Washington Post : : Retirement Accounts Questioned
Well, if "Who came up with this stupid idea?" is the question. If the unrealistic rates of return the program's supporters are promoting are to be believed, 32% of workers who divert their payroll taxes would do worse than those who don't. Using more realistic figures, the percentage jumps to 71%. Brad Plumer has more:
...Note what's involved here: benefit cut #1, a tax hike, and benefit cut #2.** That's important.
...Shiller's just pointing out that private accounts won't make up the losses from benefit cut #2 described above. But workers will also still suffer from benefit cut #1, and they'll also have to pay off higher taxes thanks to all the borrowing involved in the transition to privatization. So when you factor in all three components of the Bush plan, workers are getting not a 3.4 percent return or a 2.6 percent return, but much, much less.
...Note what's involved here: benefit cut #1, a tax hike, and benefit cut #2.** That's important.
...Shiller's just pointing out that private accounts won't make up the losses from benefit cut #2 described above. But workers will also still suffer from benefit cut #1, and they'll also have to pay off higher taxes thanks to all the borrowing involved in the transition to privatization. So when you factor in all three components of the Bush plan, workers are getting not a 3.4 percent return or a 2.6 percent return, but much, much less.
posted by Management at 7:12 AM
3 Comments:
Retirement Accounts Questioned
Paper Challenges Expected Benefits
By Jonathan Weisman
Washington Post Staff Writer
Saturday, March 19, 2005; Page E01
Nearly three-quarters of workers who opt for Social Security personal accounts under President Bush's "default" investment option are likely to earn less in benefits than those who stay with the traditional Social Security system, a prominent finance economist has concluded.
A new paper by Yale University economist Robert J. Shiller found that under Bush's default "life-cycle accounts," which shift assets from stocks to bonds over a worker's lifetime, nearly a third of workers would bring in less in benefits than if they remained in the traditional system. That analysis is based on historical rates of return in the United States. Using global rates of return, which Shiller says more closely track future conditions, life-cycle portfolios could be expected to fall short of the traditional system's returns 71 percent of the time.
Both the White House and the Social Security Administration have relied on historical returns in estimating the earnings of proposed personal investment accounts. Shiller used 91 computer simulations to analyze the past performance of stocks and bonds in a variety of portfolios. He measured the returns in 44-year increments, beginning in 1871, to approximate a worker's lifetime contributions to personal accounts.
The results "showed a disappointing outlook for investors in the personal accounts relative to the rhetoric of their promoters," concluded Shiller, a leading researcher in stock market volatility who gained fame in the late 1990s for his warnings of a stock market bubble.
Shiller's paper -- to be posted on his Web site, IrrationalExuberance.com -- is adding to research that suggests the White House has been overly optimistic in its assumptions about personal investment accounts. A recent paper by Goldman Sachs economists said the White House's anticipated 4.6 percent rate of return above inflation could be nearly 2 percentage points too high.
Even some supporters of the accounts say Bush has to change his proposal if investors are to turn a profit. Under the Bush proposal, workers would be better off choosing private accounts only if those accounts earned annual returns that exceed inflation by 3 percent.
"I'm one of these people who maintain the 3 percent rate is too high a trade-off," said Jeremy J. Siegel, a finance professor at the University of Pennsylvania's Wharton School and a longtime advocate of stock investing. "You can't get 3 percent in the market anymore."
Trent Duffy, a White House spokesman, said the administration is not contemplating changes to the proposal at this point.
"We're confident returns on the market will be well in excess of what we need to make the program work well for seniors," he said.
Life-cycle accounts were a response to critics who charged that stock market investments would be too risky for Social Security. But according to Shiller's analysis, that conservative investment strategy appears to carry a risk of its own: a paltry rate of return.
Shiller is "documenting what's well known, that bond returns have just been terrible," said Kevin A. Hassett, director of economic policy studies at the American Enterprise Institute and a supporter of personal accounts. "If we are excessively conservative, we will really be hurting workers."
Under the Bush plan, workers ultimately would be able to invest 4 percent of their income subject to Social Security taxes in their choice of stock and bond funds. At age 47, workers who had chosen private accounts would automatically be shifted to a life-cycle portfolio, unless they and their spouse specifically opt out with a waiver acknowledging awareness of higher risk.
When workers with private accounts retire, the Bush system would subtract from their traditional Social Security benefit all of the money deposited in the private account, plus 3 percent interest above inflation. That "offset" or "claw-back" equals the amount the White House assumes those deposits would have earned in Treasury bonds had they gone into the Social Security system.
But the 3 percent hurdle appears too high for many to clear, Shiller found, especially with the conservative strategy the administration has embraced. According to U.S. historical rates of return, the life-cycle portfolio fell short of the 3 percent threshold 32 percent of the time, meaning nearly a third of personal account holders would have been better off sticking with the traditional Social Security system.
The median rate of return was 3.4 percent, barely better than the traditional system. Upon retirement, accounts would yield an annuity payment of about $1,000 a year, "hardly a windfall," Shiller said.
But he also adjusted for what he expects to be lower future rates of investment return by using historic rates of return from international stock and bond markets. Those returns "correspond more closely to projections of financial economists and should be emphasized more as the appropriate evaluation of the accounts going forward," Shiller wrote.
The results were not encouraging: The life-cycle portfolio under these adjusted returns lost money compared with the traditional system 71 percent of the time, with a median rate of return of just 2.6 percent, $2,000 less in annual benefits than those of workers who stick with the traditional system.
"To say that there is a money machine in the stock market, that it can be tapped to yield great wealth without significant risk if one uses life-cycle investment methods, is a big mistake," Shiller concluded.
David C. John, a Social Security analyst at the conservative Heritage Foundation and a supporter of the Bush proposal, said Shiller's downward adjustment for lower future earnings is not supported by other studies, which find little correlation between economic growth and stock market returns. Using international markets as a benchmark for future returns is not fair, he added.
"He's bringing the U.S. [financial] market, essentially the most vibrant in the world, down to the level of stock markets in South America, Asia and various parts of Europe," John said. "I frankly find this study to be a stacked deck."
But Hassett, another supporter of private accounts, called the paper "a very thorough and interesting piece." The White House's response should not be to dismiss the paper's conclusions but to rethink the life-cycle portfolios or lower the 3 percent threshold, Hassett said. The latter is an action administration economists are already considering, he added.
http://delong.typepad.com/sdj/2005/03/joenertia_ii.html
Joenertia II
Senator Joe Lieberman is at it again:
The New York Times > To the Editor:
Paul Krugman ('The $600 Billion Man,' column, March 15) claims that when I say that every year we do nothing about Social Security's coming insolvency we add $600 billion in unfunded liabilities, I am 'helping to spread a lie.'
Nonsense. Experts we've consulted at the Social Security Administration have confirmed this estimate.
Everyone knows that Social Security is on a path to insolvency. Every year that we wait to make the program solvent will cost us more.
I know that Mr. Krugman opposes the president's carved-out private savings accounts. So do I. But if we stop there, the victims will be tens of millions of seniors who need Social Security to escape poverty.
As a columnist, Mr. Krugman has the right to just say no. As a lawmaker, I have a responsibility to work with other members of Congress in both parties and with the administration to protect this great program.
And as a Democrat, I feel a special responsibility to preserve one of my party's most effective initiatives ever.
Joe Lieberman
U.S. Senator from Connecticut
Washington, March 16, 2005
I don't doubt that the SSA actuaries "confirmed this estimate" that "every year we do nothing about Social Security's coming insolvency we add $600 billion in unfunded liabilities" to Lieberman's staff. But if Lieberman's staff had continued the conversation a little bit, they might have learned some other things.
For example:
1. Of the $600 billion, $250 billion is a simple inflation adjustment--the difference between valuing an obligation in 2004-value dollars and valuing the same obligation in 2005-value dollars.
2. If we are going to close the Social Security funding gap by cutting benefits in the future, moving the valuation date forward in time raises not just the present value of the unfunded liability but also the present value of benefit cuts in, say, 2080. The same benefit cuts in 2080 and beyond are required to close the gap whether the gap is measured as $10.4 trillion 2004 dollars or as $11.0 trillion 2005 dollars.
3. If we are going to close the Social Security funding gap by raising taxes, then what we should compare the present value of the funding gap to is the present value of the tax base. And the present value of the tax base also grows larger as we move the valuation date forward in time. The present value of GDP in 2004 was $867 trillion. The present value of GDP in 2005 will (I think) be higher by $58 trillion--$21 trillion because of the inflation effect on nominal values, $26 trillion because of moving the valuation date forward a year, and an additional $11 trillion because productivity growth in 2004 was faster than the SSA had anticipated and that has implications for the entire forecast path of GDP.
If Lieberman had said, "The SSA projects that each year we delay the present value of the infinite-horizon unfunded Social Security obligation goes up by $600 billion. It also projects that the present value of all of America's future wealth--all future GDP--goes up by $58 trillion," then Paul Krugman would not be complaining. If he had said, "In 2004 the infinite-horizon unfunded Social Security obligation was 1.20% of the present value of GDP. It looks as though in 2005 it will be 1.19% of the present value of GDP," then Paul Krugman would not be complaining.
But Lieberman strips the $600 billion number of the surrounding context needed for it to make sense. That is why he is guilty of spreading a lie. He pretends that $600 billion is the extra economic cost of delaying the Social Security fix for a year, and it is not. What it is is a combination of an inflation adjustment and a valuation-year effect.
The fact that he is so easily snookered into repeating deceptive Republican talking points makes me wish that he would curb his feeling of "responsibility to work with other members of Congress in both parties and with the administration": he's going to get taken to the cleaners.
UPDATE: Let's contrast the phony Republican $600 billion calculation with a different, real one: suppose we wait an extra year before we start fixing the Bush deficits. What are the implications? Well, if we fix the deficit--stabilize the debt-to-GDP ratio--just one year later than we otherwise would, we will have run one extra year of deficits and so boosted the long-run debt-to-GDP ratio by three percentage points. Elmendorf and Mankiw's rule-of-thumb is that $1 of debt reduces annual GDP by $0.07. That means an extra three percentage points of debt-to-GDP reduces GDP by $25 billion: puts us on a new, lower growth path where in each year GDP is $25 billion lower than it would otherwise have been. Capitalize this at a yield of 3.33%, and find that delaying action on the Bush deficit for a year is like imposing a one-time tax of $750 billion on America (offset by the fact that people benefit from the U.S. government's spending and not-taxing $360 billion it doesn't have this year: call it a net cost of $390 billion). This is a *real* economic cost: a reduction in people's wealth and standards of living. It's not the result of an inflation adjustment. It's not the result of choosing a different base-date for making your financial calculations.
A quick reminder of how the vague Social Security privatization proposal put forward by the White House is supposed to work. First, everyone's Social Security benefits get cut by 40 percent to bring the program into actuarial balance (this actually cuts benefits by too much, but the White House will need the extra money, as we'll see). Second, the U.S. lets workers divert their payroll taxes into private accounts, and borrows extra cash—$4.5 trillion over the next 20 years—to pay current retirees. Third, the U.S. reduced guaranteed benefits for younger workers even further when they retire, based on how much money those workers put into their private accounts. If your investments get better than a 3 percent return, then you'll earn enough to offset that second benefit cut upon retirement. If they do worse than 3 percent, then you lose.
Note what's involved here: benefit cut #1, a tax hike, and benefit cut #2.** That's important.
Anyway, the White House doesn't want these accounts to be too risky, so they've proposed that the government will handle all your money, and put them in relatively safe "life-cycle" accounts. But now Yale economist Robert Shiller is arguing that the vast majority of "life-cycle" portfolios are unlikely to do better than the necessary 3 percent:
According to U.S. historical rates of return, the life-cycle portfolio fell short of the 3 percent threshold 32 percent of the time, meaning nearly a third of personal account holders would have been better off sticking with the traditional Social Security system. The median rate of return was 3.4 percent....
But [Shiller] also adjusted for what he expects to be lower future rates of investment return by using historic rates of return from international stock and bond markets....The results were not encouraging: The life-cycle portfolio under these adjusted returns lost money compared with the traditional system 71 percent of the time, with a median rate of return of just 2.6 percent.
So 71 percent of private account holders will lose! Although, in truth, nearly everyone loses, and this 71 percent just happens to lose more than others. Refer to my description of the Bush plan above. Shiller's just pointing out that private accounts won't make up the losses from benefit cut #2 described above. But workers will also still suffer from benefit cut #1, and they'll also have to pay off higher taxes thanks to all the borrowing involved in the transition to privatization. So when you factor in all three components of the Bush plan, workers are getting not a 3.4 percent return or a 2.6 percent return, but much, much less.
Of course, the White House could ditch the whole "life-cycle" portfolio idea and let people invest in whatever they want. Then some people will get a high enough return to offset benefit cut #2. Though they'd have to do very, very well to also recoup losses from benefit cut #1 and the tax hike. And, of course, other people would do poorly and end up eating garbage.
**note that benefit cut #1 is bigger than what would be necessary if we did nothing to Social Security and merely cut benefits by enough to remain in long-term actuarial balance. The tax hike ($4.5 trillion over 25 years) is bigger than the tax hike necessary to repay the Trust Fund. How can this be? Well, privatization shifts the costs of generations far in the future onto current workers. To some extent, we're swapping debt tomorrow for debt today, and it all evens out. But that's not much consolation to the workers today who actually have to, you know, pay off that debt.
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