David L. Debertin
Professor of Agricultural Economics
University of Kentucky
400 CEB Bldg
Lexington, KY 40546
Bush is headed on a nationwide tour to try to sell a Social Security Privatization plan to the public, but with little in the way of specific details on how such a plan might work. he problem is, without the details on how a proposed plan would work, the public is reluctant to endorse the idea. Further, Congress is increasingly bogged down while engaged in debates based on speculation about how such a plan could work, with few operational details.
For the moment, assume that the only investment Social Security can make is US government debt. Let’s assume for the moment that some of the Social Security Trust Fund assets currently held as US Government bonds in the name of the US government on behalf of all Americans were instead put in the names of individual current and future Social Security recipients. Thus, each American would have a “privatized” government security account in his or her own name, with a specific dollar amount attached to it. I do not see why either the federal government budget nor Social Security as we know it would die if some of the government debt currently held by the trust fund (from current Social Security surpluses) collectively by all Americans were somehow divided up and put in the particular name of each individual American who is also a future social security recipient. Social Security still owns as an asset the debt in the form of government bonds, but the system has been privatized to the extent that each American knows exactly how many of dollars of government debt he or she owns,
To not take this step toward privatization means that somehow Americans must believe that Social Security is better off owning this debt as a collective whole rather than having it in the name of each individual American. The case for this argument seems very weak. Indeed, these are classic political battles over collectivism versus private ownership of assets. (They may be cleverly disguised in the rhetoric but that is what the debate is really about). Economists as a group tend to favor private ownership (putting the treasury debt owned in individual names rather than in a collective “lockbox” that is owned by everyone together) whenever possible.
But this model is simplified, because it assumes that with privatization the only thing an individual American can invest in is the debt of the US government, and a proper investment portfolio for retirement should include government bonds as part of a more diversified portfolio. Then, is not the debate REALLY about putting Social Security Funds in the stock market (private business)? That will take money away from the government which if its going to continue to spend on Social Security and other programs will have to borrow elsewhere, and subject retirees to the vagaries of the stock market.
However, retirees have already suffered a great deal because of macro policies by the Fed to keep interest rates low and drastically cut returns on savings. So there is no practical way to allow retirees to move through retirement without feeling at least some of the effects of macroeconomic winds, and what is happening in the stock market in the aggregate is just another part of the entire macroeconomic “scene which includes also items such as interest rates and inflation rates.
A major problem with the privatization of Social Security accounts embodies the concern that if the public is given the responsibility to manage their own accounts, they will take on inappropriate amounts of risk, either too conservative (keeping everything in US Government bonds throughout their working life) or too risky (investing in stock mutual
funds with too high a level of risk given their age and years to retirement).
The Freedom style mutual funds provide a great basis if the government does not want people individually trying to manage the retirement risk for themselves. Freedom funds offered by a number of different mutual fund companies have a specific year attached to them. There is usually a Freedom 2010, 2015, 2020, all the way out to 2045 or so.
Freedom mutual funds dated a long way from the current date have a high proportion of stocks to bonds, but those dated closer to the current date have a high proportion of bonds. Then as the fund ages, the fund manager automatically moves a little more money out of stocks and into bonds. New funds with dates further out are created every 5 years or so, with the newest funds with the farthest out date having the greatest proportion of stocks to bonds. After 5 years eventually a 2050 gets started, etc for those whose retirements are 5 years further out etc. etc.
Instead of using the Thrift Savings Plan (TSP) as a model, the federal government could develop something exactly like this Freedom Funds Social Security Account such that for young people their social security funds were invested almost entirely in their own name in a broad stock market index, but as retirement nears the fund gradually switches over to government bonds.
Think of a schedule like this as to percentages as to what your SS payments in each year get invested. The stock component could be a fund mimicking a broad market index such as the Wilshire 5000. For the moment I am thinking that the bond component could be exclusively issues of the US government, though eventually this could gradually be expanded to include other debt such as high-grade corporate bonds.
Your Age Stock (Wilshire 5000 index) US Government Bonds
20-30 90% 10%
30-35 80 20
35-40 70 30
40-45 60 40
45-50 50 50
50-55 40 60
55-60 30 70
60-65 20 80
over 65 10 90
These numbers are for illustration. There would be no shortage of consultants from the mutual fund industry willing to provide the Government with professional guidance as to the appropriate mix of stocks versus government debt at each age level.
Most young people do not earn much as somewhat older workers, and as a consequence, are paying very few dollars into Social Security. Almost all of their money would go into the stock market where these small amounts compound at high expected rates for several decades. Older people, earning more, are putting a significant share of those payments into government bonds which will be debt funding the current SS recipients. The payments from the young people not going into government bonds but rather into stocks are not large enough to matter that much in terms of paying current SS recipients—what IS important is that these small amounts accumulated early in a career compound for a very long period of time at a long term expected rate in the stock market of around 11%. Even broad stock market downturns several years long matter for these people little because of the long investment time horizon. If the market behaves as it has in past history in terms of rates of return, these people should be way better off than they would have been had the current system simply been continued, irrespective of significant shorter-term market fluctuations. And the US government will be better off too because the payments that need to be made from the government to keep Social Security afloat should gradually decline each year as each new year of retirees comes in with an ever bigger proportionate share of accumulated returns in their privatized Social Security account accumulated from stock market gains over the long term. Meanwhile, higher-wage older workers are still buying lots of US Government bonds to hold in their Social Security portfolios and this purchase of debt can be used to finance current social security recipients who did not accumulate a privatized account.
That way too, everyone of the same age would be bearing exactly the same risk
in terms of stocks versus government bonds, and as each American grows older the investments backing your Social Security payments would automatically become less risky and less subject to shorter term stock market fluctuations as adjustments are automatically made to the stock and bond mix as each American ages over time . Ideally, the government would automatically make the shifts between the stock index and the bonds each year as you aged, just like the freedom funds managers do. Since everyone of a given age essentially assumed the same cycle of risk over their lifetime, then everyone of a given age should end up drawing a similar Social Security payment per dollar they invested and depending on when in their life cycle it was invested. Obviously people who earned more over their lifetimes would have invested more and would ultimately collect more but that is also true today, and what you collect in part depends on how the stock market did prior to your retirement but for a 20 year old we are looking at performance over 45 years or even longer
Once this program was in place then the government might eventually debate whether they eventually want individuals to be permitted on their own to manage at least in part the stock-bond mix instead of relying entirely on the Social Security Freedom Fund managers, but what I describe above without that would be a huge step forward
from what we currently have. Politically, I can see this marketed as the Social Security
Freedom Fund all wrapped up in Red, White and Blue!
Bush really needs a catchy phrase like this to sell the idea to the public.
----David L. Debertin