Questions & Answers On Privatizing Social Security

by | Aug 7, 2001 | POLITICS, Social Security

Aren’t most people too unsophisticated to manage their private account? This is a valid concern, but there are simple solutions that have worked well over twenty years with 401(k) plans, and they could easily be applied here. First, rudimentary investment education can easily be supplied — mastering a few cookie-cutter basics is enough to equip […]

Aren’t most people too unsophisticated to manage their private account? This is a valid concern, but there are simple solutions that have worked well over twenty years with 401(k) plans, and they could easily be applied here. First, rudimentary investment education can easily be supplied — mastering a few cookie-cutter basics is enough to equip a newbie to avoid 90% of the pitfalls. Second, professional advice can be provided either through individually tailored services, or by use of collective investment vehicles such as mutual funds. And third, the number of investment choices permitted in the private accounts can be constrained to rule out the really risky stuff.

And as I’ve said before, you’d have to practically try on purpose to have bad long-term results to get outcomes that are as awful as the rates of return produced right now by the existing Social Security system. And those already awful returns are only going to get worse when taxes are inevitably raised and benefits are inevitably cut.

Okay, but what if despite all that some people blow it. Wouldn’t the government have to step in and bail them out? Well, no. Government doesn’t step in today to bail people out who arrange their affairs in such a way that their meager Social Security income isn’t enough to live on.

But wouldn’t it be better to keep risk of investment loss out of the picture entirely? Whatever may be wrong with the existing system, at least the returns are guaranteed. The returns of the existing system — poor as they are — are not by any means guaranteed. They can be reduced, delayed, taxed, or discontinued altogether at any time by the whim of Congress. Social Security participants have no property right or contractual right in their account — in fact, they have no “account” at all in the usual sense. It’s just a welfare program, like food stamps or subsidies to farmers for not growing potatoes.

The financial services industry doesn’t want private accounts, because there would be so many of them — and they’d be so small — that it wouldn’t be profitable to service them. The financial services industry put itself through a decade of competitive paroxysms to win 401(k) business when it was all up for grabs during the 1980s and early 1990s. It is now very well equipped to handle lots of small accounts. If it were not, why would American firms go all the way to Chile to service private retirement accounts there — in a country that is far smaller and far poorer?

Private accounts are just a scam by the financial services industry, designed to drum up business. Well, obviously this objection isn’t raised by the same people who raise the previous one!

Shouldn’t private accounts be modeled on the existing Federal Employee Retirement System (FERS) model? Many people have held up the 401(k)-like plan available to all Federal workers as an ideal private account system. I know that system well, by the way — they used to be my biggest customer when I was with Barclays Global Investors, who managed most of the investments in the plan.

The FERS program is deliciously simple. Employees pay part of their salary into a private account, and the employer (Uncle Sam, in this case) matches it with a contribution of its own. The accounts can be invested in an S&P 500 Index Fund, a Lehman Aggregate Bond Index Fund, or a money market fund.

It’s so simple, all the participants seem to be able to understand it. The funds all have astonishingly low fees because they are so big and so simple. And the bookkeeping is all administered by the Department of Agriculture — you know, the same folks who brought you food stamps. As a libertarian, I’d like to see a plan with more choices. But compared to the current Social Security system, the FERS plan is a dream come true. Social Security reform would do well if it did no more than emulate this winning formula.

What about the “transition costs” of moving from the current system to private accounts?
As I wrote in my column yesterday, “transition costs” are a myth. There would be no transition costs. All costs associated with shutting down the existing system are costs that are already born by maintaining it.

Why should private accounts make the stock market go up, as I have claimed? Stock prices are driven by corporate earnings, not the supply of fresh money in the markets. True, stock prices are driven by earnings. But earnings are driven by the health of the economy, and nothing would promote the health of the economy more than solving the Social Security crisis, and at the same time creating a nation of savers and investors destined to earn higher rates of return over their lifetimes.

But beyond this, there are other factors that influence stock prices besides earnings — especially tax policies that enlarge or contract the fraction of those earnings that investors get to keep, after taxes. Private accounts would be, to some extent, a tax shelter. That would raise the after-tax value to investors of even a static earnings stream. And that would raise stock prices.

If private accounts actually happen someday, which stocks could benefit the most? Fair question — but it’s the wrong one to ask. If we are able to drive a stake through the heart of the vampire that is the existing Social Security system — and thus prevent it from sucking more blood from the neck of the body politic — and replace it with a system of private accounts that can be invested in stocks — and thus ignite a booming economy and a booming market — it won’t even matter which stocks you buy. Just buy stocks.

The views expressed within represent those of the author, and do not necessarily reflect those of Capitalism Magazine’s publishers.

Don Luskin is Chief Investment Officer for Trend Macrolytics, an economics research and consulting service providing exclusive market-focused, real-time analysis to the institutional investment community. You can visit the weblog of his forthcoming book ‘The Conspiracy to Keep You Poor and Stupid’ at www.poorandstupid.com. He is also a contributing writer to SmartMoney.com.

The views expressed represent those of the author and do not necessarily represent the views of the editors & publishers of Capitalism Magazine.

Capitalism Magazine often publishes articles we disagree with because we believe the article provides information, or a contrasting point of view, that may be of value to our readers.

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