The Electric Commentary

Thursday, September 23, 2004

The New York Times tells you how to save for your retirement, and calls you stupid.

The NYT is vehemently against "privatizing Social Security," that is, allowing people to take a portion of their normal Social Security contribution and putting it into a tax free retirement account of their choosing. It's long, but how could I resist?

Among the clear-cut policy differences between President Bush and Senator John Kerry is each man's take on Social Security. In his acceptance speech at the Republican convention, Mr. Bush said, "We must strengthen Social Security by allowing younger workers to save some of their taxes in a personal account." Mr. Kerry, in his acceptance speech, said, "I will not privatize Social Security."

Mr. Kerry is right, and Mr. Bush is wrong. The president's plan would do the opposite of what Mr. Bush claims. It would weaken Social Security, hurt the economy and endanger many workers' retirements by pushing them into unreasonable risks in the stock market. If Mr. Bush were a broker peddling stocks to low-income, uninsured, indebted individuals like many of the Americans who would be included in his plan, he would be violating rules that require brokers to recommend only suitable investments.

The NYT gets off to a terrible start by making the assumption that many/most people would use their privatized funds to invest in the stock market. Some undoubtedly would, and more power to them, but those interested in safer investments have available things like CDs and government bonds. Both pay a higher rate of interest than Social Security. In fact, Social Security in its current form is one of the worst investments that a person can make. Your best case scenario, after adjusting for inflation, is that you will receive back about what you paid in with no interest accumulated! How is that less risky than sticking you money in a certificate of deposit?

Also, when did the President push the Stock Market? And when did Kerry offer a solution? “I will not privatize Social Security” is not a solution. It is merely an endorsement of a status quo that will run out of money at about the same time I will be retiring. But I’ve been reassured by Senator Kerry that this is risk free for me.

When responsible politicians talk about "fixing" Social Security, what they generally mean is finding a way to guarantee a basic level of financial security for the elderly while closing the gap that will develop over time in the system's finances if nothing is done. Social Security's trustees plan for solvency over 75 years. Currently, the program is projected to come up short in 2042, when it will be able to pay about 70 percent of the promised benefits. That's a lot of money, but the gap can be bridged over the next 38 years with a package of modest reforms, which we will discuss in a future editorial.

These “responsible politicians” are talking about:

1. Paying more money out and,
2. Bringing more money in.

Apparently they did not plan very well for the next 75 years. Notice there are no plans on how the “responsible politicians” will accomplish this. I will be waiting for that future editorial. Have any “modest reforms” in history ever raised an additional 500 billion-1 trillion dollars?

What Mr. Bush proposes - allowing workers to divert some of their Social Security taxes into personal investment accounts in exchange for agreeing in advance to receive a much-reduced guaranteed government benefit when they retire - would neither provide retirement security, nor take care of the solvency of the Social Security system. And it would wreak havoc with the overall federal budget.

So, making workers more self-sufficient and agreeing to not take money later will not reduce the burden on the SS system. Interesting accounting. Also, providing people with an interest-bearing tax-free savings account will not provide security. This is the part where they are calling you stupid, by the way.

In proposing personal accounts, Mr. Bush has promised to retain the current benefits for today's retirees and for those who are nearing retirement. So for some 40 years, workers would be making deposits into their accounts with tax money that - under the current system - would have been used to pay the benefits of those who are retired. The government would have to make up the difference, and Mr. Bush has no reasonable plan for covering this cost, which is estimated to be at least $1 trillion.

But there are options. Higher taxes (which will certainly be needed if SS is not privatized), spending cuts (ditto), and borrowing (the least desirable but most likely). The President may not close the gap in the best way, but some gap is going to have to be closed whether SS is privatized or not. The cost in the future will probably be higher because as the “zero hour” approaches and it becomes apparent that borrowing will be necessary, interest rates will skyrocket. If borrowing is less available, taxes will likely require a bigger hike, and/or spending a bigger cut. At this moment we have flexibility. This is not an easy problem, but it is better to deal with it now, rather than waiting for our backs to be up against the wall.

That leaves three general possibilities: immense government borrowing, draconian cuts in other programs or higher taxes. In a 1997 report by President Bill Clinton's Advisory Council on Social Security, those who favored ample mandatory personal accounts proposed a national sales tax of 1 percent and $1.2 trillion in government borrowing.

If offsetting steps were not taken immediately, the reduced cash flow in the transition period would drive the Social Security trust fund into the red about 15 years earlier than is currently projected. That, too, would require wrenching fiscal moves - borrowing, spending cuts, tax increases - to avoid default on the government's obligation to retirees.

When workers in a partly privatized system reached retirement, they would find that higher interest rates caused by huge deficits, reductions in government services or higher taxes had offset some - if not all - of the sums they had accumulated in personal accounts. And they would get smaller government benefits than they would if Social Security had been reformed in a more sensible way.

But these options will still be the only options if SS is not reformed. There are only a few ways for government to raise money, and this is the list. And apparently all cuts are draconian in the eyes of the NYT. The last sentence is truly bereft of logic. Even if we accept that higher interest rates would be inevitable – and this assumes that borrowing funds this effort, not taxes or spending cuts – high interest rates are only bad for the government and borrowers. If you are saving, high interest rates are good! You can purchase debt instruments and get a very high return. Most retired folks have less debt, as they have spent their lifetimes paying off mortgages. Most retired folks also have more savings. So even in the worst case scenario leveled by the Times, the private investor still comes out ahead. And we’re still waiting to hear about that “sensible way.”

However Social Security is reformed, when younger workers retire, their benefits are likely to be smaller than the benefits promised to current retirees. But a partly privatized system would produce a cut that's likely to be bigger and an income that would be far less reliable. That's because the government benefit is cut more deeply under privatization, and how much you can actually accumulate in a personal account would depend on the stock market. Anyone who lived through the 1990's knows that investing in stocks can leave you with less than you started with.

Privatization would invite overexposure to the stock market - a risk that is not justified by the potential return. Most people who already save for retirement rely heavily on stock investments through 401(k)'s and other savings plans. Even workers who have traditional pensions are more exposed to the stock market than ever, as employers increasingly strive for outsized stock market returns to make up for inadequate contributions to their plans.

Did you notice the subtle implication that benefits will be cut? Think about the consequences for a politician if he mentioned such a thing, not that it is a bad idea. And again with the stock market. I’ll respond again. Because these are private accounts, they need not go into the stock market. There are other more secure options that people are perfectly free to choose. And notice that the example used for criticism uses an analogy to pensions and how they have come to rely on the market. Pensions are just like SS. They are retirement accounts managed by people other than the retiree who are obligated to keep them properly funded. Private pension providers, unlike the government, can not just raise taxes or borrow to meet their obligations, hence the stock market investing. The Times here is criticizing private pension providers for attempting to maintain solvency and praising a system that does not even pretend to have a plan for solvency.

And people without pensions or enough income to save money in retirement plans generally do not belong in the stock market at all. Stock investing makes sense only after you have accumulated an emergency cash reserve, are adequately insured and have paid off consumer debt. Personal accounts within Social Security would perpetuate the wrongheaded notion that the stock market can bail everyone out. It can't. Mr. Bush does everyone a disservice by implying that it will.

Thank you, NYT for your advice. I’m glad to see that you have entered the field of financial planning. This is so paternalistic. If you think that it is a good idea, you should not be able to invest in the stock market. Even a mutual fund is too risky for the Times. I advise the Times to pick up a copy of the Wall Street Journal, where they can read all about bonds, CDs, Christmas Clubs, etc. The market can not bail everyone out, and no one has argued that it can. But it can be a good investment for many, and not just under the circumstances listed by the Times.

The personal account idea also does nothing about another big reason that Social Security needs reforming: people are living longer. Unless the government mandates that people convert their personal accounts into private annuities, retirees are in danger of outliving their money, leaving them to survive on the meager government benefit. And they would lose the inflation protection built into government benefits, which is increasingly important the longer you live. Those most at risk of impoverishment are old women, who live three years longer than men on average and are far less likely to have private pensions.

Social Security is adjusted for inflation after payment begins, but it does not accumulate anything that could be considered interest before that. Your money loses value every day that it sits around waiting for you to retire. Of course, it doesn’t just sit around; it gets paid out to current retirees, which causes the problem in the first place. If people live longer (and they do) they will probably also work longer. If someone is going to retire within the next 10 years, and it appears, based on the medical science of the time, that they will live for another 30, they will probably make sure that they have enough money for at least that long before retiring. SS right now, on the other hand, will not last long enough to take care of me. Unless I pump more money into it.

There is a broad social argument against privatization, which is that we all lose if our fellow citizens come up short in their quest for secure retirements. By taking the financial risk out of growing old, Social Security has had remarkable results for society at large. Poverty among the elderly is now 10 percent, down from 30 percent in 1960. Like any sound insurance system, Social Security works by broadly pooling risks. It protects everyone because it includes everyone. Personal accounts move Social Security away from a comprehensive system to one in which it's increasingly every man for himself.

Part of the reason that poverty is low among the elderly is already personal investment and private pensions, which begs the question, why is it bad to have more private savings. Those that are poor are those that survive solely on SS. SS does pool risk, however, when a risk is pooled and the system failed, it is a disaster for millions of people. When risk is on the individual, that individual has a huge incentive to get it right.

The “every man for himself” phenomenon is also alive and well in SS, as it is when any commons is a provider of resources. One of the problems of Social Security is that everyone on it has an incentive to get as much out of it as possible. I think that Abraham “Grandpa” Simpson said it best:

"I didn’t earn it, I don’t need it, but if they miss one payment I’ll raise hell!"

None of these arguments deter Mr. Bush and other advocates of personal accounts. For them, Social Security is primarily an ideological struggle. Social Security supports retirees by shifting income from the young to the old via taxes, and from the rich to the poor via the formula for calculating benefits. To Mr. Bush and his supporters, taxation and redistribution are anathema, and Social Security is an anticapitalist ploy to squelch initiative and growth. Those same arguments were leveled against Social Security when President Franklin Roosevelt established it in 1935, and when its constitutionality was upheld by the Supreme Court in 1937.

For Democrats it is also an ideological struggle. So what? Privatizing SS makes sense. Doing nothing about it does not make sense. That is the only important issue. Is it good to shift money from young to old (which incidentally shifts money from poor to rich)? After SS is shifted to the old, it is then shifted again so that the poor elderly get more and the rich elderly get less. Social security may not be an anti-capitalist ploy, but it is certainly anti-capitalist, which is precisely why it is running out of money.

Let’s assume that you are a responsible person and you save up all of your life. You are forced to participate in the social security program not for your own good, but because if you did not, there would not be enough money to support those who are not responsible if the responsible are not included. Stating that it is for your own good (if it is a worthwhile argument at all) only applies to you if you do not save any money. Finally, stating that something was upheld by an FDR Supreme Court for the purpose of bolstering an argument is pretty worthless, as all FDR era Supreme Court decisions were coerced by FDR, who threatened to increase the size of the court to ensure a sympathetic majority.

There is not positive solution offered in this article, nor does Kerry offer one. Personal accounts may not be a cure all, but they are a good start, and certainly better than the status quo. Even though the Times claims hat they will offer up positive ideas in the future, they make several arguments in favor of the current system in the course of the editorial. If they truly favor the current system and simultaneously detest taxes, “draconian spending cuts” and borrowing as much as they say they do, I suspect the reason that they side-step offering solutions is because they don’t have any. The current system can only be maintained with a lot of extra government income, there is no way to magically create money out of thin air. If they think that raising taxes or borrowing or cutting spending or some combination is a good idea, they should come out and say so. However, if they decide to do so, their argument against private accounts completely falls apart. They have nothing.


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