Beware Get-Rich-Quick Plan for Social Security

The recent balanced-budget accord clears the decks for President Clinton and Congress to consider an even more difficult issue: repairing Social Security.

Proposed strategies and fixes are in Mr. Clinton's reading bag while on vacation in Martha's Vineyard, the island haven off the coast of Massachusetts.

The subject may not fit everyone's idea of summer reading, but the plot has definitely thickened.

"The president believes we need a bipartisan approach to addressing Social Security issues," says White House spokesman Barry Toiv.

The big threat many see for Social Security is the retirement of baby boomers. The number of workers per retiree will shrink from 3.3 today to 2 in 2040.

So, the argument goes, paying the pensions of these retirees will be a crushing and unfair burden on future workers. Some reformers call for legislation allowing investments in stocks and other assets that offer a better return than the Social Security fund gets by tucking its present surplus in Treasury securities. Or benefits must be cut.

One point economists hope Clinton will keep in mind: There's no free lunch. Schemes for investing Social Security funds in the stock market pose risks. And the only way this approach can help the nation's retirement system is if it boosts overall productivity - an unproved thesis.

Dean Baker of the Economic Policy Institute says privatization is not a good solution.

Workers, he says, must always provide the goods and services needed by retirees and children. Haircuts and food can't be stockpiled for future generations.

The real question is: How will retirement be financed?

The options

At present, Social Security revenues provide almost half of American retirement benefits on a pay-as-you-go basis. Payroll taxes go to Washington. Then most of the money goes out right away as Social Security pension and disability checks.

The most radical reform proposed by some members of the Advisory Council on Social Security last December calls for gradually replacing the present system with a "personal security account" plan. Workers, starting next year, would set aside 5 percent of earnings in individual accounts that they could invest in stocks or other government-approved classes of assets.

These workers would pile up a portfolio that, theoretically, would benefit from the historically high rate of return for stocks - an average 5.2 percent more each year than long-term US Treasury bonds between 1926 and 1995.

When retired in the next century, they would presumably be sitting pretty with fat portfolios. But the next generation of workers will still provide the goods and services the retirees need.

It's just that retirement will be financed differently. Workers will pay lower Social Security taxes. Instead they will provide the pension funding indirectly through the private market. Retirees will collect dividends and interest or sell stock to pay for their needs. Workers will pay for that investment income by buying stock or through the prices of goods and services they buy.

Workers on average won't really be any better off - unless the new system somehow boosts productivity sufficiently to offset Wall Street investment fees.

Risks for investors

For retirees, there will be a price, writes Susan Miller, an economist formerly at the Federal Reserve Bank of New York. They will be taking a market risk.

Investors in stocks earn a large premium because they accept a higher risk. A minority of the public has enough money or is willing to take that risk. If millions more put money into stocks via the proposed personal security accounts, demand for stocks would push up prices to a point where the risk premium is reduced, Ms. Miller holds. Instead of paying 5.2 percent a year premium, the extra return on stocks could be less.

Further, Miller notes, stock returns have been nearly twice as volatile as returns on long-term US Treasury bonds. In fact, stocks made less money than bonds during seven out of 60 overlapping 10-year holding periods since 1926.

Baby boomers could push up stock prices while saving for retirement, and push them down when selling these assets in retirement. Some individuals, particularly less sophisticated investors, could make poor investment decisions and have few funds for retirement.