Response to Moderator's Q on Privatization Premise

[National Dialogue Moderator <moderator>]

If the goals of Social Security reform include boosting national savings and raising the rate of return received on payroll tax contributions, this can be achieved without creating a system of  individual accounts.  A portion of the trust funds that are not needed to pay current benefits can be invested in equities to achieve a higher rate of return than Treasury securities would yield.  Increasing the rate of return to the trust funds would reduce the size of the long-term imbalance and consequently reduce the amount by which benefits otherwise would need to be reduced or taxes raised.

Investing a portion of the trust funds in equities will increase the rate of return to the trust funds without incurring the costs or the risks of individual accounts.  Under an individual accounts system, payroll taxes needed to pay current benefits would be diverted into private accounts.   The cost of making up for this diverted revenue - the transition cost - would reduce the rate of return for individual accounts.  If the trust funds were invested in equities, only monies not needed to pay current benefits would be used so there would not be a transition cost.

Individual accounts also incur administrative costs to set up and monitor accounts for approximately 148 million workers.  These administrative costs further reduce the rate of return for individual accounts.  These costs can be avoided by investing the trust fund in equities.

Investing a modest portion of the trust fund in equities also can increase Social Security's rate of return without exposing workers to individual market risk.  By investing a portion of the trust fund, the risk of losing some of the investment during a period when the stock market declines would be pooled across all workers and spread over time.  While there may be some decline in invested funds during a market downturn, the trust funds are sufficiently large to ride out the decline while continuing to make benefit payments.

Investment of the trust fund can be accomplished without exposing private businesses to political influence.  The federal Thrift Savings Plan (the federal government employees' defined contribution plan) and the pension plans of the Federal Reserve Board invest in the private market and have shown no evidence of investment choices based on political concerns.  In addition, several steps can be taken to prevent political intervention in private sector decisions.  A politically and fiscally independent governing board could be set up to administer the investments.  The board would contract with portfolio managers to passively invest the trust funds in broadly indexed equity funds.  Board members would effectively be prohibited from voting stock.  Finally, a limit could be placed on the size of the trust fund investment compared to the stock market value.  For example, the Social Security Administration actuaries estimate that under President Clinton's proposal, the trust funds would hold less than four percent of the total market value, on average, over the next 40 years.

Investing a portion of the trust funds in equities would help women and minorities in several ways.  Because this investment would reduce the long-term imbalance, the amount by which benefits otherwise would need to be reduced would be limited.  Administrative costs incurred by individual accounts would be avoided.  To the extent that administrative costs for individual accounts are fixed, these costs would eat up a larger share of savings in the accounts for low-wage workers than high-wage workers and thus would adversely affect minorities and women, whose average wages are lower than those of non-minorities and men.  And investing a portion of  the trust fund protects workers from the risk that their investments could do badly under a system of individual accounts leaving them inadequate income in their old age.  In general, women and people of color have less fiscal capacity to withstand losses given their lower level of earnings and other assets.


Kilolo Kijakazi