Social Security Reform
The Social Security Administration has evaluated a proposal by Peter Ferrara for private social security accounts.
This plan would establish voluntary, progressive individual accounts for workers who are under age 55 on January 1, 2005 and would provide for a reduction in the Social Security retirement and aged survivor benefits for those who participate. All participating workers would be guaranteed that the total benefits available from the combination of the OASDI program and their personal account would be at least equal to OASDI benefits scheduled under current law if they choose the default investment option…
Individual account (IA) assets would be invested by individual workers through a central administrative authority with a default allocation 65 percent in broad indexed equity funds and 35 percent in broad indexed corporate bond funds.
To make up for the loss of tax revenue to pay Social Security beneficiaries, the Ferrara plan contemplates a combination of lower government spending elsewhere and increased government borrowing.
The analysis makes the assumption that the real return on stock market accounts will be 6.5 percent. If the overall economy grows at 3 percent and corporate profits also grow at 3 percent, then these stock market returns must come from a drop in the risk premium, which eventually has to fall below zero.
I have raised this issue before. I think that the assumption of 6.5 percent real returns for stocks distorts the analysis of Social Security privatization. Although I am sympathetic to privatization, I believe that the analysis ought to be conducted as carefully and reasonably as possible.
[note: I initially misread the SSA document and thought that they assumed 7 percent returns, not 6.5 percent, on the stock market]
For Discussion. Under Ferrara’s proposal, those of us under 55 could direct a portion of our Social Security taxes to private accounts. We would be guaranteed a minimum return equal to what we would have received from Social Security, provided that we invest in the “default portfolio” of stock and bond index funds.
Assuming that the guaranteed minimum return induces everyone to choose the “default portfolio,” how does Ferrara’s proposal differ from one in which the government itself invests payroll tax receipts in the default portfolio?