Economics, Entitlements

Sloan’s Social Security Claims Are Turkey

turkeyWriting in the Washington Post, Allan Sloan singles out Social Security personal accounts as a policy “turkey.” Both reasons Sloan gives, however, turn out to be wrong. It’s a shame, since Sloan is a bright guy and his main point—that government’s role is to provide a basic income to keep people out of poverty in retirement, not to run an investment or wealth building program—is a legitimate one. But if you present evidence to support your argument, there’s an obligation to make sure you get your facts right, and he doesn’t.

Sloan’s argument is based on market risk: in short, he says, due to several large market declines in recent years, had we passed Social Security personal accounts as proposed by President Bush in 2005, many retirees today would be hurting. Sloan cites two reasons. First, he argues that falling stock prices would have hit their accounts at just the wrong time. Second and less obviously, he suggests that individuals retiring today would need to annuitize their accounts—that is, convert their lump sums into a monthly lifetime income—at a time when interest rates are very low. Low interest rates translate into a small annuity payment.

Both points make sense, until you actually start picking at the details of the Social Security reform plan Sloan is criticizing. The reason I raise this objection isn’t because I believe anyone will try to pass President Bush’s reform plan anytime soon—I’m on record saying a different tack is preferable—but because criticisms like Sloan’s portray the designers of Bush’s plan (among whom I played a very minor role) as not very competent. That would be unfair.

Regarding Sloan’s first charge, back in 2008 I wrote a paper for AEI that expressly examined the market risk issue, prompted by President Obama’s question, “Imagine if you had some of your Social Security money in the stock market right now. How would you be feeling about the prospects for your retirement?” The answer from my paper was:

…despite the recent market downturn, individuals investing four percentage points of the 12.4 percent payroll tax in a personal account holding a “life-cycle” portfolio and retiring today would have increased their total Social Security benefits by more than 15 percent. Moreover, a simulation of ninety-five cohorts of individuals retiring from 1915 through 2008 found that all of them would have increased their total Social Security benefits by holding personal accounts.

The reasons for this are twofold: first, individuals would be invested over a long period including both bull and bear markets, so the end result is what matters; and second, under Bush’s plan, individuals nearing retirement would automatically have their accounts shifted from stocks to bonds. So while account holders would have lost money during recent market downturns, near retirees would have been largely protected from these losses.

Sloan’s second point is subtler, but it’s also one I addressed explicitly in my 2008 AEI paper. Sloan is right that low interest rates at the time you retire would mean a smaller annuity payment from your personal account. But it is possible to completely and costlessly protect account holders against this risk. The reason is that individuals who choose to hold an account receive a reduced traditional benefit, and this reduction is based upon the annuitized value of the individual’s account contributions. In other words, account holders retiring at a time of low interest rates would receive a smaller benefit reduction than those who retired when interest rates were high. Therefore, account holders could be perfectly hedged against interest rate risk at the time of retirement.

I like Sloan and on policy I agree with him more than I disagree. But when you’re going out on a limb by singling out a given policy as a “turkey,” you really need to check on the evidence that’s backing your claim. In this case, it’s pretty shaky.

Image by Tiia Monto.

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