THE GREAT SOCIAL SECURITY DEBATE, PART II

 In last week's WWNK, we analyzed how Social Security currently works and whether it's indeed on its last legs, as politicians would like to have us believe. In Part II, we're going to dissect Bush's reform plans and see if they can really stand up to their promises.

All of the foregoing was necessary to provide the backdrop for the most radical proposal to change Social Security since its inception, George W. Bush's drive to privatize. The basic notion is simple: Allow younger workers to divert about a third of their Social Security taxes into private investment accounts. This money would be put into the stock market, or some combination of stocks and bonds, in the hope of generating a relatively high rate of return. In addition, these accounts could be used not only for retirement income but, unlike the present setup, would be private property. They could, for example, be willed to a decedent's heirs, thereby holding out the prospect of helping to alleviate intergenerational poverty and, incidentally, to improve the lot of African- Americans. (For an interesting analysis of how Social Security is racially discriminatory,
click here).

When considering the President's ideas (remembering that they are in flux), it is logical that we first ask whether they are intended to fix what he believes is wrong with the system. The answer is a clear "no". An Administration briefing handed out to the media in February put the matter succinctly: "Personal accounts would have a net neutral effect on the fiscal situation of Social Security."

Say what? We've been led to believe that privatization is about saving the system. If it isn't, then what is it about?

An internal White House memo, leaked to the press in early January, provides some guidance. In the memo, Karl Rove aide Peter Wehner outlined the Administration's thinking on the overall subject. Wehner admits that "Personal Retirement Accounts alone... simply cannot solve the Social Security problem." (What will, he says, is benefit cuts. That crackling third rail has been stepped on.) However, he goes on, "we consider our Social Security reform not simply an economic challenge, but a moral goal and a moral good... Our goal is to provide a path to greater opportunity, more freedom, and more control for individuals over their own lives."

As this spokesperson makes clear, the President has a grand vision. He has said it often. He wants to transform America into an "ownership society", much along the lines of the Chilean model (see
WWNK 11/1/04), with more emphasis on self- reliance and fewer government handouts.

This really frames the debate as a philosophical and not an economic one, and in our opinion, that's the way everyone should look at it. All the talk of a "crisis" and "saving" Social Security is just so much political bunk. What we should rather be asking ourselves is: Do we want to continue having present workers subsidize retired ones, or do we want to let present workers put some (or most, or all) of their money to work in the marketplace, specifically for themselves, and to use the resultant nest egg for their own retirement and for the benefit of their descendants? Or to put it another way, should individuals be trusted to keep their own money and use it to look after their own retirement?

One of the ironies of the situation is that privatized accounts wouldn't even have to be invested in the stock market at all (the aspect of the plan opponents call the most risky). Merely diverting half of workers' contributions into T- Bills, and allowing for the miracle of compound interest, would result in more money at the end than the full contribution will produce under the present system. Which is to say that if the other half were invested in the stock market, and you lost every penny there, you'd still come out ahead.

Regular WWNK readers will know where we come down on this. True privatization sounds like a laudable aim to us. But is that really what the White House is offering? As with all politicians and their promises, the devil is in the fine print. When we examine that, we find that the reality isn't quite so straightforward. For example, under the Administration's proposal, the individual wouldn't control his or her account; the government would keep and administer the money, deciding how to allocate resources and when to distribute profits. Now, due to the financial ignorance of so many, one could argue that there should be some bar against high-risk investments (the Chilean system does), but this setup forces us to rely on the government to administer our personal monies in our best interest. Talk about risk.

Worse still, the Bush plan specifies that upon retirement, workers would be returned only the amount that exceeded inflation-adjusted gains over 3 percent. The SSA hopefully projects a return of 4.6% above inflation; the Congressional Budget Office, less sanguine, thinks a 3.3% return is more realistic. Either way, the government gets to hang onto the first several percentage points of your profit; brokerage fees included.

What does this mean in the real world? Assume that you invest $1,000 per annum for 40 years, starting today, and realize gains at 4%, midway between SSA and CBO estimates. At the end of that time, your "personal" account would grow to $99,800 in today's dollars, but the government would then take back $78,700, a pretty hefty bite. But what if it only grew by an average annual 3%? Thanks to the government's 3% fee, your net is zero. What they intend to do if there are some lean years and profits fall below that mark has not yet been decided, but it's not inconceivable that you could wind up owing the government money.

This sounds like just another confiscatory government scheme to us. Or as Peter Orszag--head of the Pew Charitable Trusts' bipartisan Retirement Security Project--puts it, what this amounts to is a loan from the government, to be paid back upon retirement at an inflation-adjusted 3% interest rate. Even conservative Stephen Moore, author of the book Bullish on Bush, admits that this plan undermines the notion of an "ownership society." However, the question is why the government should have the right to take back any profits from a "private" account at all.

In the end, no doubt, the mechanics of partial privatization will be tinkered with. But there's another huge issue to confront, and it may well prove far more of an impediment to genuine change: If, in the near future, present workers are allowed to divert a third of their incomes into private accounts, then SSA receipts will drop by that amount. How do we finance the transition costs?

The answer is--you guessed it--debt. The Administration's own estimate is that over the first ten years of its fully phased-in privatization plan (2009-2018), $1.4 trillion will have to be borrowed. For the ten years after that, the figure is $3.5 trillion more. It could run higher if Chile proves representative. They spent 3% of GDP on the transition, which in the U.S. translates to about $330 billion per year.

Whatever the cost, this will be added to present federal debt ($7 trillion and counting), along with the rest of the red ink our reckless spending habits generate over the next four years (2004 deficit alone: $477 billion), raising the question: At what point will we drown in the sea of our own indebtedness? Nobody knows. The only certainty is that there will be such a point.

However, a transition to the Bush version of partial privatization, costly as it may be, is not the only reason for concern. Recall that the Administration admits the changeover won't help avert the "crisis" represented by the exhaustion of reserves in 2042. Yet according to the Wehner memo, "our aim is [not only] to introduce market reforms in Social Security [but also to] make the system permanently solvent and sustainable." That's an ambitious goal, considering the large potential shortfall. In order to achieve it, Wehner adds, "we're going to take a very close look at changing the way benefits are calculated."

What's really being proposed here, without quite saying it, are benefit cuts. At the moment, increases in Social Security benefits are indexed to rising wages. According to Wehner, the 2050 retiree will receive about 40% more (in real terms) than someone drawing today. This, he thinks, is indefensible. Why should the rate of increase escalate like that? Why not index the yearly boosts to inflation rather than wages, since the latter usually tends to outpace the former?

If this adjustment were made, the solvency of Social Security would benefit at what seems like no real cost to beneficiaries. Sounds good. Once again, though, we have to examine the real-world consequences. Luckily, the Congressional Budget Office has done the math for us. The CBO has computed benefits promised at retirement in three ways.

Option 1: Scheduled benefits--what someone would get in their first eligible year if the current system were retained but made fully solvent through increasing revenues.
Option 2: Payable benefits--what someone would get if no action whatsoever were taken to "save" Social Security.
Option 3: White House plan--what someone would get under the present Administration proposal for a 1/3-privatized account.

Option 3 results were determined using the intermediate scenario, a switchover to price rather than wage indexing beginning in 2011, and risk-adjusted gains for private investments. Under all options, initial benefits claims are assumed to be filed at age 65, and payouts are expressed in 2004 dollars (if you are able to read governmentspeak without going stark raving mad, here is the
CBO document from which the figures below are taken).

The numbers are a bit startling. Workers would do a lot worse under Option 3 (partial privatization) than they would under Option 1 (current system with revenues adjusted to maintain solvency). More surprisingly, they would even do worse than under Option 2, if Social Security is not tinkered with in any way. The results hold across all income levels and birth dates--in fact, the more recently you were born, the worse you'd do under Option 3.

Interested readers can click on the link above and go directly to Table 2 to see results for all the different combinations of income and birth year, but here's one example: If you were born in 2000 and were a middle-income worker, your first-year payout at age 65 would be $26,400 under Option 1 and $19,900 under Option 2. Under the White House plan, expected benefits would be only $14,600. Thus, partial privatization would yield a net loss of 50% versus presently scheduled benefits, and 34% if nothing is done at all!

Any way you slice it, that is a hefty benefit cut.

What all of this truly means is anybody's guess, since facts and figures are routinely twisted this way and that, but these are our own conclusions:

1) Social Security could use some tweaking, if we wish to continue with the present system, but the "crisis" is far less serious than the most vociferous proponents of change have made it out to be, and may in fact be entirely illusory.

2) Those most stoutly proclaiming the need to maintain the status quo are probably doing so out of political considerations, not economic ones. The truth is that investing money in even the most stodgy instruments and allowing it to grow is better than robbing Peter to pay Paul.

3) True privatization, whether partial or not, would be better than what we have now. If we can afford the transition costs.

4) The White House partial privatization plan is probably the worst of both worlds. It preserves 2/3 of the present system. It is not real privatization at all. And it is too basically flawed to do much, if any, good in the real world for its beneficiaries.

This is a very important issue, for all of our futures. We encourage readers to do their own due diligence before making up their minds on the matter, and to let their political representatives know what they decide.

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Posted 03-14-2005 7:10 PM by Doug Casey