Would Americans as a whole be better off if the existing Social Security system were partially supplanted by a system of individual accounts? Who would gain, and who would be worse off? How might such a shift affect the national economy, if at all?
These are important questions that a new panel appointed by the Bush administration must examine in coming months. George W. Bush ran on a platform that included changing Social Security to include some form of private investment accounts. Now he has to present a detailed plan of how to administer and implement such a major change in a program than most U.S. citizens hold dear.
Critics have complained that although the panel is bipartisan in the sense of having members of both major parties, it is packed with individuals who already openly support some system of individual accounts (IAs).
That complaint may have some validity, but I respect many of the panel members and trust them to do their work with integrity. Meanwhile, citizens who feel strongly about Social Security bear some responsibility for studying the issues.
Most of the public discussion thus far contains naive assumptions. Proponents point to the high returns IAs would have experienced in the 1990s bull market. Opponents describe helpless, baffled grannies choosing between buying Duke Power or Cisco Systems and besieged by oily, hard-sell stockjobbers.
Both these stereotypes are pretty thin. Long-term investments in private capital markets do provide higher returns than the Treasury bonds in which Social Security “trust funds” are “invested.” But private capital markets also involve more risk and volatility. It is easy to identify significant periods such as 1930-1950 or 1971-1985 during which T-bonds would have provided a better return than equities.
But it is also pretty clear that IAs need not plunge every retiree into the Nasdaq. Risk-averse retirees could put their accounts into Treasuries and experience roughly the same risk and return as the Social Security funds in general.
My objection to IAs is that they will not do anything to increase productivity or output. True, hundreds of billions of dollars of IAs will be invested in private markets.
But increased Treasury borrowing caused by smaller flows into the “trust funds” will exactly offset this new investment. Retirees will have a different kind of claim on future output, but there will not be any more output to claim.
That criticism seems to be too academic to most of the people to whom I voice it. But such individuals may be swayed by the more pragmatic arguments of two critics of the potential cost and administrative complexity of implementing IAs.
As founder and former CEO of the Vanguard Group, John C. Bogle practically invented the modern mutual fund. In a March 21 talk to the National Press Club, Bogle presented a scathing critique of the mutual fund industry, criticizing most funds’ high administrative costs, which average about 3.5 percent annually, and their increasingly heavy emphasis on advertising and marketing rather than on prudent management.
In the question period following his talk, he applied the same criticisms to IAs. If individual accounts bear the same average administrative costs as mutual funds, most of the higher returns of private capital markets compared to “trust fund” earnings will be wiped out.
Another useful source is a study by pension researchers Kelly Olsen and Dallas Salisbury. They argue that “an objective examination of how to administer such accounts raises concerns that cut across ideology.” They further highlight three considerations:
- Social Security policy directly affects 96 percent of the U.S. work forces and their employers every pay period.
- Over twice as many workers are covered by Social Security as the number of individuals in the U.S. who own shares in mutual funds.
- No unified system currently has the capacity to administer 148 million IAs. A system of IAs with full participation would include at least seven times the number of currently active 401(k) accounts.
© 2001 Edward Lotterman
Chanarambie Consulting, Inc.