Take Social Security Private? Be Careful

Merrill Lynch & Co. has described the impact of the baby boomers on the nation's retirement system as a "ticking demographic time bomb." Many Americans share this concern, and a presidential commission has now proposed fixes.

But to economist Mark Weisbrot, the system ain't broke.

"The whole idea that the Social Security system is in crisis and needs some reform is a gross exaggeration," he says. The system faces no solvency threat in the near or intermediate future, adds Mr. Weisbrot, research director at Preamble Center, a year-old Washington think tank. The system could finance benefits for 35 years, thus including the baby boomers, without any changes necessary in benefits or taxes, he says.

Even beyond then, any necessary alterations would be minor and easily manageable, Weisbrot asserts.

That's certainly not the popular view among baby boomers. Their gloomy opinions of Social Security's soundness are being reinforced by a campaign financed by Wall Street to privatize the system in part or in whole. It is led by the Cato Institute, a libertarian research body in Washington that has no love for government and $2 million of business financing for a three-year privatization campaign.

When the presidential Advisory Council on Social Security presented its report Jan. 6, the director of the Cato Institute's "Project on Social Security Privatization," Michael Tanner, quickly told the press there is now a "consensus" the system must be restructured and that private capital markets can provide a better return on investment than can the government.

The consensus does not extend to Weisbrot. Using an advance copy of the Advisory Council report, he prepared a 21-page analysis that challenges the partial-privatization recommendation of the divided 13-member panel. One five-person faction calls for putting 48 percent of the Social Security payroll tax into individual accounts (managed by the beneficiaries) that could invest in stocks and corporate bonds. Another two members suggest putting revenues from a 1.6 percent payroll tax increase into financial markets. Federal appointees would manage the money.

Both these plans count on a 7 percent annual rate of return after inflation, a rate stocks have provided on average over the past 60 years. But Weisbrot calls this assumption inconsistent with the projected 1.47 percent rate of real (after-inflation) growth of the US economy. That's the Social Security Trustees' "intermediate projection" for the next 75 years.

This projection, not the Trustees' more optimistic or more pessimistic projections, is used by the Advisory Council. In the past 35 years, though, the economy has grown at a far higher 3.27 percent annual rate. "The return on equities cannot be the same under these vastly different conditions," says Weisbrot.

Stock prices are typically driven up by rises in corporate earnings, which in turn rise roughly in line with the nominal growth of the overall economy. In his calculations, Weisbrot projects a 2.8 percent dividend yield on stocks. Add this to 1.47 percent real economic growth, and the projected real return on equities on average over the decades ahead would be 4.34 percent a year - much less than 7 percent. A 7 percent annual stock-market rise with 1.47 percent earnings growth would produce an "impossible" price-earnings ratio of 79 by 2035, versus about 20 now.

The differing stock returns have a huge impact. With 7 percent returns over a working lifetime (40 years), an investment of $1,000 will grow to $16,445; at 4.34 percent, the $1,000 grows to just $5,675. Then if management, insurance, and brokerage fees of 1.5 to 2.5 percent a year are deducted from each individual account, according to its size, the return would finance a level of benefits below what the system now provides.

Even worse, says Weisbrot, retirees would be subject to the vagaries of the market. For instance, from 1968 to 1978, the stock market lost 45 percent of its value after inflation.

Weisbrot doesn't expect the economy to grow as slowly as the Social Security Trustees conservatively project. That would be the worst performance in history. But if growth does exceed 1.47 percent, payroll-tax revenues will swell. And any long-term need for alteration of the system will shrink, if not disappear, he notes.

Privatization, he figures, would mean a riskier Social Security system that promises, on average, lower benefits. And it would create a two-tier system that would further separate the interests of well-to-do and poor retirees, making it politically vulnerable.