Briefing Book

White House Conference

Francis X. Cavanaugh Francis X. Cavanaugh Public Finance Consulting 7213 Oakridge Avenue Chevy Chase, Maryland 20815 301-652-0777 Fax 301-652-9520 WHY SOCIAL SECURITY INDIVIDUAL ACCOUNTS (SSIA) CANNOT BE MODELLED AFTER THE FEDERAL THRIFT SAVINGS PLAN (TSP) OR OTHER LARGE 401(K)-TYPE PLANS 1. The TSP is an employer based plan Like other large 401(k)-type plans, the TSP is sponsored and implemented by employers with the personnel, payroll, and systems staffs needed to support highly complex electronic record keeping, investment, educational, and communications operations. The Thrift Investment Board is a wholesaler of financial services. It is the employing agencies that handle the retail operations and the essential face-to-face counselling services, Such functions could not be performed by the 6.5 million employers now paying Social Security taxes. Host private employers have less than ten employees and little support staff. Over eighty percent of private employers are now reporting to the Social Security Administration on paper, a highly inefficient and error-prone operation. 2. The TSP is voluntary. Proposed SSIAs would be mandatory on the employee or the employer. Thus, SSIAs would be beset with very costly compliance problems not faced by TSP, 401(k)s, or the present Social Security system. While many employers do not comply with the present requirement to pay Social Security taxes, their employees do not lose Social Security benefits so long as their employment is verified. But failure to make timely contributions to SSIAs would reduce SSIA balances and investment income. 3. The TSP is for a relatively high income, educated, and stable work force. Social Security workers are relatively low income, uneducated, and include many temporary and part-time employees. Forty-six percent of Social Security workers earn less than $15,000 a year. Seventy-five percent of households with incomes from $10,000 to $25,000 have no direct or indirect stock investments. Essential investment and other counselling services, perhaps provided by the private sector, for this population would be very costly. A SSIA deposit of two percent of an average wage of, say, $20,000 would produce contributions to the account of just $400 in the first year. The average annual cost of servicing a 401(k) account is estimated to be at least $100, based on the three government and private studies discussed in the November 1998 report of the Employee Benefit Research Institute. (Current private sector servicing costs actually run up to $300 a year per employee for 401(k) plans with less than ten employees.) SSIA servicing costs would be much higher, as noted above. So the expense ratio in the first year would be much higher than 25 percent, or 2500 basis points (compared to the current TSP expense ratio of just 6 basis points), which would obviously be much higher than the estimated rate of return on investments. As account balances increased, the expense ratio would decline. Yet it is likely that there would be no net earnings, since total expenses would exceed total investment incomes over a forty year working life of an average SSIA holder. Thus the present. Social Security trust fund, which is invested in Treasury securities (with net earnings after inflation of about three percent over the past three decades), would clearly be a superior investment to SSIAs. The only feasible way for the Social Security system to benefit from the higher returns offered by the stock market is to invest a portion of the Social Security trust fund in stocks, which is what virtually all large public and private pension and retirement funds in this country have already done. Why then do SSIA proponents claim that their plan would be cost-effective? They argue that if the TSP can service 2.3 million individual accounts for $23 a head then surely SSIAs for 148 million Social Security workers could be serviced for less, because of economies of scale. What they fail to understand is that economies of scale can only be realized by increasing the number of workers in each workplace. We are a nation of small business, and it is not likely that our 6.5 million employers are about to merge into conglomerates large enough to make SSIAs cost-effective. SSIAs are doomed to failure because of intractable "smallness" problems -- small businesses and small average incomes subject to Social Security taxes. We have no experience with a system of mandatory individual savings accounts dependent on performance by low income employees and small employers. There is no empirical basis for claiming that SSIAs would be administratively or economically feasible. If Congress were to enact the pending SSIA legislation, it is likely that. the program would be recalled within six months. 1 Mr. Cavanaugh was the first Executive Director and CEO of the Federal Retirement Thrift Investment Board (1986-1994), which administers the TSP for Federal employees. Before that, he served in the U. S. Treasury (1954-1986) as an economist and as the senior career executive advising on Federal borrowing, lending, and investment policies.