5. Can't Each Strategy's Strengths Help Cure the Other's Weaknesses?

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

5.  Can't Each Strategy's Strengths Help Cure the Other's Weaknesses?

Again - in the spirit of seeking a more robust solution....

(Or, to quote the author of a popular on-line essay, "With 
enough eyeballs, all problems are shallow."  If we get enough 
people looking at this, maybe we'll get it solved.)

There are so many different stakeholders in this discussion.
And each set of stakeholders has a legitimate concern.
If all the stakeholders are listened to, the perfect solution 
has to meet a demanding set of criteria.

- Future benefits should be protected, for all retirees.
- This includes spousal benefits, survivors benefits, and disability benefits.
- Payroll taxes should not be increased.
- Lasting solvency should be assured.  ("Actuarial balance" isn't enough)
- Permanent federal subsidies should be avoided.
- The risks associated with Trust Fund investment in stocks should be avoided.
- The risks associated with private accounts should be avoided.
- Even though Social Security is meant to cover nearly the entire workforce, 
it still shouldn't take over too much of the stock market.
- Stock return forecasts should be prudent.
- And rates of return on money paid to Social Security shouldn't be pitifully low.  

These criteria force the Congress away from a "pay-as-you-go" 
strategy.
It isn't possible to hold the line on payroll taxes, while 
still protecting current benefits, in a pay-as-you-go framework.
A "fund the gap" strategy is the only one that holds out hope 
of protecting benefits while holding the line on the payroll tax.

But a "fund the gap" strategy also raise tough issues.  Neither 
capital accumulation strategy is without risk:  How to get the 
benefit of Trust Fund investments, without the risks?  How to 
get the benefit of private accounts, without the risks?

This brings me to my next two questions:

H.  (For Nadler & Pomeroy)  Wouldn't pairing a Trust Fund 
strategy with a private account strategy offer a substantially 
more effective method for taking away the risks associated with 
a Trust Fund strategy? 

I.  (For Kolbe, Stenholm, Gregg, Santorum, Shaw, Sanford, and 
Bunning) Wouldn't pairing a private account strategy with a 
Trust Fund strategy offer a substantially more effective method 
for taking away the risks associated with a private account 
strategy?

It seems obvious that we can't solve the problem of protecting 
retiree benefits solely with a private account strategy.  Too 
much variability in stock market returns from one cohort to the 
next.  Too little likelihood that the seven percent return 
pattern from the past will repeat itself in the future.  The 
more that Social Security depends on private accounts to solve 
the problem, the more difficult it is to finance any program 
that equalizes returns for different cohorts.

And - if we do go down the one path that offers the greatest 
chance of protecting retiree benefits, the "add-on" path 
proposed by Rep. Shaw - the more inevitable it is that we'll be 
forced to accept permanent federal subsidies of Social Security.

And it seems equally obvious that we can't solve the problem of 
protecting retiree benefits solely with a Trust Fund strategy, 
unless we're willing to allow the Trust Fund to acquire roughly 
a third of the entire U.S. stock market.  

Which is why we need to give serious consideration to doing 
both at the same time.

Personal Retirement Accounts - if managed by a hundred different 
fund managers - create the perfect environment for shielding 
the Trust Fund's assets from political interference.  Farm the 
Trust Fund's asset pool out to the same fund managers.  Do so 
in proportion to their popularity as PRA managers.  If Merrill 
Lynch has been chosen to manage two percent of the nation's 
PRA's, give it two percent of the Trust Fund's assets to manage 
as well.

Require that all Trust Fund stock assets be invested in very 
broad, 5000-stock index funds.  Authorize each fund management 
firm to vote the stocks that are under its control.

This has many salutary effects.  

First, by pairing the Trust Fund with personal accounts, the 
Trust Fund's ultimate size is cut in half.  Full retiree 
benefits can be protected with a Trust Fund that's only half as 
big as would be needed if there were no personal accounts.    

Second, control of Trust Fund stocks winds up being much more 
decentralized than it would if there were no personal accounts.

Third, with Trust Fund assets being managed by firms that 
America's workers have picked themselves, the barrier to 
Congressional tampering becomes just that much stronger.  "Keep 
your hands off my investment fund manager" becomes an effective 
rallying cry to ward off Congressional meddling.  

Fourth, it makes the task of managing PRA's much less expensive, 
both for employers, and for PRA fund managers.  After all, PRA 
deposits can simply piggyback on top of Trust Fund deposits.  
Social Security collects and disperses the necessary account 
data, and neither the employers nor the fund managers need to 
feel any additional pain.

Fifth, with all these safeguards in place, the Trust Fund 
portfolio is now free to invest in a more stock-rich portfolio, 
and, hence, to earn a substantially higher rate of return, 
which....

Six, makes it easier to protect full benefit levels for future 
retirees, with...

Seven, no diminution in progressivity.

The arguments for pairing a Trust Fund strategy with a private 
account strategy are really quite strong.

And  - on the personal account side - the arguments side are 
equally strong.  A private account system, properly restructured, 
benefits greatly from being paired with a strong Trust Fund.

Consider what might be called the "First Decade" approach to PRA's. 

There's no reason to make a retiree try to stretch his or her 
PRA money to cover all the rest of their years.  On retirement, 
it makes much more sense to convert a PRA into a ten-year 
annuity.  At that age, a ten-year annuity is worth about forty 
percent more, per month, than a lifetime annuity.

On retirement, the Social Security benefit can be figured just 
as it now is.  For every annuity dollar received, the Social 
Security benefit is reduced by X amount.  Ninety cents, perhaps.  

After the First Decade of retirement, once the annuity money 
has run out, the retiree's Social Security checks now deliver 
full benefits.  Spousal benefits and survivor benefits continue, 
as now.  COLA's continue.  Progressivity continues.  Even during 
the First Decade, a retiree continues to get the same benefit 
level he'd get now.  In fact, depending on the formula, the 
annuity-plus-Social Security check total will even be a little 
higher.

The First Decade method also has many salutary features.  

First, longevity risk goes away.  Retirees get their money's 
worth out of their PRA's, but they're covered even after their 
PRA's run out.  

Second, the right balance is struck between investing and 
insuring.  During the first few years of retirement, when most 
everyone is still alive, the First Decade approach leans 
strongly on investment-based retirement financing approach.  
Later, when no one knows who'll be alive and who won't, Social 
Security's traditional insurance-based financing strategy kicks 
in with full force.

Third, the issue of market risk is essentially eliminated.  The 
cohort that retires when the market's peaking gets more money 
in annuities, but less money in Social Security checks.  The 
cohort that retires just as the market crashes gets less money 
in annuities, but more money in Social Security checks.  Why is 
this possible?  Because the private account system has been 
paired with a strong Trust Fund.

Fourth, pairing PRA's with a strong Trust Fund makes it possible 
to protect retiree benefits, while still avoiding the need to 
impose a permanent federal subsidy.  

Here's an outline of the financing structure.

- The OASDI share of thepayroll tax drops to 10.4 percent.

- Two percent of pay goes into PRA's.

- A fifteen year, $2.8 trillion subsidy is paid from the federal 
budget into Social Security.  Once this subsidy period is done, 
no further subsidy is needed.

- The earned income cap is raised, to return to the practice of 
making ninety percent of all payroll taxable for Social Security 
purposes.

- Benefit taxes now diverted to Medicare are instead turned over 
to Social Security.

- And - if Congress wants to keep benefits as close as possible 
to a hundred percent - state and local government new hires are 
added to the Social Security program.

In addition, the Trust Fund is required to invest all of its 
assets on open financial markets.  Insider dealing transactions 
between Social Security and the Treasury are ended.  The Trust 
Fund is allowed to have up to fifty percent of its assets 
invested in stocks, and it's required to have all of its assets 
professionally managed by PRA fund managers.

Furthermore, PRA owners are strongly encouraged to invest their 
money in index funds.  Their annuities are "insured" against 
cohort risk only if they've kept their money in index funds.  
(It's not Social Security's job to insure people against bad 
personal investment decisions, only to insure them against risks 
that affect an entire cohort.)

Call this the Two-Track Strategy for Saving Social Security.

[For good measure, I'd also throw in KidSave accounts, though 
they do little to help Social Security until about 2065.  I'd 
like them tied to high school graduation, to give all kids an 
incentive to graduate.  "If you haven't earned your diploma by 
the age of 21, your KidSave money reverts to the Social Security 
Trust Fund.  If you have graduated, your KidSave money should be 
worth at least $100,000 to you when you retire."]

The Two-Track Strategy is capable of satisfying all the success 
criteria listed at the beginning of this posting:

- Benefits are protected, for all retirees, at very nearly a 
hundred percent.

- The overall payroll tax is held at 12.4%:  10.4% to Social 
Security, and 2% to PRA's.

- Long-term solvency is assured.  PRA's and the Trust Fund both 
grow to about thirty-plus percent of GDP.  They reach that level 
by 2050, and they remain just as strong in 2075.

- Permanent federal subsidies are avoided.  After the $2.8 
trillion subsidy ends, that's it.

- The risks associated with a strong Trust Fund have been 
overcome.

- The risks associated with a strong PRA program have also 
been overcome.

- Social Security's total share of the stock market, counting 
both PRA's and the Trust Fund, is held down to a third or less.  (
(Which is not too bad, considering that Social Security covers 
the whole workforce, and considering the highly decentralized 
structure for managing and controlling those assets.)

- Imprudent seven percent forecasts are avoided.  The Two Track 
Strategy works even with real returns on stocks averaging five 
percent.  

- For a 12.4% payroll tax, more people get more benefits for 
more years than is possible under any other scenario.  

There is, however, one extremely strong caveat.

Social Security has to be broken free of the federal budget.  
It can't be operated as a normal government program any more.  
Because it has fiduciary responsibilities to millions of current 
and future retirees, it needs to be set up as a nearly-independent, 
partially-funded retirement program.  Social Security needs to 
run its own bank account, not depend on the Treasury.  It needs 
to cut its own checks to beneficiaries.  Its asset-management 
system needs to be fully separated from the U.S. Treasury.  The 
practice of commingling Social Security retirement surpluses 
with federal budget operating deficits must end, forever.  None 
of these reforms can work until Social Security's compromised 
relationship with the Treasury has been ended.

So - my next question to the panelists.  

J.  Wouldn't a two-track savings strategy be an effective 
method for taking away the flaws and the risks that otherwise 
accompany a pure PRA strategy?  Wouldn't it also be effective 
in taking away the flaws and the risks that otherwise accompany 
a pure Trust Fund strategy?

-Steve Johnson