RE: Kolbe-Stenholm, and a two-track alternative

["Steven H. Johnson" <info@sscommonsense.org>]

Dear Sen. Gregg and Rep. Stenholm,

Thank you for your responses.  
I was hoping to clarify the amount of OASDI benefits, as a 
percent of taxable payroll, still paid out by the Kolbe-Stenholm plan.
I take it from your remarks that in the earlier version, they were
about 10.5% of taxable payroll, but that they're now up to about
11.23% of taxable payroll.

I also wanted to make the point that it's unlikely that the entire
difference can be made up from the fruits of a two percent investment
program, at any reasonable rate of return.  I stand by that point.
Two percent paid into PRA's today ultimately replaces about 
four percentage points of payroll tax, in the aggregate, if one
assumes an average real return of about four percent. 
Kolbe-Stenholm leaves about an eight percent gap, between full
benefits as defined by current law, and the benefits that will be
paid, under the Kolbe-Stenholm proposal. 
A two percent of payroll investment rate can't replace benefits worth
eight percent of payroll without a rate of return equal to at
least six percent.  I think that's way out of reach.

Financially, Kolbe-Stenholm is probably the most stable proposal
that's been put forward.
Taxpayers pay in 10.4% of taxable payroll, and Social Security
pays out benefits equal to 10.5% of taxable payroll, or 11.23% of
taxable payroll.
But K-S does generate quite a large gap between current law 
benefits and future law benefits, and it's amazingly sanguine 
about the ability of a two percent investment strategy to make up
a seven or eight percentage point gap.

As it happens, I do favor advance funding, though obviously my
remarks were taken otherwise.
With the percent of Americans over 64 rising from 12% of the population
to 20% of the population in the quarter century between 2008 and
2033, we really have no choice.
I even like the idea of setting aside two percent of payroll and
putting it into private accounts, as Kolbe-Stenholm proposes.

I am, though, a double contrarian on the issue of how best to 
achieve advance funding.
I'm also a pessimist on the prospective stock market rates of
return, for reasons spelled out in another message of mine in response to
a comment by Sen. Santorum.
(For an empirical analysis on return rates, see "Are Seven Percent Returns Realistic?"
at http://www.sscommonsense.org/page04.html)

My view is that the risks involved in a personal account strategy
for advance funding can be controlled much more effectively if
such a strategy is also combined with a Trust Fund-based strategy
for accumulating capital.  
For this view, I'm sure conservatives will count me as a contrarian.

And I also believe that the risks involved in a Trust Fund-based 
strategy can be controlled much more effectively if we also have a 
strong program of personal accounts.  
And for this, liberals will also count me as a contrarian, I'd imagine.

Oh, what the heck.  I'm willing to take bruises from both sides, 
though, because I think a two track solution is the best answer.
(I got my master's degree from the same place Jim Kolbe got his,
and I love this stuff.  
My spreadsheet model tracks the Trustees' numbers on actuarial 
balance to the fourth significant digit, so I think my numbers 
are pretty darn dependable.
My dad also served in the Congress some years back, so I've got
a lot of sympathy for the panelists.)

Suppose we had a hundred Fund Management companies handling personal
accounts.  
Why not use the same companies to manage the assets owned by the 
Trust Fund?
Trust Fund assets could be allocated to independent fund management
firms in proportion to their popularity with the American people.
If two percent of all employees choose Merrill Lynch, then allocate
two percent of the Trust Fund's assets to Merrill Lynch. etc.
Require that all Trust Fund assets be invested in very broad
market index funds.  (5000-stock funds, not 500-stock funds)
Require the independent fund managers to vote the Trust Fund-owned
stocks according to prudent fiduciary principles.
Such a system would, it seems to me, dramatically decentralize
the voting control of Trust Fund stocks.
And, because the stocks would be held by firms chosen by America's
working people, they'd be much more insulated from political
meddling by the Congress.

On the other hand, were a Trust Fund-based strategy for advance 
funding to try to stand on its own feet, without being paired 
with a private account system, the ownership concentration issues 
would be much more severe.
I don't think the Aaron-Reischauer solution is nearly good enough.
It seems to me that the best way to reduce the risks involved in
a Trust Fund-based approach to advance funding is to pair the
Trust Fund with personal accounts, for the reasons cited.

On the other hand, personal accounts, all by themselves, entail
considerable risks.
The Kolbe-Stenholm-Gregg-Breaux et al approach gives us zero help
on the issue of cohort risk.
Did the "notch babies" create a political firestorm?
It would be a mere flicker compared to the firestorms that cohort
inequities are sure to create.
Had PRA's existed over the past seven decades, stock returns for
the highest return cohort would have outperformed stock returns
for the lowest return cohort by nearly A FACTOR OF THREE.
Jim.  Charlie.  Judd.  I can't believe you want to answer to 
constituents who wind up in the low return cohort, looking at the
returns being raked in by consituents in the high return cohort.
You don't.  You really don't.  No politician would.

What Jim Kolbe called a "clawback" strategy is really the only way to
equalize outcomes for different cohorts.
A rule that says, "For every dollar you receive from your PRA-
financed annuity, your Social Security benefit check is reduced
by ninety cents," achieves the kind of inter-cohort equalization
that's needed.
Cohorts retiring with low returns are cushioned, should such a 
rule be in effect.

But that sort of cushioning is awfully difficult to finance if Social 
Security has no asset reserve of its own.
If Social Security has an asset reserve of its own, through a 
parallel capital accumulation strategy based on the Trust Fund,
it gets a whole lot easier to take away the Cohort Risk issue
associated with a personal account system.  

None of the above is doable, I would offer, if Social Security's 
relationship to the federal budget remains as muddy as it is now.
We are at a momentous transition point for Social Security.
Its status as a money in-money out federal program has to be changed.
SS needs to become as free-standing as possible, with its own
bank account, paying checks out of its own funds to retirees,
its own portfolio, acquired in arms length transactions on open
financial markets, and so on.
As long as the federal government makes it a practice to commingle
retiree assets with operating deficits, Americans will never
trust Social Security to accumulate any significant amount of
assets in anything. 
If there is to be any advance funding, Social Security needs to
be given a Caesar's wife relationship with the federal govt.

What - Rep. Stenholm challenged me to say - is the alternative 
to the Kolbe-Stenholm advance funding approach?

As a double contrarian on this issue, I'm absolutely eclectic.

Take the last two percent of the payroll tax, as is done
in the Kolbe-Stenholm et al plan, and applying it to personal accounts.

Add in the Moynihan proposal to raise the earned income cap, so
that ninety percent of all payroll is once again taxable.

Add in the Clinton proposal to contribute an additional $2.8 trillion
from general revenues to Social Security.

Phase out the practice of diverting a portion of the tax on benefits
to the HI trust fund.

Allow the Trust Fund to invest up to 50% of its assets in stocks,
but farm out all its assets to approved fund managers, as described
above.

In time, such a dual track strategy produces two sizable pools of capital.
The Trust Fund grows to about 35% of GDP, and stays perpetually
at that level.
PRA's grow to about 30% of GDP, and stay perpetually at that level.
With a total capital pool worth 65% of GDP, there's enough capital
to "fund the gap."
The projected "gap" amounts to about 2.5% of GDP.  
Total benefits to retirees etc are expected to reach 7% of GDP.
The 12.4% payroll tax only brings in about 4.5% of GDP.
With a pool of capital equal to 65% of GDP, the proceeds from 
the twin pools of capital are sufficient to fund the 2.5% of GDP 
gap.

The two-track strategy ought to score well on anybody's checklist.

-Retiree benefits are protected.  Total cuts need be no more than 
four or five percent, in the out-years.  If GDP turns out to be
a little healthier than the Trustees predict, no cuts are needed.

-The payroll tax need not be raised.  Longterm costs stay at 12.4%.
(2% for PRA's, 10.4% for Social Security)

-Long term solvency is assured.  The capital pool is 2075 is just
as large as it was in 2050, as a percent of GDP.  Sen. Santorum
is right.  Actuarial balance is a silly way to define the long-
term goal.

-Permanent federal subsidies are avoided.  Yes, there is a one-time
subsidy of $2.8 trillion, spread over 15 years.  But that's it.
(versus the Archer-Shaw plan, or the Feldstein plan, which
create permanent federal subsidies.)

-The issue of ownership concentration risk, associated with a pure
Trust Fund capital accumulation strategy, is dampened very substantially.

-The issue of cohort risk, associated with a pure private account
strategy, is also dampened very substantially.

-The total return to retirees goes up considerably.  For the same
money that's being spent now, a lot more people get a lot more
coverage for a lot more years.

That's it for now.  There are more tweaks in the two-track plan
than I've spelled out here.  (See http://www.sscommonsense.org/page02.html)

The Kolbe-Stenholm plan is an interesting one, but the claim that
a two percent investment strategy can close what is basically an
eight percent (of taxable payroll) gap simply stretches credulity.

Steve Johnson, Director
Common Sense on Social Security
http://www.ssommonsense.org