Why Personal Accounts Would Work

This is a Commentary On Social Security

Commentary-

Why Personal Accounts Would Work

By David John
March 17, 2005

A good actor can take someone else's words and make them believable. A good columnist can, too.

Recently, syndicated columnist Michael Kinsley latched on to an idea first floated by actor Rob Reiner. Kinsley and Reiner want to prove that personal retirement accounts (PRAs) for Social Security cannot work. But their arguments are simply wrong.

Kinsley and Reiner claim that there is no way a conservative portfolio of stocks and bonds can grow at an average rate of 4.7 percent annually (after inflation) if the economy grows as slowly as Social Security actuaries predict. That 4.7 percent return is important; it's what The Heritage Foundation estimates a PRA would earn after inflation. Although Kinsley didn't mention it, our prediction is based on a portfolio that consists of 50 percent stock index funds and 50 percent government bonds.

Such a return is possible and even likely. A new study by the London Business School shows that stock market returns are higher on average in slower-growing economies than in rapidly growing ones. The study found that investors earned 12 percent a year buying in down markets and only 6 percent when market growth was in the top 20 percent.

Just three days before Kinsley's column was published, Stephen C. Goss, the nonpartisan Social Security chief actuary, used precisely the economic assumptions criticized by Kinsley to project that over the next 75 years, "the long-term ultimate average annual real yield assumed for equities [stocks] is 6.5 percent." Congressional Budget Office estimates echo Goss' numbers.

Kinsley and Reiner also claim that if the economy grows faster than the actuaries predict, Social Security's problems will be solved without personal accounts.

But several studies, including data from the nonpartisan Social Security actuaries, show that there is virtually no chance that faster economic growth could solve Social Security's coming huge deficits.

In fact, higher economic growth would make the problem worse. Yes, higher earnings would increase the amount of Social Security payroll taxes collected in the short run. But because benefits are linked to wages, they also would increase the amount of retirement benefits that would have to be paid.

The actuaries do admit that there is a 2.5 percent chance the economy could grow fast enough to solve Social Security's problems. Of course that also means that there is a 97.5 percent chance that it won't. It certainly doesn't make sense to gamble our children's retirement security on such odds.

Most disturbingly, Kinsley also writes: "But if free markets work the way they are supposed to -- and I would like to hear The Heritage Foundation say that they do not -- the effect of the government's announcing that government bonds are a bad investment and officially pushing people to put their money elsewhere will be to make it more expensive for the government to borrow money. So even if private stocks and bonds are a better long-term investment than government bonds (after factoring in risk and so on), they won't stay that way for long."

This makes little sense. No one is saying that real government bonds (as opposed to the non-negotiable "bonds" that substitute for real assets in the Social Security trust fund) are a bad investment. Our projections, as noted above, are based on PRAs that are 50 percent invested in government bonds. The Bush proposal assumes that 20 percent of PRAs are invested in government bonds. Government bonds are a fine investment for people who want to avoid risk and can afford the lower returns paid by government bonds.

On the other hand, stocks and other types of bonds pay a higher return in part because they have a higher risk level. Stocks and bonds rise and fall by the day, week and month. However, over long periods such as 20 years or more, they almost always rise at a significant annual average rate.

This is what makes stocks and bonds perfect for retirement investing. Holding them for 20-plus years virtually guarantees significant profits at a fairly low risk level. A system of PRAs would increase demand for both stocks and government bonds. There is no reason to assume that demand for either will fall or that the risk-based difference between what each pays will change significantly from the SSA or CBO projections.

We can have personal accounts that allow individuals to build retirement nest eggs they will own and control. In fact, such accounts are the only proposal on the table that can preserve Social Security for decades to come. The time to act is now.

John is a senior research fellow for Social Security at the Heritage Foundation.

Distributed nationally on the Knight-Ridder Tribune wire

About the Author

David John Senior Research Fellow in Retirement Security and Financial Institutions

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