What Verdict Has The Past Year Rendered On Social Security Reform?

It’s hard to remember, but much of 2005 was spent arguing about Social Security reform, an issue that’s been quiet since then. But with President Obama’s statements that he wants to take on Social Security, and his sponsoring of a “fiscal responsibility summit” in February, there are new stirrings on reform on Capitol Hill. For that reason, it makes sense to revisit some of the conclusions drawn over the past several years.

In this context, it’s worth touching on two main issues. First, what do recent market returns say about the case for Social Security “personal accounts” invested in stocks and bonds? And in a future post, what can we now say about whether to balance Social Security’s finances through tax increases or benefit reductions?

Over the past year, the S&P 500 totally return fell 37 percent, with many investors – including this one – losing close to half their portfolios. During the election campaign, then-Sen. Obama asked a campaign audience "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? …If my opponent had his way millions of Americans would have had their Social Security tied to [the] stock market this week. Millions would have watched as the market tumbled and their nest egg disappeared before their eyes.”

These statements prompted me, in a research paper for the American Enterprise Institute and subsequent calculations, to answer Obama’s question: if we’d had personal accounts, how would today’s retirees have fared? The answer is: a lot better than I’d have guessed.

Using stock and bond data from 1871 through today, I simulated a fairly typical Social Security personal accounts plan, in which workers would invest 4 percent of the 12.4 percent payroll tax in an account, which would be managed by a “life cycle” portfolio that shifted from stocks to bonds over time. In addition, account holders would receive a reduced traditional benefit, to make up for paying less into Social Security. If the personal account benefit exceeded the reduction to traditional benefits, account holders would come out ahead.

The first chart below shows percentage changes in total Social Security benefits for people retiring from 1915 through 2008. I assumed each worker held an account their full working life and retired at age 65. The headline figure is that even workers retiring in 2008 would have increased their total benefits by 15 percent. While current returns are low, they weren’t enough to take away from higher returns over a full career. And here’s a sub-headline: no cohort of retirees from 1915 through 2008 would have lost money by holding an account. Benefit increases ranged from 6 to 23 percent, with an average boost of 15 percent.

But not all workers would hold an account for a full career. Had we passed Social Security reform a few years back, many workers would have gotten into the market and retired soon thereafter, leaving little time to recover from the crash. This is a legitimate point, but does it change things?

The chart below simulates people who retired in 2008, but started holding an account at different ages. The full career account holder, as noted above, received 15 percent higher total benefits. Workers with less time in accounts received smaller benefit increases, and a smaller number of retirees – those who started accounts after age 48 – would actually have lost money. But only a little. The average benefit lost was only 0.3 percent, and the largest lost – for retirees who began participating in accounts at age 53 – was only 0.7 percent. The reason is simply that by that age, most workers would have shifted their accounts away from stocks and into bonds. Under President Bush’s plan, their accounts would automatically have shifted to bonds.

I’m fully aware of how recent market returns have impacted perceptions of Social Security accounts, and I think prior conservative dreams of “privatizing” Social Security are largely gone. It makes little sense simply repeat old plans when new ones are called for. But it also doesn’t make sense to enter any policy debate with an unrealistically low perception of your own policies. I hope this post fleshes out the market risk idea a bit more fully.

In a future post, I’ll touch on where this leaves the fiscal side of the Social Security debate.