Why the Social Security Trust Fund Needs to be Supplemented by Personal Retirement Accounts

(Previously posted on Redstate.com.  See 2012 Update below.)


SOCIAL SECURITY BONDS

It is often alleged that the bonds that are held by the Social Security Trust Fund are really just "worthless pieces of paper," that they are "merely IOUs."  Starting from this position results in a faulty analysis of the Social Security problem and its solutions.

The bonds are not worthless. They are as worthy as the Treasury Notes, Bonds and T-bills that any private citizen can buy.  They're backed by the full faith and credit of the United States of America, and there is no safer investment available.  Bonds are essentially IOUs, but that doesn't make them worthless.  The problem isn't that they're "worthless," it's that they don't pay enough interest to be the sole class of security supporting ANY trust fund.

THE TRUST FUND

This state of affairs came about because the legislation that created the "Trust Fund" mandated that all excess receipts (taxes) be used to purchase only Government Retirement Securities (I'll call them Bonds), and nothing else.  

This results in the cash being transferred to the general fund, leaving the Trust Fund holding the Government Bonds.  Safe.  But any financial analyst will tell you that if you want to properly fund a trust, it should be invested in a diversified portfolio of different classes of securities--not just Bonds, but Stocks as well; for private individuals there would be other securities that are appropriate, too.  A balance of stocks and bonds actually provides more safety and greater income than do bonds alone.  Believe it or not, but it's true.

So, to rail against the "looting of the Trust Fund" as many people do is to tilt at windmills.  The true problem is that the Trust Fund doesn't earn enough income from its Bond investments to fulfill its long-term obligation to future SS recipients.  And that's what the Personal Retirement Accounts (PRA) are intended to correct.  

WHY PERSONAL RETIREMENT ACCOUNTS ARE NEEDED

It would be illegal and inappropriate for the Government to invest directly in stocks for the Trust Fund, but the PRAs will let individuals do just that, and in the process they will actually REDUCE their risk (remember, right now we're all guaranteed that somewhere around 2045, our benefits under the current system will have to be cut to 70% of the promised payments) while earning considerably more than the Government Bond rate on the money in the Personal Account.  They may also choose some other investments, similar to current government employee retirement plans.  (I read several years ago that the average SS recipient receives a return of about 1% on his SS tax payments.  I suspect that it's less, now that workers who've paid a lot more into the system are retiring.)

WHY THERE REALLY IS A PROBLEM

There are three essential facts about the existing SS System.

One.   We are paying current benefits out of current SS tax receipts, and the excess receipts are being used to buy Government Bonds in the Trust Fund.  Those bonds earn interest at bond rates, which is regularly reinvested in more bonds in the Trust Fund.  The excess receipts and their interest can't legally be invested anywhere else.

Two.  About 2018, there will no longer be any excess tax receipts to buy bonds with, and thereafter some of the old bonds will have to be redeemed to help pay benefits.  (Side note:  The money will come from bond sales to the public that the Treasury will hold.  This will NOT increase the public debt, because it will be a case of selling a new bond to pay off the old one.)

Three.  About 2045 or so, all the bonds in the Trust Funds will have been redeemed.  Whether the year is 2042, 2045, or 2052 is irrelevant.  It will happen, and at that point benefits will have to be cut to equal what is being received in taxes, or taxes will have to be increased to keep benefits level.  This is the problem that Bush is trying to solve.
These are facts based on demographic trends, not just guesses, and even Democrats agree that they're true.   So the question is "What to do about it?"

THE SOLUTIONS

There are three, and only three, solutions to the problem.  (1) Raise taxes, now or later; (2) Cut benefits, now or later; (3) Invest some of the money that would otherwise go to the Trust Fund in securities that can provide higher rates of return than Government Bonds.  This is the Personal Retirement Account solution.

Because of the aforementioned demographic trends, Solutions 1 and 2 only delay the day of reckoning.  In fact, the plan to raise tax receipts by raising the SS tax ceiling doesn't even help in the long run, because it would also increase the future liabilities of the system.

Solution 3 is the only one with a chance to actually solve the problem.  PRAs for voluntary participants (starting under age 55) would more than make up for the reduced benefits that the New Plan participants would expect from the Trust Fund.  They would have an overall bigger retirement income, and there would be less required from the Trust Fund.  True, the Fund would have less in it, but it wouldn't be any worse off relatively than it is now, because its liabilities would be reduced.  

In fact, I think the Government could stipulate a Guarantee, that New Plan participants would never receive less than they would have under the old system.  And of course nobody would be forced to participate.  The old plan would always be there for workers who want to stay in it and risk receiving reduced benefits around 2042, without the PRA to help soften the blow.

WHY NOW?

The longer we wait to solve it, the harder it is to manage the solution.  Benefit reductions become more certain, tax increases become more onerous, and the PRAs have less time to apply the magic of compounding.  If PRAs had been implemented even 10 years ago, we'd be much better off today.

WHAT I LEFT OUT

I didn't mention the benefits that accrue to families whose primary bread-winner dies just before or soon after retirement.  With PRAs, the family would at least receive the money that had been put into their Personal Account.

The PRAs will only help with the RETIREMENT part of Social Security.  They will have no effect on the INSURANCE part.

I also didn't mention the costs of implementing a PRA option into the Social Security System.  Right now, that cost is at best a guess.  Furthermore, the cost of doing nothing is something over $11 trillion, because the present system is underfunded by at least that amount.  The cost of ANY solution has to be compared to THAT bogey, rather than being compared to zero cost.

To be perfectly clear, I must point out that Personal Retirement Accounts appear to be only part of the solution, but I contend that they are an essential part.  Without them, changes only serve to prop up a failing Ponzi scheme for a few more years.

CREDIT WHERE IT IS DUE--TO A POINT

I first attacked this subject several months ago.  At that time, I postulated the "three and only three solutions" rule described above.  Since then, I have found that I wasn't the first person to make this statement.  Before the turn of the 21st century, none other than President William Jefferson Clinton made the same claim in a speech favoring the creation of Personal Accounts for Social Security.  He may not have been the first, either, but he said it before I did--I just wasn't aware of it.

I believe it tells us something about President Clinton's character that he has been completely silent recently on the matter of Personal Retirement Accounts, when his support could possibly turn the debate around in the best interests of the American people.

2012 Update:  Early in this piece I wrote, "The true problem is that the Trust Fund doesn't earn enough income from its Bond investments to fulfill its long-term obligation to future SS recipients."  Although that is correct as far as it goes, it falls short of its mark.  The biggest problem is that Trust Fund monies are all invested (for "safety") with the government itself, which is way too much like any business which invests its pension fund 100% in its own stock.  No problem exists as long as the company is successful, but in the case of even an apparently bulletproof company like Enron, when pensions and employee savings are self-invested in that company and it suddenly isn't paying its own way (and the US Government/Nation is definitely not paying its own way today), those pensions and savings will eventually be lost.  Social Security liabilities/benefits are such a huge part of the federal budget that it is terrible money-management practice to have all of the SocSec assets invested in, essentially, itself.  Furthermore, the benefits SocSec is expected to pay out have become impossibly large for its asset base (Trust Fund) supplemented by feasible tax receipts, especially if it's self-invested in government bonds.