Social Security is the healthiest component of the U.S.’s retirement saving system
Bloomberg’s Josh Barro is the lead writer for the Ticker, Bloomberg View’s blog on economics, finance and politics.
Social Security is the healthiest component of the U.S.’s retirement saving system
Last week I wrote that Social Security is the healthiest component of the U.S.’s retirement saving system and should therefore be expanded. This isn’t a popular position; liberals tend to prefer defined-benefit pensions from employers and conservatives defined-contribution accounts, such as 401(k)s and individual retirement accounts. But the reason Social Security works so well is that it lacks a fundamental problem that undermines the effectiveness of these other retirement vehicles.
Both defined-benefit pensions and defined-contribution accounts are based on a shared and problematic premise: It is possible to set aside x percent of today’s gross domestic product for retirement and generate retirement income from those savings that exceeds x percent of future GDP. This is to be achieved by investing in your retirement savings by adding assets that typically grow at a faster rate than the economy as a whole.
Such returns are possible. Some asset classes have long-run rates of return that exceed GDP growth: equities, for example. But the high returns are a compensation procyclical risk: These assets will tend to strongly outperform GDP when the economy does well and significantly underperform it during recessions.
It doesn’t make sense to finance retirement in such a risky way. Retirement savings exist disproportionately for the benefit of people with low or moderate means and a relatively low tolerance for risk. If retirement assets were invested safely, they would not be expected to grow faster than the economy as a whole.
So 401(k) and traditional pensions are both just efforts to finance retirement on the cheap by taking on excessive risk. The problem created by risk manifests itself in different ways with the different vehicles.
That is, private pensions no longer rely on the premise that retirement can be made cheaper through investment in assets that grow faster than GDP. But such a free lunch was what made the plans attractive for employers in the first place, and as employers have faced the plans’ real costs, they have increasingly eliminated them.
In the public sector, the free lunch lives on in the financial statements of pension funds. Governments fund their pensions based on an expected rate of return on a risky portfolio of assets, most commonly between 7.5 and 8 percent a year, far above the roughly 5 percent growth path we might expect for nominal GDP.
All of these options (expanding Social Security or downshifting the risk in other investment vehicles) would cause retirement saving to appear to become more expensive. But it wouldn’t actually make saving more expensive: It would just replace hidden costs created by risk with explicit costs.
Americans would then face a stark reality: Retirement, which is basically just another word for spending the final sixth of your life on vacation, is expensive. I am agnostic on the question of whether people ought to respond by saving more or retiring later. Advocates of later retirement tend to be elite people with jobs that are interesting and not physically demanding. But facing up to the true cost of adequate retirement saving would help Americans make more sound choices about how to deal with the fact that retirement is expensive.
From a political perspective, maybe the middle ground is a mandatory DC plan such as the Australia Superannuation plan. One thing to keep in mind is that this would be a demand leakage though one mitigated when people begin to withdraw funds.
The main question is if this type of plan politically hurts or helps protect SS.
keep your eye on the ball.
there is no need for another “middle ground.”
the workers can pay for their own social security with an extra eighty cents per week each year.,
the “not middle” ground is either “cut benefits”
“make the rich pay.”
i find it incredible that people can’t understand that.
Coberly not suggesting we replace SS, but have a second system alongside that is politically palatable.
SS itself is in quite good shape. if it requires a tiny hike in the payroll tax so be it. I don’t even think it needs that unless, austerity rules the day, which will hurt SS and the economy.
I like this. It really is up to the next generation whether they prefer higher taxes or to work longer, but if the latter is to be a real possibility, we would really need an employer of last resort, for the ones most able and willing to work longer are not the ones that have to worry about continuing or finding work. Extending work would lead to considerable expansion of disability.
i think you may have it backwards. Those who will want to work longest will have the best jobs and highest pay. No reason they can’t work if they want to.
It’s the least of us who will find it hard to go on much after 60, let alone 65. And since we can pay for it ourselves, there should be no obstacle to our retiring at that age.
The “higher tax” is so miniscule it is laughable. But somehow too many folks don’t understand the difference between eighty cents per week per year while you are working, and trying to get along on 750 dollars a month instead of 1000 (it can be done) or working into deep old age.
And “we” ARE the next generation. While that eighty cents per week per year is being phased in, we are gradually paying for our own future retirement.
I realize many people can’t understand this, “pay as you go” has too many parts for them to keep track of. But you ARE paying for your own future retirement.
It’s rather elegant. If you pay an extra eighty cents per week this year and retire next year, you will not have paid more than an extra forty dollars… and your longevity will not be that much different from the guy who retired last year.
But if you pay an extra eighty cents per week this year, and another extra eighty cents per week next year… and so on… for another forty years, that will add up to a significant… but unfelt… amount which will pay for your longer life expectancy that is at least several years longer than that of the guy who retires today.
It is also the case that wages will be rising, so the “benefits” you get, “wage indexed”, will be more than what you paid in. This is not a burden on the following generation, because they will get the same benefit… that is, an effective interest on their payroll “tax,” and the tax increase will not be going on forever, while, presumably, the wage increase will.
mmcosker you also could look to our own federal government’s Thrift Savings Plan for a model that might be adapted for everybody (as a supplement to Social Security). Employees and the employer contribute, like many private 401-k programs; safe/conservative investment options exist along with riskier ones; and admin costs are low.
I wonder if anyone has studied the osification of faculty in American universities. Like other professional positions that are not physically demanding its becoming impossible to pry senior professors out of their positions unless they croak and then they have to be carried out. Result? Young PhDs can’t find appropriate levels of work. but who can blame the geezers of academia? Four to six hour class load, $150K annual salary and sorrounded by twenty year olds. Those are all approximate measures, but it gives one a picture of why academics may be getting out of touch with real life.
It seems to be happening in medicine also. Health centers outside of densely populated regions haven’t enough patients to keep their staff physicians gainfully employed.
Maybe I can restate Dale’s point in a more technocratic way.
Is there a contribution rate to a mandatory DC plan that meets ALL the following conditions?
1) is equal to or less than the amount needed to fully fund Social Security scheduled benefits under Intermediate Cost Alternative assumptions
2) would sustain equivalent disability and survivors coverage along the way
3) actually can produce assumed ROI given GDP and productivity numbers of Intermediate Cost
Another way of asking this is to see curent actuarial gap as setting your budget and Intermediate Cost as setting your investment parameters. And if your plan model requires tweaking either that budget or those parameters then you have an obligation to rescore SS under the new assumptions.
This was essentially at the core of Dean Baker’s 2005 NELB (No Economist Left Behind) Challenge. Which no one actually met except under conditions which gutted their overall plan. That is you could still get needed ROI on equities by repressing the share of productivity going to American workers (via off shoring or straight out wage suppression) but then are faced with the question of how workers would actually finance their contributions out of that reduced compensation.
But mostly nobody even got to that final point. As an example the LMS Plan posited a total contribution of 5.2% of payroll to a gap then scored at 1.92% and only produced positive results for a subset of workers. And at that never revealed their assumed GDP and productivity numbers vis a vis Intermediate Cost.
Oh and BTW. On setting your DC contribution rate be sure to leave room for fees. While the actuarial gap assumes admin costs right at a historically proven 1% , any management/admin fees above that reduce effective ROI.
Good Luck! And write if you get Work! (or in this case workable numbers)
The beauty of the Northwest Plan is that we just assume crap outcomes for workers going forward (a fair assessment of the projected effect of Intermediate Cost economic outcomes on Real Wage give. It’s suppressed GDP/Productivity model) and quantify the cost of the fix needed under those adverse conditions. What this means in practice is that any improvement in actual numbers over Intermediate Cost assumptions simply lowers the cost of NW. And we piggy-back on any competitors assumptions of more favorable outcomes.
As it turns out the three authors of NorthWest have different opinions on the adequacy of IC assumptions. But in the end it soesn’t matter. For one thing the overall bias of IC is to the conservative and downside, the only question is the degree. For another NW has an automatic backup plan that triggers in case IC actually proves too optimistic. Whereas privatizers are mostly locked into 6.5% real returns forever.
Well fine. Posit 3% GDP, 2% Productivity and 1.5% Real Wage to fund those DC accounts and the NorthWesterners will just pocket our winnings and cut down the projected cost of our plan. Did Dale say 80 cents a week? Heck we now propose 50 cents a week. And thanks for the higher Real Wage in the meantime!!!
Because good news for workers is good news for worker retirement under Social Security. While bad news for workers craps all over schemes based on worker contributions. And it is not clear there is any needle eye to thread here.
actually, I wouldn’t mind seeing a “defined contribution” plan if it was kept entirely separate from Social Security.
the reason is that such a plan would undoubtedly make money more often than not, and it would therefore make retirees a little richer than they would be with SS alone. and because they would “own” it, they could stop complaining about SS which does rely on the fact that some people die before collecting “all” of their benefits, to be able to pay benefits to those who live longer than they are “expected” to.
i would rather see the SS tax raised significantly and pay people a significantly higher benefit, because, like Barro, I think SS is the best way to fund a retirement SECURITY plan.
but watching the way people “think” over the years, i suspect they’d pay for the “market based” plan with great pleasure and delusions of great wealth.
i’d just have to hope they’d then leave SS alone “just in case.”
i’d like to go a bit further about “crap outcomes.”
Social Security is designed as insurance against “crap outcomes.”
Some people will always get a “crap outcome” in life.
If we could guarantee ourselves that we would not find ourselves 60 plus years old facing a “crap outcome” we would not need Social Security.
But even during the past 70 years of relative prosperity (the highest the world has ever known), well over half the population has faced “crap outcomes” when they needed to retire.
Social Security is not an investment that will make you rich, or even “middle class.” It is there to keep you from eating out of dumpsters and sleeping in doorways. And while “you” are too smart to ever need it, society as a whole needs it. Not only does it make the difference between destitution and “gentle poverty” for half the population, it makes the difference between “gentle poverty” and “reasonable comfort” for about 80% of the population. And I am reasonably sure that about half of the rest would not be “well off” if that first 80% did not have Social Security. You can’t get rich in a country where half the old people are facing destitution. The very rich, of course, will always be very rich… they live off carrion.
I would have some hope that either Social Security to which people contributed more than enough for poverty level benefits, or a government run market-based retirement system would raise the amount of retirement income most people can look forward to. But I would not rely on that “market based” plan. As Josh Barro points out, the market always goes bad at the worst time.
Bruce: “we just assume crap outcomes”
“the three authors of NorthWest have different opinions on …”
Dale: “well over half the population has faced “crap outcomes””
I am sorry I missed this thread. The above comments generate plenty of thoughts about the how of convincing people that scheduled benefits with a stable, worker-funded Pay-As-You-GO program (the NW Plan) is what they should want.