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Issues in Privatizing Social Security: Report of an Expert Panel of the National Academy of Social Insurance.

Edited by Peter A. Diamond.

Cambridge, MA: MIT Press, 1999. Pp. xvii, 168. $25.00.

This report shows that economists can write clearly about complicated macroeconomic and highly charged political issues. MIT professor Peter Diamond summarizes the findings and deliberations of a 20-member, high-powered panel reviewing several questions pertinent to how Social Security should be privatized--transformed into private individual accounts or advanced funding through a government authority.

Bottom line? The panel recommends permanently advance funding Social Security, investing Social Security assets in the stock market, and moving fast. If nothing were done, the Social Security payroll tax would increase from the current 12.4% tax on payroll (shared equally by employers and employees) to 17% in 2030 and to 19% by 2075. However, if in 1999 the tax rate is hiked by 2.2 percentage points, to 14.6%, the system is solvent for 75 years in its current pay-as-you-go structure. One-sixth of current revenue accumulates in the $1 trillion trust fund; however, the fund is designed to be spent down after the baby boomers retire. The panel argues that a permanent trust fund would put the system on very different footing. Money accumulating now could stave off future tax increases, over and above the 14.6%, and be able to increase benefits with lower tax hikes in the future.

The book is jam-packed with macroeconomic possibilities--such as how advance funding a permanent trust fund to about $1 billion a year with stocks and corporate bonds affects supply and demand and thus relative asset prices--without resorting to equations or mathematical flare. Another discussion is the refreshing and balanced examination of how advance funding the Social Security system, either through individual accounts or through a trust fund, may or may not increase savings in such a way as to increase investment.

The panel carefully parses the events that could lead to how advance funding Social Security could have the opposite effect and decrease savings. Savings swaps could occur. Corporations may pull back on their advance funded pensions and individuals might reduce their other forms of savings as Social Security taxes increase. In addition, as the trust fund accumulates assets, the government might be tempted to use the trust fund to hide deficit spending and thus neutralize the boost in accumulation.

The panel rightly observed that payroll tax hikes will increase low and middle income savings by reducing their consumption. These groups don't save much, so increased taxes will come from spending.

The book is organized in a model way. The questions are in italics and the panel's conclusions in bold. Each chapter holds up to what is promised in the introduction. The Executive Summary--a common literary form in Washington and, unfortunately, often missing in standard economic writing--efficiently summarizes the panel's conclusion. Diamond has expertly identified the recommendations; yet the reader gets the feel for a true debate with the consistency of a single author.

The panel was divided on whether "Social Security should include individual defined-contribution accounts or stay with traditional defined benefits (p. x)." The divisions came from "differences in values, for example, the degree of importance attached to individual versus collective responsibility, and the differences in political predictions, not from differences in economic analysis" (p. x). The panel agreed that individual accounts may make Social Security more popular and that individual accounts would entail higher administrative costs. The Panel opposed the ability of individuals to voluntarily opt out of Social Security.

The panel did address the concerns of a minority (more about them below) by establishing principles in case the Social Security system would ever be transformed into individual accounts. The panel recommended that individual accounts be mandatory, that people should have diverse assets, lump-sum payoffs would be banned, and that government would require all accounts to be transformed into a real annuity. (The panel report does not include the cost of annuities; they are illustrative. In 1999 $100,000 buys a 65-year-old person an annual nominal annuity of about $10,000. A survivor's option reduces it by 35%, an indexed option even further. Baby boomers will pay on average about $210,000 in real payroll tax.)

There are four types of costs in a pension system: collecting funds from employers and workers, accounting, money managing, and disbursement. The high administrative costs of an individual system play a big role in the panel's lack of agreement on individual accounts.

Even for large employers being responsible for directly depositing workers' contributions to individual accounts with multiple money managers is a large burden. Now employers reckon with the Social Security Administration (SSA) once a year and the SSA reconciles all the contributions made on behalf of workers--many who have had multiple employers. The panel report implies, but does not simulate, how much more costly individual accounts would be as workers become more mobile.

Under an individual account system, mobile workers might not merge accounts when they change jobs. This means they would pay multiple fees. Also, larger accounts would pay lower fees than smaller accounts, malting returns (net of fees) regressive.

What might surprise readers is how the power of compounded fees affects final benefits. The panel agreed that a 1% charge for individual account balances would reduce accumulation in a 40-year old account by 20%. This is equivalent to an annual load charge of about $230 per worker per year compared to the $18 charge now, which does not reduce benefits. Last, employers would have to be monitored, the accounting verified, and the returns credited properly by a new and large government watchdog agency.

Much of the Social Security debate is about "money's worth," which is defined in the book's comprehensive glossary as "any measure of the value of benefits in relation to the taxes or contributions" (p. 146). Money's worth falls as any pay-as-you-go system ages. In 1940, Ida Fuller was the first Social Security recipient. She paid $44.00 in total contributions, and living until 100, she collected $20,933.52 (she received a whopping return). Future recipients are estimated to earn a range of - 1% to 5% returns depending on circumstances. Advocates for individual accounts argue that workers could get a higher return with individual accounts. Diamond notes that projected returns don't account for risk or the insurance value of the inflation indexed, defined benefit return from Social Security. The projected returns from an individual account program also do not take into account the transition costs.

The main arguments of the proponents for individual accounts are summarized: Individual accounts would increase national private savings and thus private investments while reducing the political risk of Congress using the trust funds for government spending or for political purposes. Further, individual accounts will restore confidence in the system and emphasize individual responsibility, choice, and ownership. People can choose their level of risk aversion, and individual accounts may discourage tax evasion. Individual accounts would eliminate the political risk of further benefit cuts.

The detractors respond that individual accounts cost too much and expose workers to the following risks: financial market risks, longevity risks, and people making poor investment choices and having bad luck. If people own individual accounts, political pressure for early access to their accounts might not preserve adequate benefits for workers and survivors. National savings actually might decrease as people reduce their savings elsewhere, and creating individual accounts could take away support and funding for disability benefits and other benefits because Social Security is partially a redistribution program. Lastly, individual accounts would undercut community solidarity. There are ways, the proponents for the defined benefit structure argue, to increase confidence in the system without creating individual accounts.

Perhaps the best way to read the book is to start with the protest letter (included in the Appendix) of panel members, including Stanford economist Michael Boskin (former Council of Economic Advisor member under President Bush), Wharton School's Olivia Mitchell, and Watson Wyatt principal Sylvester Schieber, who resigned rather than sign the report. They wanted more discussion of Social Security's financial future and the full risks of trusting government promises, more discussion of Social Security's Supplemental Income program (SSI) and a fundamental change in the format and tone. They complain the report unduly represents the beliefs of 75% of the 20 panel members--the majority sufficient for a panel recommendation. They argued that anyone reading the report would think the panel wants a permanent trust fund invested in stocks and that individual accounts are too expensive. They wanted a list of all that was agreed upon unanimously followed by minority and majority reports for the remaining issues. Though they were offered room for a dissent, Boskin's flu and Mitchell and Schieber's busy schedules caused them to write the memo instead.

The memo as a companion to the report reveals that hardworking, dedicated public policy economists and professionals took time out from their regular jobs to find answers to vexing issues that will face the nation for decades to come.
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Title Annotation:Review
Author:Ghilarducci, Teresa
Publication:Southern Economic Journal
Article Type:Book Review
Date:Apr 1, 2000
Words:1485
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