Why would private accounts help?

Factual Questions
1

President Bush is pushing the idea of private accounts as part of his plan to fix Social Security. I haven’t heard any explanation of how he thinks that would help. Looking for a factual answer, not a debate of the merits.

As I understand it, the basic problem is that more money is coming out of the system than going in, and the demographics suggest that deficit will continue to grow dramatically. Putting money into private accounts would divert money from going into the system, which would seem to make things worse not better. There must be something that I’m missing.

I’ve looked high and low, and all I can find is political posturing, not an explanation of what and why. What’s the economic theory I’m missing?

2

Private accounts would not fix Social Security.

They are a separate “improvement” to the program designed to give people more control over their money, but the plan will not (in and of itself) increase the amount of money flowing into the program.

In short adopting private accounts is a completely separate issue from “fixing” Social Security. You can fix Social Security without adopting private accounts, and you can adopt private accounts without fixing Social Security. They are independent events.

From what I understand, at least.

3

I think you’ve hit the nail on the head. I don’t think there is any theory as to how private accounts would “save” social security. I believe the White House admitted at one point that private accounts will not alleviate the basic problem that in several years the trust fund will be operating at a deficit.

Now leaving that aside. I think the basic theory as to why private accounts would benefit individuals is the same as why personal 401(k) account or IRAs benefit people. It provides a way to get people to save money for retirement. As to putting that theory to practice, we already have a model: the Private Pension system in the UK. If you want to discuss how well that’s working, Great Debates or the Pit would be a better place for that.

4

Well, the private accounts aren’t being proposed as a “fix” for SS, but as a way to reduce reliance on taxes, but that may just come to the same thing. The idea is that the growth of private accounts will be derived from return on investment, and not so much from payroll taxes. Because the capital would come from payroll taxes, , though, the intial diversion of tax money would require current Social Security obligations to be paid with monies from the General Fund. Eventually, the savings from the private accounts would exceed the cost of turnover. I can’t imagine how long that would take, and there are a lot of details about Bush’s plan that I don’t have, including whether there’s any SS payments after the account runs out, and what happens to the accounts after the holder dies.

5

The President hasn’t proposed a specific plan yet, so it’s impossible to say exactly what he has in mind. That said:

Garfield’s understanding is mostly correct. Switching assets to private accounts will not in and of itself increase the amount of money flowing into the program.

However, the proposal is not separate or independent from the idea of “fixing” the system, at least not down the road, because the thought is that over the long run private accounts will increase the total amount of money available to the program, even as it doesn’t increase the (contributed) amounts flowing in. Specifically, the idea is that accounts under control of individuals will seek, and on balance find, higher returns than those received on the trust fund assets AND that much of that return will not be an intergovernmental asset transfer but will come from other sources (stock appreciation, etc.) So over time, the pool of assets which are in private accounts will be larger than if that pool had been in the social security system and the SUM of total program assets (the private assets plus the system’s assets) will be larger. With a larger pool of assets it will be easier for the non-private part of the system to fund promised benefits – basically, the amount that has to come from the system will be smaller.

6

In addition to what everyone else has said, I read an article explaining the background as to why the “privitization” concept came about. This may be self-evident, but it wasn’t to me until I read the article. It said that since we’ve had the S.S. program, people have grappled with the question of what to do with the trust fund other than just have it “sit there”. The idea of investing the money in the stock market had been suggested, but it was decided that it would create a problem, since it would in essence give the government partial ownership of private companies, rendering them no longer private. So it was decided to invest the money in bonds, so that the government sells bonds to itself, and uses the proceeds from the bond sales to fund the general budget. The problem with that is that it’s been widely criticized as simply “raiding” the trust fund, and many have doubts that the borrowed money will ever be repaid. The idea behind privitization is that the only way to effectively invest the money is to allow private citizens to do it themselves.

At least, that was my reading of the article. Feel free to correct me or add to that.

7

Correct me if I’m wrong, maybe my view is too simplistic, but I thought the debate basically came down to making a choice of:

Leave SS dollars where they are, earning little interest, safe and guaranteed to be there, however the funds are not enough to cover future expenses

or

Let individuals invest the SS dollars themselves into private stocks and funds hopefully earning more interest dollars to cover the shortfalls, however the market is risky and the money can be lost, and there is no safety net if the market crashes.

Is this the general gist of the debate?

8

Essentially, yes. To use a Las Vegas example, do you want to keep your money in the bank, or blow it on a night with the slots?

The only guaranteed winners under privatization are the investment bankers who will be selling those funds.

9

We have an old dog we had fixed.
They are so much easier to control after fixing them.

10

Actually, Wall Street is decidedly leery of the SS accounts. They’re virtually guaranteed to pay less in fees and commissions than regular brokerage accounts, and any plan that makes it past Democratic opposition is going to have strings attacked like the cables on the Brooklyn Bridge.

11

To whom the benefit?

The shell game proposed might do this, and might do that, with regards to the effect on social security, or taxes. No one is really sure.

But I think it is laughably silly that no one has looked at who will gain the most, in dollars over the relative short term if forty or fifty million people suddenly have money to invest in the same sets of securities which are now valued by the demand for them without this sudden influx of investment capital.

Hint: Your senator and congressman are one of the class of citizen who will benefit the most.

Tris

12

Actually, Wall Street is decidedly leery of the SS accounts. They’re virtually guaranteed to pay less in fees and commissions than regular brokerage accounts, and any plan that makes it past Democratic opposition is going to have strings attacked like the cables on the Brooklyn Bridge.

13

Private accounts, per se, have existed for more than 30 years. Anyone ever heard of an Individual Retirement Account?

As mentioned already, diverting some of the revenue stream for social security into private accounts will not help social security. The revenue must be made up somehow, presumably from general revenues or increased taxes.

The economic theory you are missing is what all of us are missing. It has yet to be explained, let alone explained in detail, by the Bush administration. What the shell game evolve.

14

Just for reference, some areas in the US have opted out of the SS system due to a loophole that was plugged shortly after the loophole was exploited. One area is Galviston TX, and IIRC there are 2 more. Returns to the receicptants seem to run about 3 to 4:1, and were running 9:1 during the stock market bubble (all IIRC). Some other countries also use private systems which seem to work well.

15

kanicbird: some areas in the US have opted out of the SS system due to a loophole that was plugged shortly after the loophole was exploited. One area is Galviston TX

For a detailed comparison of the “Galveston plan” with traditional Social Security, check out this analysis (a pdf file listed as Social Security Bulletin vol. 62, no. 1) by the Social Security Administration.

The analysis finds that the Galveston plan generally provides higher benefits to those with higher earnings, but it also has higher payroll taxes. Moreover, it has a higher risk of outliving one’s benefit options, and no additional spousal or dependent benefits such as traditional SS provides. Note also that the Galveston plan is available only to workers employed by Galveston County itself. Since working for local government often involves somewhat better job security, lower turnover, and higher pay than comparable jobs in the private sector, the Galveston plan participants may not be comparable to the average contributor to Social Security.

kanicbird: Some other countries also use private systems which seem to work well.

Which countries in particular are you referring to? AFAIK there are a number of “privatized” national pension systems currently in existence, but certainly not all of them could be said to “work well”.

16

Let’s toss some numbers out into the mix…

As my postulates I had this:

Worker age: 22-73
Worker Starting Salary: $25,000
Worker annual rise in pay: 4%
% of salary invested in private account: 3%
% Return per year on the private account: 5%

So it’s not like I’m lowballing here.

Age	 Income 	SS Investment	SS Return	Total Private Account

2006 22 $25,000.00 $750.00 $37.50 $787.50
2007 23 $26,000.00 $780.00 $78.38 $1,645.88
2008 24 $27,040.00 $811.20 $122.85 $2,579.93
2009 25 $28,121.60 $843.65 $171.18 $3,594.76
2010 26 $29,246.46 $877.39 $223.61 $4,695.76
2011 27 $30,416.32 $912.49 $280.41 $5,888.66
2012 28 $31,632.98 $948.99 $341.88 $7,179.53
2013 29 $32,898.29 $986.95 $408.32 $8,574.80
2014 30 $34,214.23 $1,026.43 $480.06 $10,081.29
2015 31 $35,582.80 $1,067.48 $557.44 $11,706.21
2016 32 $37,006.11 $1,110.18 $640.82 $13,457.22
2017 33 $38,486.35 $1,154.59 $730.59 $15,342.40
2018 34 $40,025.81 $1,200.77 $827.16 $17,370.33
2019 35 $41,626.84 $1,248.81 $930.96 $19,550.09
2020 36 $43,291.91 $1,298.76 $1,042.44 $21,891.29
2021 37 $45,023.59 $1,350.71 $1,162.10 $24,404.10
2022 38 $46,824.53 $1,404.74 $1,290.44 $27,099.28
2023 39 $48,697.51 $1,460.93 $1,428.01 $29,988.21
2024 40 $50,645.41 $1,519.36 $1,575.38 $33,082.96
2025 41 $52,671.23 $1,580.14 $1,733.15 $36,396.25
2026 42 $54,778.08 $1,643.34 $1,901.98 $39,941.57
2027 43 $56,969.20 $1,709.08 $2,082.53 $43,733.18
2028 44 $59,247.97 $1,777.44 $2,275.53 $47,786.15
2029 45 $61,617.89 $1,848.54 $2,481.73 $52,116.42
2030 46 $64,082.60 $1,922.48 $2,701.94 $56,740.84
2031 47 $66,645.91 $1,999.38 $2,937.01 $61,677.23
2032 48 $69,311.74 $2,079.35 $3,187.83 $66,944.41
2033 49 $72,084.21 $2,162.53 $3,455.35 $72,562.28
2034 50 $74,967.58 $2,249.03 $3,740.57 $78,551.88
2035 51 $77,966.29 $2,338.99 $4,044.54 $84,935.41
2036 52 $81,084.94 $2,432.55 $4,368.40 $91,736.35
2037 53 $84,328.34 $2,529.85 $4,713.31 $98,979.51
2038 54 $87,701.47 $2,631.04 $5,080.53 $106,691.09
2039 55 $91,209.53 $2,736.29 $5,471.37 $114,898.74
2040 56 $94,857.91 $2,845.74 $5,887.22 $123,631.70
2041 57 $98,652.22 $2,959.57 $6,329.56 $132,920.83
2042 58 $102,598.31 $3,077.95 $6,799.94 $142,798.72
2043 59 $106,702.25 $3,201.07 $7,299.99 $153,299.78
2044 60 $110,970.34 $3,329.11 $7,831.44 $164,460.33
2045 61 $115,409.15 $3,462.27 $8,396.13 $176,318.74
2046 62 $120,025.52 $3,600.77 $8,995.98 $188,915.48
2047 63 $124,826.54 $3,744.80 $9,633.01 $202,293.29
2048 64 $129,819.60 $3,894.59 $10,309.39 $216,497.27
2049 65 $135,012.38 $4,050.37 $11,027.38 $231,575.02
2050 66 $140,412.88 $4,212.39 $11,789.37 $247,576.78
2051 67 $146,029.39 $4,380.88 $12,597.88 $264,555.54
2052 68 $151,870.57 $4,556.12 $13,455.58 $282,567.24
2053 69 $157,945.39 $4,738.36 $14,365.28 $301,670.89
2054 70 $164,263.21 $4,927.90 $15,329.94 $321,928.72
2055 71 $170,833.73 $5,125.01 $16,352.69 $343,406.42
2056 72 $177,667.08 $5,330.01 $17,436.82 $366,173.25
2057 73 $184,773.77 $5,543.21 $18,585.82 $390,302.29

So at age 73 our worker (who’s done fairly well, I admit) will have $390,000 in his private account. At a 6% CD rate he’ll realize $23418.XX per year in interest if he doesn’t want to touch the principle.

That’s going to come as one hell of a shock for our subject given that he was making $184,000 the year before. I hope he had some other investments along the way.

And if he tops out at say, $50,000 in salary…

Age	 Income 	SS Investment	SS Return	Total Private Account

2006 22 $25,000.00 $750.00 $37.50 $787.50
2007 23 $26,000.00 $780.00 $78.38 $1,645.88
2008 24 $27,040.00 $811.20 $122.85 $2,579.93
2009 25 $28,121.60 $843.65 $171.18 $3,594.76
2010 26 $29,246.46 $877.39 $223.61 $4,695.76
2011 27 $30,416.32 $912.49 $280.41 $5,888.66
2012 28 $31,632.98 $948.99 $341.88 $7,179.53
2013 29 $32,898.29 $986.95 $408.32 $8,574.80
2014 30 $34,214.23 $1,026.43 $480.06 $10,081.29
2015 31 $35,582.80 $1,067.48 $557.44 $11,706.21
2016 32 $37,006.11 $1,110.18 $640.82 $13,457.22
2017 33 $38,486.35 $1,154.59 $730.59 $15,342.40
2018 34 $40,025.81 $1,200.77 $827.16 $17,370.33
2019 35 $41,626.84 $1,248.81 $930.96 $19,550.09
2020 36 $43,291.91 $1,298.76 $1,042.44 $21,891.29
2021 37 $45,023.59 $1,350.71 $1,162.10 $24,404.10
2022 38 $46,824.53 $1,404.74 $1,290.44 $27,099.28
2023 39 $48,697.51 $1,460.93 $1,428.01 $29,988.21
2024 40 $50,000.00 $1,500.00 $1,574.41 $33,062.62
2025 41 $50,000.00 $1,500.00 $1,728.13 $36,290.76
2026 42 $50,000.00 $1,500.00 $1,889.54 $39,680.29
2027 43 $50,000.00 $1,500.00 $2,059.01 $43,239.31
2028 44 $50,000.00 $1,500.00 $2,236.97 $46,976.27
2029 45 $50,000.00 $1,500.00 $2,423.81 $50,900.09
2030 46 $50,000.00 $1,500.00 $2,620.00 $55,020.09
2031 47 $50,000.00 $1,500.00 $2,826.00 $59,346.10
2032 48 $50,000.00 $1,500.00 $3,042.30 $63,888.40
2033 49 $50,000.00 $1,500.00 $3,269.42 $68,657.82
2034 50 $50,000.00 $1,500.00 $3,507.89 $73,665.71
2035 51 $50,000.00 $1,500.00 $3,758.29 $78,924.00
2036 52 $50,000.00 $1,500.00 $4,021.20 $84,445.20
2037 53 $50,000.00 $1,500.00 $4,297.26 $90,242.46
2038 54 $50,000.00 $1,500.00 $4,587.12 $96,329.58
2039 55 $50,000.00 $1,500.00 $4,891.48 $102,721.06
2040 56 $50,000.00 $1,500.00 $5,211.05 $109,432.11
2041 57 $50,000.00 $1,500.00 $5,546.61 $116,478.72
2042 58 $50,000.00 $1,500.00 $5,898.94 $123,877.65
2043 59 $50,000.00 $1,500.00 $6,268.88 $131,646.54
2044 60 $50,000.00 $1,500.00 $6,657.33 $139,803.86
2045 61 $50,000.00 $1,500.00 $7,065.19 $148,369.06
2046 62 $50,000.00 $1,500.00 $7,493.45 $157,362.51
2047 63 $50,000.00 $1,500.00 $7,943.13 $166,805.64
2048 64 $50,000.00 $1,500.00 $8,415.28 $176,720.92
2049 65 $50,000.00 $1,500.00 $8,911.05 $187,131.96
2050 66 $50,000.00 $1,500.00 $9,431.60 $198,063.56
2051 67 $50,000.00 $1,500.00 $9,978.18 $209,541.74
2052 68 $50,000.00 $1,500.00 $10,552.09 $221,593.83
2053 69 $50,000.00 $1,500.00 $11,154.69 $234,248.52
2054 70 $50,000.00 $1,500.00 $11,787.43 $247,535.94
2055 71 $50,000.00 $1,500.00 $12,451.80 $261,487.74
2056 72 $50,000.00 $1,500.00 $13,149.39 $276,137.13
2057 73 $50,000.00 $1,500.00 $13,881.86 $291,518.98

Still a good chunk of change but still not enough to get much traction on. At that level a 6% CD would net him $17490 per year in income. Still kind of a shock.

17

Triskadecamus, but if we were to stand to benefit, why should we be jealous that someone else benefits, too, even if it’s a little more. My boss’s 4% pay raise may be 100% bigger than my 4% pay raise, but I don’t begrudge him for it.

Jonathan Chance, I’ll be lazy and assume the numbers are correct, but then again, social security is not a retirement plan. Anyone who’s not already dirt poor that’s expecting social security to maintain their standard of living is in for a sad, sad suprise when they retire. We have no right to live like kings, and we’re lucky that we have citizenry that support the taxes necessary to ensure that no one must die in thier old age due to total, abject poverty. I’ll use your adjusted figures for this scenario:

Worker age: 22-67
Worker Starting Salary: $25,000
Worker annual rise in pay: 4%
% of salary invested in private account: 3%
% Return per year on the private account: 5%
% of salary invested in 401(k): 20% (15% + 5% employer)
% Return per year on the 401(k): 5%
Note: off a little month for doing year by year rather than day by day.
Also: pretty crappy pay raise - inflation only for the rest of the guy’s life? No promotions? No merit increases for going from burger flipper class 3 to burger flipper class 1?
Also: pretty crappy rate of return (assuming we’re allowed to manage our funds, we can move to better performance. Maybe no 20% returns like the 90’s, but probably closer to 9%).

So…



Year  Age  Income     Investment   Return    Account    401 Investment  Return    Account     Total Save
2051  67   146029.39  4380.881761  12597.88  264555.54  29205.87        83985.88  1763703.62  2028259.16

So, 6 years earlier retirement, he can afford a lot more E.D. medicine. Assuming he wants to live with 5% return without touching the principal, he’d still be netting considerably less than his working income – $101,413 vs $146,029 ($44,616 less). But, retirement is often cheaper than working life: mortgage and transportation costs alone should mitigate this difference. Plus, unless he believes in leaving a huge fortune for his kids, why wouldn’t withdraw some of the principal for special purchases?

Also, consider that the above scenario is someone that starts at $25,000 and never makes career advancements. His life is going to be pretty humble the whole time anyway.

And my “he’s” could just as well be “she’s” – no sexism implied and hopefully not inferred.

18

Ooh, I should point out that if by the year 2067 83-years old is considered a young retirement age, then our friend will be able to retire at 83 and make more money on his returns than on his salary!

19

It’s likely that the very rich, who already own a disproportionate percentage will benefit by more than 8 percent. This is going to be a bubble bigger than the 1920’s. It’s going to allow those who already hold securities to multiply their fortunes, not add to them.

Tris

20

Well, remember, I’m dealing with averages. So those raises and such are subject to whim. Also, starting at $25K is pretty generous in the world as most people live it.

Also, I think the effect on the market makes that average return of 9% fairly optimistic. If private accounts kick in we’re liable to see a quick surge in the market because more cash is out there chasing equities. Then it’ll settle in as an accepted part of the market. But putting extra cash in there is liable to have some effect on the dollar, too.