January 6, 2005
Social Security 101: Private Accounts Should Earn You More
By Mort Kondracke

The first time I ever heard of Social Security reform was in 1967. It was one of the myriad ideas on various subjects floated by the late Rep. Roman Pucinski (D-Ill.), who served in Congress from 1959 to 1973.

"Puch," as everyone called him, was chairman of the House education subcommittee, but he was interested in everything from foreign policy to social mores.

As I best remember it, he told me in one of the many interviews I had with him as a reporter for the Chicago Sun-Times: "Just think, if Social Security money were invested in the stock market, the system would have much more money than it does and so would every beneficiary."

Nothing came of that suggestion, at least for many years. But in the context of the current controversy over President Bush's Social Security proposal, it's worth asking: Suppose I had been able to open a personal savings account in 1967. How much better off would I be?

Larry Lindsey, Bush's former top economic adviser and a booster of his plan, calculates that if I'd started an account at age 28 and invested one-third of my and my employers' payroll taxes in a stock index account - up to a maximum of $1,000 a year - the account would now be worth $157,000 and pay out a monthly benefit of $911 when I retire.

Two-thirds of my and my employers' payroll taxes would still be invested in government bonds through the Social Security system, giving me an additional benefit of $1,179 for a total of $2,096 - a good deal better than the $1,787 a month promised in my annual Social Security statement.

Under the plan Bush is likely to propose, Lindsey says, my benefit would be reduced by $319 a month because Bush plans to change the basis of inflation adjustments, pegging it to the cost of living rather than to average wages. This would leave me $1,797 a month - only $10 a month more than I'd get under current rules.

Because of this, I'd likely side with the so-called "free lunch crowd" - including Republicans like former Housing Secretary Jack Kemp and former House Speaker Newt Gingrich (R-Ga.) - who oppose changing the inflation formula.

Either way, though, if private savings accounts had been instituted in 1967, the Social Security system as a whole would be solvent, instead of facing an $11 trillion shortfall as the Baby Boom generation retires.

That's the main reason that Bush favors Social Security reform plus a "carve out" inflation adjustment: Over the long-term (after paying back $2 trillion the government needs to borrow to get it started), earnings will wipe out Social Security's $11 trillion shortfall.

Bush is surely right about this: Money invested in private markets will almost certainly earn more than money invested in government bonds, making more for workers and shoring up the system.

Specifically, the average annual return on funds invested in the Social Security system right now is 1.8 percent after inflation. The average return for stocks is 7.4 percent per year. That's over the period from 1926 to the present, including the Great Depression. In the past 200 years, in fact, stocks have averaged a 10.4 percent annual return before inflation.

Assuming that most workers would not want to put their money entirely into stocks and instead would divide it evenly with corporate and government bonds, the average return would be 4.9 percent, still vastly outstripping Social Security.

This means that, if the future is anything like the past, workers should be far better off having their money invested in private markets than in Social Security.

Various opponents of Bush's private savings plan, including Senate Democratic leader Harry Reid (Nev.) say that Wall Street commissions will eat up most of the proceeds.

However, it's likely that Bush's plan will not allow for investment in individual stocks but rather in a restricted array of mutual funds, mostly index funds, that charge little or no commissions involved.

Granted, private markets do entail risk. But the risks are not as great as worried veterans of the dot-com bubble might think. According to Ibbotson Associates, whose annual investment yearbook is the bible for the investment industry, stock prices can be highly volatile over short periods, but aren't over the long term.

In 1931, at the start of the Depression, large company stocks fell by 43 percent - the worst year ever. In 2002, they fell by 22 percent and in 1974 by 26 percent. And in 1953, they boomed by 53 percent and in 2003 by almost 29 percent.

Such variations make private accounts look scary, but Ibbotson's statistics show that stocks have lost money over 10-year periods only twice since 1926 and have never lost money over any 15-year period.

Over any 20-year period, the worst stocks have ever done is to earn an average 3 percent annual return, which is much better than the average annual return for Treasury bonds.

And if, under Bush's plan, younger workers put their private savings into safer funds split 50-50 between stocks and bonds, there is practically no chance of losing money even over a 10-year period, based on Ibbotson's historical tables. So, private savings accounts seem safe enough. But it seems to me that - both for political reasons and justice's sake - people who bear any risk at all should be able to achieve higher rewards.

This means that those who choose to invest in private accounts ought to receive a higher reward than those who stick with the guaranteed Social Security system. As the early arguments in the Social Security wars show, Bush opponents' loudest argument is that "there is no crisis" because Social Security won't run out of money until 2042 (according to the system's trustees) or 2052 (according to the Congressional Budget Office).

What Bush's critics rarely point out is that, under current law, benefits will automatically be cut by 25 percent when the system goes broke. So it needs to be fixed. And the best way to fix it is to depend on a growing American economy. It's what we're going to do anyway.

If the American economy somehow collapses, the government couldn't meet its Social Security obligations. Based on history, though, the chances are it will grow.

Mort Kondracke is the Executive Editor of Roll Call.

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