This ought to be a "Both-And" issue

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

The solution set for Social Security is not quite as Robert Reischauer
stated it - cut benefits, raise taxes, or improve the rate of
return on savings.

The solution set also includes the option of accumulating a 
substantially larger pool of capital.

By 2075, according to forecasts, the payroll tax of 12.4% will
bring in funds worth about 4.5% of GDP.  The payments to 
beneficiaries will run about 7% of GDP.  If Social Security had
at its disposal a sufficiently large pool of capital (worth 
about 65% of GDP), the earnings on that pool would be worth 
about 2.5% of GDP, enough to make up the gap between the 4.5% 
coming in, and the 7% going out.

So the issue is not only how to get a higher rate of return, but
also how to accumulate a larger pool of capital.  (Today's Trust
Fund, by way of comparison, peaks out at about 16% of GDP,
then get drained down to zero.)

Here's where a Both-And strategy provides a far more powerful
answer than either of the Either-Or options presented by the
two panelists.

It is much easier to control the ownership concentration risks
associated with a Trust Fund-based capital accumulation strategy,
IF such a strategy is paired with a private account capital 
accumulation strategy.

It is much easier to mitigate the cohort risk issues, as well as
all the other issues, associated with a private account-based
capital accumulation strategy, IF it is paired with a hefty Trust 
Fund.

The details of this argument are spelled out in "The Two Track
Savings Solution: An Intelligent Compromise," which can be found
at the Common Sense on Social Security website, www.sscommonsense.org

In brief, though, here are the findings.  A two-track strategy
is a much lower risk path to achieving the nation's primary goals
for Social Security reform.

a) Future benefits can be protected more fully.  The package of 
cuts proposed by Robert Reischauer and Henry Aaron in their book
are equivalent to a straight line benefit cut of 10.8 percent, 
although their cuts start at a lower level and then become 
progressively steeper. Their cuts also fall with disproportionate
force on the very old, the blue collar retirees, women, and the 
poor.  A much lighter regimen of benefit cuts is possible with 
a two-track strategy.

b) The line can be held on the payroll tax.  The rate can be kept
at 12.4%.  Yes, the tax base needs to expand modestly.  The 
earned income cap needs to be calculated in a way that once again 
subjects 90% of all payroll to Social Security taxation.  But 
the rate remains the same.

c) Long term solvency can be assured.  This is a much more powerful
goal than the restoration of "actuarial balance," which is
simply a euphemism for saying that Social Security's insolvency 
date has been pushed back to 2077.  Long term solvency means something very
different.  It means that Social Security's pool of capital is 
just as large in 2075 as it is in 2050.

(The 1983 Greenspan Commission made the mistake of shooting for
actuarial balance, not genuine solvency.  That mistake ought 
not be repeated.)

d) Permanent federal subsidies can be avoided.  The fifteen year
Clinton subsidy is an excellent strategy for building up the Trust
Fund to a level that actually means something.  But it's a subsidy
that goes away.  The Feldstein recommendation on private accounts, 
by contrast, which has many attractive features, nonetheless
entails a perpetual subsidy from the federal budget.  Permanent
federal subsidies are unnecessary in a two-track solution.

e) Undue risk can be avoided.  In a two-track strategy, the 
ownership concentration risks associated with a Trust Fund-based
capital accumulation program can be reduced much more dramatically
than they can be in a pure Trust Fund strategy.  The cohort
risk problem with private accounts can be eliminated, from a 
retiree's point of view, if private accounts are coupled with
a hefty Trust Fund.

How can the risks be dispelled?  Let's start with the Trust Fund.

Private accounts will bring with them a hundred different Investment
Management Firms.  Require Social Security to farm out its Trust
Fund assets among those firms.  Do it in proportion to their
popularity with American workers.  If Merrill Lynch has been chosen
as the PRA manager by two percent of all workers, put two percent
of Trust Fund assets into Merrill Lynch's hands.  Require all
Trust Fund assets to be invested in very broad index funds.  Have
the Investment Management Firms vote the stocks they're holding.

This is a far more effective system for decentralizing the control
of Trust Fund assets, and for insulating them from Congressional
interference, than the system proposed by Robert Reischauer.

On the private account side, there's no need to have private accounts
stretch to cover all of a retiree's remaining years.  Private
accounts aren't going to solve more than a fifth of the total
financing problem anyway.  On retirement, new retirees should
be expected to convert their PRA savings into fixed, ten-year 
annuities.  Monthly payments on these will be forty percent 
higher than the monthly payments on lifetime annuities.

On retirement, Social Security still calculates a person's Social
Security benefits in the same way that they're now calculated, with the 
same progressivity.  And Social Security checks continue to be
paid, with one difference.  During the first ten years, when
the PRA annuity money is coming in, Social Security checks are
reduced.  For each dollar in annuity money the retiree receives,
the Social Security check is reduced by ninety cents.

[Retirees are kept whole, no matter how long they live.  And they
reach retirement having paid the same payroll tax as now.  Yet
the system as a whole supports a retiree population 80% larger 
than today's, in relative terms.]

The Common Sense PRA Strategy finesses all the objections 
that have been raised against private accounts from the liberal
side of the debate.  Longevity risk is virtually eliminated.  
The ten year strategy takes an "investment" approach to financing 
the first ten years of retirement, and an "insurance" approach 
to financing the latter years.

Cohort risk still exists in a macro sense.  Markets will go up,
markets will slide.  But individual retirees are cushioned against
the impact of cohort risk.  This would not be possible in a pure
PRA strategy.  Social Security wouldn't have the necessary 
reserves.  IT'S ONLY POSSIBLE IF PRIVATE ACCOUNTS ARE COMBINED
WITH A HEFTY TRUST FUND.  (sorry about the caps. subtler forms
of emphasis don't seem to be available with this system.)

And management fees and complexity are disposed of.  As a practical
matter, with Social Security sending monthly investment checks to
each of the hundred or so Investment Management Firms that are
handling PRA's, individual PRA's can simply piggy-back on top of that.
The account-by-account recordkeeping is taken care of by Social
Security.  The Investment Management Firms simply take care of 
the aggregate asset pool.

In about forty years, a two-track strategy brings us to a point
at which the Trust Fund's assets are equal to about 35% of GDP.
PRA assets are equal to about 30% of GDP.  

Note what this means.  The proceeds are equal to roughly 2.5%
of GDP - enough to make up the 2.5% gap between payroll tax
proceeds, and obligations to beneficiaries.

Half of the assets are in stocks, half in bonds.  The average 
return is probably about four percent.  And the average size of 
the entire stock market is probably about 100 percent to 120 
percent of GDP.  Thus the Social Security-related retirement 
ssets belonging to the entire American workforce are held to 
only a fourth or a third of the entire stock market.  

That's not bad, when you think about.  People used to think
the stock market couldn't do anything more than take care of 
the coupon-clipping Rolls Royce set.  Now it's helping the 
entire work force.

Yet a total Social Security-related stock ownership share equaling
only a third to a fourth of the entire stock market is 
a far cry from the Burtless assumptions that would have given 
PRA's triple ownership of the stock market.

What's the bottom line here?  Yes, we can debate the either-or 
issues if we wish.  But I personally believe that we'll have a 
more fruitful debate if we reframe it as a Both-And debate.

-Steve Johnson