so e-mails I have received about Social Security since the mandate to change the New Deal program was announced by the President and the front page news that pensions have received, I have chosen six to respond to in today's commentary. If these answers still don't satisfy the worried, you can feel free to contact me personally and I will try to help. But be warned, these are not answers that are candy coated.
What exactly is meant by privatization? The idea behind privatization seems simple on the surface. It would allow people create private accounts that would be theirs alone, a pay in and watch it grow program that is much the same as a 401(k) plan and similar retirement programs sponsored by companies.
These types of plans have been successful for two reasons: One, it removes the burden of liability from the company and their profit and loss statement dropping the responsibility squarely in the laps of their employees and two, they create a new investor class. But by creating this new group of investors has not necessarily meant that the employee has done well because of this shift in how companies take care of employees and their retirement.
Creating a new investor class the way this program has done has instead allowed companies to wash their hands of any retirement obligation. Forcing folks to find out where to put their retirement savings although has not been as successful for the employee.
The some of the former benevolence of the company sponsored pension plan has carried over into these plans as employers offered matching funds to encourage employees to take advantage of these programs. Problem was, these funds were mostly squandered as employees picked restrictive matching (i.e. when the company matches on company stock only) or failed to chose the right fund for their investment goals. Many defined contribution plans offer a default fund if the employee fails to decide how to allocate their money. This is often a low yielding money market fund that has languished for years beneath the weight of current monetary policy.
Although some education gains have been made in correcting these investment mistakes, the average employee is still under invested and largely misdirected when they finally do participate.
That is the downside of privatization - a term that supposedly does not poll well. In the President's plan, accounts similar to those offered by private industry will be created. These have been promised to somehow be better directed and offer more security. Don't count on it.
The markets have continued to fascinate us. We tune in to the goings on from Wall Street with either envy or confusion. For every report on the future of the markets and their cheerleaders who see nothing but blue skies and sunshine ahead, there are those, like me, who seriously doubt the direction of the markets.
Tying private accounts to the stock market is risky business and may not have the returns that are currently being touted. Citing historic returns in this era of soaring deficits, globalization, concerns over the economic disruptions resulting from terror may not be the wisest approach to instilling confidence in the average worker who may still see the Street as the den of robber barons.
Will everyone get these accounts when the program changes? Once again, this depends on who listen to and who you want to believe. The only group that did well when pensions were dismantled and shifted towards private accounts were the businesses who sponsored them and the industry that provides the investment services. If the United states government decides to changes their program, shifting the burden of retirement onto the worker, there is little argument that the government will benefit more than we will.
How much this shift will cost is debatable. Before I get to the cost of the programs change - another question further on - let's look at who the change is proposed for and how it will affect us.
Without a doubt, some change is needed. Currently the system is determining benefits and their increases to wages. A proposal to change this to benefits based instead on prices will have an immediate effect on retirement age and the money those future retirees receive. The reason the program has survived as well as it has was because of this wage-based accounting. The changes in the amount of workers paying into the system has come down considerably since it inception in 1935. But because of wage increases and payroll tax increases, which are shared by both companies and employees equally, the system has allowed adequate time to find solutions to the predicted problems that lie ahead. Those problem are based on the fact that retirees will outpace workers creating a negative balance. Estimates for solvency have ranged over a wide period but most agree that by 2015, we will know whether solvency will take the program apart on its own.
Providing solutions will not be as easy as identifying the problem.
Currently, the proposed program change will be offered on a voluntary basis. Far too many what-ifs present themselves for any concrete arrangement to be finalized or even offered. With a history of passive involvement in the market by the average worker, suppose a very small percentage of the eligible choose these new accounts? Suppose the fear that every one on Wall Street is crooked and that improper accounting is the norm. Will this keep the average American sitting on their hands? Suppose the skeptics are found not only in the older population, but the younger one as well?
In fact, AARP has vocally opposed any effort by the administration to create the privatization of the program. They however do not object to the creation of private accounts to help supplement the program. Younger people have been the focus of these changes mostly due to their lack of belief in the future of the program. They have grown up listening to politicos warn of the current account deficits and wholly believe that system does not offer them any hope of a benefit. Older workers have not responded well to the terminology "privatization" and seem to want to fix the status quo rather than dismantle the program in any noticeable way.
What kind of accounts would be created? Many options have been presented, each with their own problems, some larger than others. Investing ins the stock market via mutual funds that offer little risk would default to index funds. These low expense - that's right, the cost of administering your plan would fall directly on you - would seem the most likely. But if Congress is involved, expect special interest groups to object to some of the companies in those indexes. This would create new problems as indexes are re-created in a politically correct manner and possibly at the determent of returns.
Some have offered a combination of stock funds and bonds or funds that are weighted with bonds. Bonds, for the uninitiated are a much more complex form of investment that depends on many different economic cycles. When investments are locked into bonds, the fixed rate is determined and could offer little help in an inflationary society. Once again, depending on the investment, inflation will play a role in the success of the program.
Annuities have the same problem. A retiree who buys an annuity at retirement will receive a fixed income for the remainder of their life and that of their spouse. Inflation will eat away at this fixed income actually lowering the real benefit. The owner of the annuity would need to live almost twenty years to see a $100,000 policy reach its original investment. When the owner dies, so does the policy negating the inheritance value of any change the administration has offered.
While we are on the subject of annuities, the money paid monthly to an annuity holder of a $100,000 policy, which by the way is twice what the average retiree has currently saved at 50 years of age not counting equity in their homes, would supply the retiree with $500 a month with no cost of living increases. The average worker earning $35,000 a year is eligible for a Social Security retirement benefit of $700 a month with cost of living increases. Even with a change in how those increases are calculated, the worker under the current plan is far better off than a retiree facing an annuity alone.
Is there a risk? The current plan is risk free. Politicians have been studying remedies to fix the program for over twenty years with little success. Much of their decisions simply put off meaningful solutions by trying to push the retirement age further into the future. While this is a good idea based on life expectancy, their attempt at actuarialism does not take into account the middle and lower class worker's labor pains by the time they reach retirement age. Many simply cannot continue to work much past 65 - if they can make it that far.
The risk in putting money into the markets is inherent. With a current return on Social Security investments at 3% and with the best long term average for the stock and bond mix proposed in the change at 3.5%. It makes the change accompanied by the cost of these new investments hardly worth it. Many folks hesitate to make long term predictions. That should raise a red flag.
How much is this going to cost? Reform always costs money. But it doesn't necessarily mean that the change in the program is the best way to spend it. Two things should happen first. If the solvency of the program is at stake, Congress should look elsewhere for money. For decades, they have been dipping into the Social Security surplus - and yes, even during this age of less workers supporting increased retirees, there is still an estimated $500 billion in surplus received through payroll taxes - and leaving IOUs. Congress should pay those IOUs back instead of legislating them away.
That would, by default, expose the folks in Washington to fiscal policy that would be embraced by the nation. Changing the way our elected officials do business would have a ripple effect throughout the economy by encouraging savings. Unfortunately, they would have to borrow money to make up for their previous transgressions.
The estimated cost for dismantling the program - and do not kid yourself on this one, once the change is begun, conservatives will continue to take the program apart until it does not resemble the current system in any way - over $2 trillion. And that is just for starters.
This was recently evidenced by two announcements from the White House. The first from Gregory Mankiw, the chairman of the Council of Economic Advisers was quoted during a conference on tax policy : "There are no free lunches here", and the second from the President himself: "We will not raise payroll taxes to solve this problem".
Creating personal accounts will not decrease the national debt even as more is created to change the program. National savings, now at an anemic .02% will not change without some sort of increase in debt. In our current model of economic health, savings, while worthy, is not something that is encouraged.
In other words, the more we save, the more debt will be needed to make up for the shortfall under current economic conditions. A shift to a savings based society will have short term budgetary issues as money for expansion dries up.
The President is quick to point out the advantages of Chile's reform of their social system in 1980 as the model for our reformation. But not so quick. There were several things in place when the program in that country shifted.
The Chilean government tied this changed to "one-time" government bonds with costs spread to future generations, a residual payroll tax, governmental privatization of many state run industry and a deliberate surplus that was created before the reform could be enacted to help pay for the change. None of these conditions are available to us.
It probably more apt to compare our efforts to Argentina, whose national debt ballooned because of their effort to borrow to fix a debt problem in their social system. The bottom line is that raising taxes is the best way to fix the system as proposed by the President.
Would you be able to invest if your retirement was your responsibility? I wonder, if given the opportunity when I was twenty-five, would I have done so. By the time I was thirty, I was well into raising a family. By the time I was in my forties, I realized that I needed to supplement my retirement, which was to be funded by a pension and Social Security. Had neither of those two been there, my working career would need to be extended far beyond my ability t remain productive and viable in the work place.
Poorer workers struggling in lower paying jobs would have little incentive to divert much needed funds to their future when their present demands so much. That is not a liberal patronization of the working poor. It is a reality that I have lived and I knew what I was missing as every earned cent went to the family budget. Imagine a realization by American workers that retirement was nearing and nothing had been done by them to insure a future. If young folks do not believe in the program now, there is little likelihood that they would possess the farsightedness needed to prepare for their future.
At Arm's Length: 12.16.04
Evidence that these investors are finding inflation worth betting
against can be found by subtracting the yield from Treasuries of similar
maturity against the yield of Treasury Inflation Protected Securities or TIPS. Also a look at the President's Economic Summit.
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