Briefing Book

White House Conference

STATEMENT OF ALICIA H. MUNNELL [1] BOSTON COLLEGE THE PETER F. DRUCKER CHAIR IN MANAGEMENT SCIENCES THE WALLACE E. CARROLL SCHOOL OF MANAGEMENT FULTON HALL 140 COMMONWEALTH AVENUE CHESTNUT HILL, MASSACHUSETTS 02167-3808 617-552-1934 FAX 617-552-0431 The best way to assure all Americans an adequate basic retirement income is to maintain the current defined benefit structure and not to move toward a system of defined contribution accounts. Let me briefly summarize the reasoning behind that conclusion. I. Social Security is not facing a crisis. The projected increase in Social Security spending due to the aging of the population is neither enormous nor unprecedented. The cost of the program is projected to rise by 2 percent of GDP. Budget changes equal to 2 percent of GDP are not uncommon; defense spending increased by 5 percent of GDP at the start of the cold war and declined by 2 percent between 1991 and 1998. The financing situation does not require radical change. II. The desire to increase national saving and broaden investment options for workers-- changes that have been used to justify individual accounts--can be achieved more effectively within the structure of the current program. The federal government can accumulate reserves. The non-Social- Security portion of the budget is headed for balance in 2002. We can keep it there and build up reserves in the Social Security trust funds. The states do it for their pension funds; the federal government should be able to do it for its major retirement system. Broadening Social Security's investment options to include stocks is feasible. We know how to prevent interference in private sector activity: set up an independent investment board, invest in a broad index, and delegate voting rights to fund managers. III. The economics are clear: Social Security's defined benefit plan is better than individual accounts for providing Americans with their basic retirement pension. Because Social Security is a defined benefit plan, it can spread risks across the population and over generations. This means that individual retirees would not risk large losses in the stock market just as they approach retirement. The risks would not disappear, but gains and losses could be averaged over time and among the entire population. Pooling investments in the Social Security trust funds also keeps transaction costs low, ensuring higher net returns than individual accounts. Administrative costs for individual accounts are likely to amount to a 20-percent cut in benefits. Data from the U.K. and Chile, countries that have adopted individual accounts, suggest that the costs could be even higher. Annuitizing individual accumulations reduces benefits by another 10 percent. Social Security also avoids the pressure for individuals to gain early access to their accounts, leaving retirees with inadequate retirement income. This risk is very real; individuals already have access to funds in IRAs and 401(k) plans. Social Security assures that accumulated funds are transformed into inflation-indexed annuities so that retirees do not outlive their retirement resources. Private annuities are over-priced for the average person, and Inflation-adjusted annuities are not available in the private sector. Social Security provides full benefits for disabled workers who would not have time to build up adequate reserves under a system of individual accounts. Disability benefits would be cut under all existing plans for individual accounts. Social Security protects women. It provide spouse's and widow's benefits; it automatically provides inflation-adjusted annuities (women live longer than men), and it protects divorcees (after ten years of marriage). Private accounts contain none of these protections. Finally, Social Security protects those with a lifetime of low earnings by replacing a greater percentage of earnings for low earners than for high earners. This redistributive component would be lost to the extent that payroll taxes were diverted toward individual accounts. IV. There is no reason to move towards a defined contribution system; much of the projected shortfall can be eliminated with good policy changes. For example, extending coverage to new state and local workers, slightly increasing the maximum taxable earnings base, and reflecting BLS corrections to the CPI in the COLA are all consistent with the goals of the program. Broadening the investment options for the trust funds to include stocks will increase the return on fund reserves and close the remaining financing gap. V. The argument against individual accounts applies only to the basic retirement income. On top of a fully financed Social Security system that preserves today's promises, voluntary supplemental individual accounts administered by Social Security are a good idea. They would encourage additional saving and keep administrative costs to a minimum. 1 The author served as a Member of President Clinton's Council of Economic Advisers and Assistant Secretary of the Treasury for Economic Policy.