By Stephanie Kelton
Some of the members of the president’s National Commission on Fiscal Responsibility and Reform are using the trumped-up crisis in Social Security to push their decades-in-the-making agenda of privatization. For example, Andy Stern, one of the commission’s key members, wants to see the system transformed from one that guarantees a minimum standard of living to the elderly, their dependents and the disabled into one that leaves them (in whole or in part) dependent on the vagaries of the market.
Asked to comment on Stern’s privatization proposal, Dean Baker recently said:
“I don’t think it’s necessarily a bad idea …. If he’s talking about getting money out of the trust fund for that purpose, I could live with it. You’d get a higher return now that stocks are falling.”
To defend his position, Baker pointed out that the Trust Fund, which consists almost entirely of non-marketable government securities, is only earning about three percent but that “it would be reasonable to assume a six or seven point return” on funds invested in the stock market. Hmm . . .
Seven is greater than three. You can’t argue with that. That is, unless you look more closely at what privatization would actually entail.
Since President Obama’s deficit commission hasn’t proposed anything concrete (yet) – i.e. we don’t know how much of the current system they want to privatize – let’s go ahead and use George W. Bush’s privatization proposal, simply for purposes of demonstration.
In 2005, President Bush pushed for partial privation of Social Security, which would have allowed workers under the age of 55 to divert up to 4 percent of their current payroll tax contribution into their own retirement accounts. Workers who decided to participate would then depend upon benefits from two sources: (1) the (now lower) guaranteed benefit they would continue to receive from Social Security and (2) the market benefit that would accrue in the form of gains in their personal account. Clearly, the more an individual diverts into private accounts, the less they would receive in the form of a guaranteed benefit, and, hence, the more they will rely upon gains in financial markets.
Here’s the way a Senior Administration Official sold the Bush plan in 2005:
“The way that the election is put before the individual in a personal account structure of this type is that in return for the opportunity to get the benefits from the personal account, the person foregoes a certain amount of benefits from the traditional system.
Now, the way that election is structured, the person comes out ahead if their personal account exceeds a 3 percent real rate of return, which is the rate of return that the trust fund bonds receive. So, basically, the net effect on an individual’s benefits would be zero if his personal account earned a 3 percent real rate of return. To the extent that his personal account gets a higher rate of return, his net benefit would increase as a consequence of making that decision . . . .
. . . the specific trade-off that you’re making in opting for a personal account is based on your decision that you
think you can beat the 3 percent real rate of return.”
So that’s the privatization pitch: privatization offers better prospects for growth and, ultimately, a more comfortable retirement. This is especially true in the case of younger workers, because they can get in early and experience the magic of compound interest. This, apparently, is where Dean Baker is coming from.
It’s a choice that seems to make sense for those who expect their personal account to earn a rate of return that exceeds the rate of return earned on Treasury bonds (held in the Trust Fund). But is it really such a no-brainer? Let’s look more closely at the implications of diverting withholdings into personal accounts.
Investing in a personal account means foregoing a portion of the guaranteed benefits that would have been received under the traditional system. Advocates of privatization see no harm in this, since earnings on personal savings accounts should more than offset the foregone benefits. Chart 1 on page 13 of this essay provides a diagrammatic description of the role of personal savings accounts in offsetting guaranteed benefit reductions.
It works like this. When a worker agrees to establish a personal account he is effectively asking the government to lend him part of his Social Security tax so that he can invest it in the stock market. The government would monitor these loans and investments by establishing parallel accounts, a ‘notional account’ (to keep track of the loan) and a ‘personal account’ (to keep track of the investment). This means that diverted payroll contributions would be double-counted, and each account would be credited, over time, with interest – the notional account would accumulate interest at the rate of return on Treasury bonds, and the personal account would accumulate interest at the nominal portfolio rate of return, less annual fees.
To make the argument concrete, consider a highly simplified example. Suppose an individual’s notional account would equal $100,000 at retirement. If this person’s life expectancy at retirement is 20 years and the annuity draws zero interest and comes at zero administrative costs (simplifying assumptions), the annuity on this account would be $5,000. This sum – known as the “clawback” – would be deducted from the defined benefit amount, to arrive at the “benefit after clawback.” If the defined benefit (calculated using an inflation-index) would have otherwise been $12,000 per year, it will now be $7,000. Now, if the poverty-level of income is $16,000, this individual’s personal account will need to be sufficiently large (well above $100,000) to allow an additional (lifetime) benefit of $9,000 per year through annuitization.
As time goes on, the size of the clawback would grow, relative to the benefit, because the clawback would be proportional to wages, whereas the defined benefit would be fixed in real terms (i.e. indexed to prices). This would make workers increasingly dependent on the annuitized value of their personal accounts. Moreover, workers will have to pay a fee – to financial firms – to annuitize their individual accounts, a cost that could absorb as much as 10 to 20 percent of their savings, as Dean Baker showed when he was an outspoken critic of privatization in 2005.
With the size of the after-clawback benefit projected to decrease over time, it is likely that the whole private account will need to be annuitized. And, unless the stock market performs incredibly well, there is a good chance that the annuitized value of the private account will be insufficient to sustain many Americans in retirement.
The groups who are most vulnerable to this kind of shortfall are women and minorities, who make up a disproportionate share of America’s low-wage workers. This has been emphasized by Diana Zuckerman, president of the National Research Center for Women and Families, who argued that “[w]omen depend more on Social Security than men do, because women are less likely to have their own private pensions when they retire.” And, even when they do have pensions, Zuckerman said, “their pension checks are, on average, half as large as men’s are.” This means that our nation’s low-wage workers are particularly vulnerable because they are less likely to have other forms of saving, pensions, etc., to supplement Social Security in retirement.
So here we are again, this time with a Democratic president and a deficit commission stacked with conservatives posing the same question the Bush administration asked in 2005: Do you want your money in a Trust Fund that earns a 3 percent real return, or would you prefer to invest it in a personal account that might yield nearly 7 percent after inflation? Using this simple argument, people like Andy Stern will try to persuade Americans that the answer is fairly obvious.
For the sake of millions of Americans who are able to avoid the anguish of poverty only because of the benefits they receive under the current system, I hope Dean Baker will return to his roots and lead the progressive charge to preserve Social Security as we know it.