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February 04, 2005

Daniel Froomkin Writes About Social Security

In his morning White House briefing:

Avoiding the Tough Questions (washingtonpost.com): One overarching issue is that the White House is talking about Social Security as if it were one big underperforming 401(k) program. In other words, they're implying that workers right now get back what they put in plus interest -- and that the interest rate they're getting is not so hot.

But it's not that way, not by a long shot. Social Security is a complex social insurance program that uses payroll taxes from current workers to pay benefits to the elderly, the disabled and their families in a progressive manner that guarantees an income floor below which the least fortunate are not allowed to sink.

Where this becomes really important is in trying to make sense of the brief and somewhat enigmatic comments that a senior administration official made on Wednesday (here's the transcript) about how the government would reduce guaranteed benefits for the people who opt for personal accounts.

The official said, in essence, that Social Security would:

A) Calculate what the contributions to the private account would have earned if the money had been invested at 3 percent on top of inflation,

B) Estimate what that amount would provide monthly if annuitized, and then

C) Subtract that amount from what the monthly benefit they otherwise would have gotten.

Therefore, the official said, if your investment makes more than 3 percent after inflation (minus administrative fees) you'll come out ahead (not including whatever additional across-the-board benefit reductions are approved.)

That's pretty complicated.

But even worse, the formula is based on two very misleading premises.

One is that people's payroll taxes are now being invested at 3 percent. They aren't. Most of the money people pay in today is going right back out again. Only a small amount is, temporarily, being invested in federal bonds, and even that won't be the case in a little over a decade.

The other is that Social Security benefits are a direct function of how much people put in through their payroll taxes. The way Social Security is now set up, for instance, a single wealthy person gets a vastly lower "rate of return" upon retirement than a poor person with a stay-at-home spouse. Someone who lives to 100 gets a much better rate of return than someone who dies at 65. Those are just some of the progressive, insurance-like aspects of Social Security that are really at the program's heart -- and that are being downplayed in the current debate.

And I'm afraid that any hypothetical case that tries to simplify this should be considered highly suspect.

Another issue that Bush is not necessarily being up front about is the "nest egg" he says private accounts will provide. In a nutshell, that may only be the case for the rich. Many lower-income people would be forced by the government to purchase annuities with their accounts, to keep themselves out of destitution as long as they live.

But annuities expire upon death.

In fact, if survivor benefits -- which now are pegged to the worker's benefit amount -- are reduced because of the private accounts, survivors would be considerably worse off.

Furthermore, when Bush uses the much-admired Thrift Savings Plan as an example of how personal accounts would work, it is worth noting that the TSP is an "add-on" on top of Social Security for federal workers. It's not a replacement; it doesn't divert payroll taxes from Social Security....

Posted by DeLong at February 4, 2005 11:06 AM