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The Problem with Personal Savings Accounts

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By Gordon66
February 4, 2005

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In another thread a poster asks:

What exactly is so threatening about the prospect of removing some small amount of governmental control over a portion of any given individual's income?

The most obvious thing wrong with the plan is that it will add trillions to the national debt.

However there are three additional aspects of the private accounts plan, all of which will further accelerate the trend towards greater income inequality in America.

First, the current shift in wealth from rich to poor will be reduced.

If you make 90k a year then the diverted 2% (or whatever it will become, this is just the wedge under the door) comes to $1,800 a year. Instead of that going into the general pool, it goes ALL TO YOU.

If you make $8 an hour (25% of Americans make $8 or less) then your 2% comes out to $320 a year. Whoa Nelly, where will you spend it all!

Of course, those that make six times as much ($90k vs $16k) do not get six times as much SS payout under current rules. They get more like three times as much.

So, to sum up, the $90k a year worker keeps all the $1,800 instead of more than half of it going to those lower down on the income scale. The $16k a year worker loses a positive subsidy of some amount (don't know how much).

Second, the current shift in wealth from those that die young to those that die old will be reduced.

Social security is a social insurance program. Personal accounts lose the insurance element. When you retire on social security, you keep getting paid whether you live to be 70 or 100. The people with the "misfortune" to live longer don't face the prospect of a fixed amount being spread over a variable number of years.

With personal accounts if you die "young" (say, at 70), all your remaining private account goes tax free to your estate instead being put back in the pool. Just like the higher wage earner keeps all of the 2% instead of giving half or more back to the pool, the short lived keep all the 2% instead of giving half or more back to the pool.

Those that are poor and happen to live a long time would be totally screwed under the new plan. Their diverted 2% would be worth next to nothing on a yearly basis, yet the fixed portion of social security will have been substantially reduced. And these are the same people that are likely to have nothing but Social Security.

Third, current implicit shift in wealth from those that retire in good economic times to those that retire in bad economic times will be reduced.

Those fortunate enough to retire when the market is high will have more wealth for retirement than those that retire when the market is down. If you converted a nest egg invested in the S&P into a life annuity in Spring of 2000 you'd have almost 50% more guaranteed income than if you retired and bought your annuity at the subsequent market trough. Yet, immediately buying a life annuity is probably what a responsible retiree who really needs the wealth in the private account should do. Not that I expect more than a small fraction of such retirees would actually do this. ("Hey, let's take my teensy private account and minimize my yearly payout").

So here is the bottom line: social security was always intended as a social safety net. For people that were too poor, too ignorant, too undisciplined, or too unlucky to be able to provide adequately for their own retirement, the program would ensure that these folks would have at minimally decent quality of life in their retirement years. History shows that no matter how you arrange the incentives in a society, there will always be a large segment that needs the safety net. Talents will always be distributed in bell curve. Good fortune and bad fortune will always exist. There will always be ants and grasshoppers.

The only reason that Social Security works today with "only" 13.4% of earnings withheld is precisely because of the three elements of wealth transfer that private accounts would reverse: from rich to poor, from short lived to long lived, and (implicitly) from those who retire in bull markets to those who retire in bear markets.

The plan has some positive elements (greater average returns in private accounts, individual control) but this comes at the price of shredding the safety net.

So, I would like to turn around the sentence that motivated my post:

What exactly is so threatening about a society trying to ensure that all citizens have a minimally decent retirement?

Gordon66


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