The Kerry campaign has seized on a new argument against allowing workers to invest part of their Social Security taxes for themselves. As summarized in today’s Washington Post:
President Bush’s push to create individual investment accounts in the Social Security system would hand financial services firms a windfall totaling $940 billion over 75 years, according to a University of Chicago study to be releasedtoday. . . .
[Austan] Goolsbee, an informal Kerry economic adviser, examined the [privatization] option that is often cited as the most realistic.
Under that plan, workers could invest as much as 2.5 percent of their earnings – or about 40 percent of their share of Social Security taxes – in private accounts, which Goolsbee anticipates would be managed by private investment firms once their balances reach $5,000. He estimated that annual management fees would be 0.8 percent, a conservative figure, he said, considering that management fees across the spectrum of mutual funds average 1.09 percent.
The result: Over 75 years, fees would total $940 billion, more than a quarter of the $3.7 trillion deficit the Social Security system will run over that time period. That would be the largest windfall in U.S. financial history, Goolsbee said, more than eight times the revenue loss that Wall Street suffered during the 2000-02 stock market collapse. [Does it matter that 75 years is 25 times as long as 2000-02? – ed]
Professor Goolsbee’s figure implies that, on average over the next 75 years, privatization will increase aggregate household wealth by $1.6 trillion (heavily backloaded in the later years, as investments accumulate). When more money is invested, investment managers naturally make more money, too. That is good for them, but it is not bad for investors. The higher fees are simply the product of the increase in the value of their assets.
If one wishes to see a real “windfall”, look at the last bull market. Between 1995 and 2000, the value of equities held by households rose by $3.3 trillion. If the average management fee was Professor Goolsbee’s “conservative” 0.8 percent, the bull market “handed financial services firms” over $26 billion in the year 2000 alone, twice the average annual “windfall” predicted for privatization. Is that an argument in favor of stock market stagnation? To be consistent, the Kerry campaign would have to say that it is.
As an argument for John Kerry’s ultraconservatism on Social Security – he promises to change absolutely nothing, notwithstanding that, within 15 years, benefits will exceed the taxes levied to pay them – this one is about as cogent as Michael Moore’s fantasy that the invasion of Afghanistan was undertaken to promote a gas pipeline. The issue that Senator Kerry ought to address is whether retirees will benefit by trading off government promises for increased pools of personal assets. Professor Goolsbee’s analysis, while a useful reminder that smart investors pay attention to management fees, plays a trivial role in answering that question.
Addendum: Ramesh Ponnuru observes that the Kerry campaign’s rollout of this theme attributed to Professor Goolsbee contentions that weren’t in his report. More hinges coming loose.
It is amazing how few people have blogged about privatization of social security and how little information there is on the Internet on a topic which we think will literally redefine the American economy.
A very simple analysis that we did shows that it is very difficult to estimate how an average American will benefit but there is no doubt that privatization will give a short-term boost to the economy and create new business opportunities.
Posted by: Management Consultant | Monday, January 03, 2005 at 12:56 PM