Posted on: Sunday, February 6, 2005

EDITORIAL
The problem with 'personal accounts'

We've explained on this page why the alarm President Bush is raising over the nation's retirement plan will likely turn out to be a false one ("There's no crisis at Social Security," Jan. 23).

Now let's look at some real problems with "privatizing" social security.

In the 2004 Economic Report of the President, Bush's advisers say that the Social Security trust fund's "annual deficit is currently projected to grow to 6.67 percent of taxable payroll by 2080. Only by reducing annual benefits or increasing the payroll tax (or the income tax on benefits) by a total of 6.67 percent of taxable payroll can solvency be restored in the long term on a pay-as-you-go basis."

The alternative, the report says, "is to allow the gap between the cost and income rates to persist (provided that it is not increasing over time) and rely on the investment income from a portfolio of assets to cover the gap."

In other words, private accounts must grow at 6.67 percent — each year for 75 years — for privatization to work.

Here's why that is unlikely:

• The experience of privatized systems in other countries, such as the United Kingdom and Chile, is that administrative fees take a major bite out of the earnings of participants.

• By how much will traditional benefits be reduced for those electing to open private accounts? A background briefing by a "senior administration official," reported by The New York Times, put it this way:

"In return for the opportunity to get the benefits from the personal account, the person forgoes a certain amount of benefits from the traditional system. Now, the way that election is structured, the person comes out ahead if their personal account exceeds a 3 percent rate of return, which is the rate of return that the trust fund bonds receive. So, basically, the net effect on an individual's benefits would be zero if his personal account earned a 3 percent rate of return."

• If your personal account held a few thousand shares of the next Microsoft, wouldn't you earn more than 6.67 percent? Not likely. To prevent too much risk exposure, Bush said in his State of the Union address, "We will make sure the money can only go into a conservative mix of bonds and stock funds."

• The "worst-case scenario" projection that Bush is using to forecast that the trust fund will be exhausted by 2042 assumes that the U.S. economy will grow — not at the 3.4 percent annual rate we've experienced in the past, but at 1.9 percent — over the next 75 years. That's because retirement of the baby boomers will shrink the labor force.

• The price-earnings ratio — the value of a company's stock divided by its profits — used to average around 14. Now it's 20. What would it have to be to earn 6.67 percent at a 1.9 percent growth rate?

Paul Krugman of Princeton and Dean Baker of the Center for Economic and Policy Research calculated that the P/E ratio would have to be about 70 by 2050 and more than 100 by 2060.

Here's the bottom line: In the unlikely event that the economy performs well enough over the next 75 years to make privatized accounts work, it would also perform well enough to make the present Social Security system continue to work, with no changes, for just as long.