Saturday, May 07, 2005

Place Your Bets

John Tierney wrote in the NYT After a recent column comparing Social Security with the Chilean system of private accounts, I was deluged with letters from readers eager to explain why I am a superficial nitwit. In this case, they're at least half right. The column was superficial because I simply looked at how much more money I'd have if I had invested my Social Security contributions in the private account of a Chilean friend and economist, Pablo Serra. The numbers were impressive - my projected pension would be triple what I'm promised by Social Security - but they're not as important as another consideration: which type of pension is riskier?

Pablo has done well because Chilean mutual funds have yielded high returns in the past two decades - probably higher than I would have gotten from an American mutual fund, although here I'd still be way ahead of Social Security. Historically, stocks have yielded returns two to three times what Social Security pays. Still, stocks could yield much lower returns in the future, as critics of private accounts have pointed out in advertisements comparing the market to a slot machine and extolling the "guarantee" of Social Security. But there's also another kind of risk to consider, one that Chilean workers kept mentioning to me. The best part of their private accounts, they said, was that they'd put "la plata donde mis ojos la vean" - the money where my eyes can see it. They knew they might lose some of it in the stock market, but they preferred that to watching it all disappear into politicians' hands.

Which is exactly what would happen.
My Social Security, far from being a guarantee, comes with a political risk that will become clear around 2017, when I'll be 64. That's when the Social Security Administration expects to start paying out more than it collects in taxes. In theory, there is a trust fund to cover this shortfall. When Congress sharply raised Social Security taxes in the 1980's, the idea was to generate surpluses during the baby boomers' working years that would finance our retirement. Instead, Congress spent our money, leaving the Social Security trust fund with a file cabinet full of i.o.u.'s in the form of Treasury bills. It's not a problem now, because for the next few years the baby boomers' taxes will provide an annual surplus for Social Security of about $100 billion, allowing Congress to dole out the extra money for its favorite causes, like farm subsidies and weapon systems and West Virginia buildings named after Robert Byrd. But in four years the surpluses start declining, and they turn into deficits around 2017, when Congress must begin repaying those i.o.u.'s.
And the only way to do that would be to borrow money (a short term solution that would leave us worse off in the future, raise taxes, or cut benefits (including eventually cutting the entire Social Security program)
By the time I'm in my 70's, the Social Security shortfall will force Congress to find new taxes or make spending cuts that are more than half the size of the Pentagon's budget. If I make it to age 88, there will no more i.o.u.'s left in the trust fund, so everyone's benefits would have to be cut by 27 percent. Faced with the grim math, President Bush offered a progressive compromise last week to Democrats: protect the poor while moderating the growth of benefits for higher-income workers. Democrats refused to bite, denouncing his "cuts" without offering a plan of their own, and members of both parties wondered why any politician would jeopardize his party's chances in 2006 by tackling an unpleasant future problem.

You can call the Democrats irresponsible obstructionists, but they're just following the first rule of politics: get re-elected. It's the same rule followed by the politicians from both parties who have spent the baby boomers' retirement money. Why set aside money for 2017 if it could be used to woo voters and campaign contributors for the next election? I can't protect my pension against political risk, but Pablo can help protect his against the risks of the stock market. As he approaches retirement, he can gradually shift his money out of stocks and into bonds, like the ones that financed the private road between Santiago and the port city of Valparaiso, which will be paid off by tolls. The Chilean pension system has billboards along the road proclaiming, "Your savings are financing this highway, and this highway is financing your retirement." Those billboards have been on my mind. My pension depends on 535 politicians who will be asked to vote for steep tax increases or budget cuts that they fear could cost them their jobs. Pablo's pension depends on people driving between Chile's two largest cities.


Orrin Judd blogged Wouldn't it be amusing if every time a politician or pundit wrote or spoke about the "risks" of privatization they were required to reveal how much money they had invested in their own 401k, IRA, mutual funds, etc.?

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