This year's swoon in stock prices is proof that allowing workers the freedom to choose Personal Retirement Accounts in place of the longstanding Social Security framework is a bad idea.
Or at least that's what desperate defenders of the status quo insist. Think Al Gore and his infamous "lockbox."
What is missing from this discussion is a full understanding of just how much greater market investment returns are compared with what the redistributive Social Security promises, let alone what it can afford to pay. The difference is in fact so great, stocks are the overwhelming winner even when one takes into account the recent market downturn. Consider the following information assembled by Peter Ferrara, director of the new International Center for Law and Economics in Washington, D.C., and as reported in a recent Wall Street Journal article:
Let's assume John Q. Taxpayer, a single, moderate-income worker, is retiring today. For argument's sake, let's imagine that instead of paying into Social Security his whole life-long, John had been allowed to place his payments into a Personal Retirement Account when he first entered the work force way back in 1959 at the tender age of 22. In his first job, young John was earning just $4651 a year, not bad for 1959.
Now, suppose our hard-working Mr. Taxpayer received the average increase in wages each year that was actually experienced by workers over the last 43 years. He then paid into his Personal Retirement Account each year the exact amount of Social Security taxes actually paid by him and his employers that instead went to finance his present retirement benefits. Being a bit cocky, John brashly invested all this money entirely in stocks each year and earned the average return on large-cap stocks that was actually earned for each of the last 43 years, as reported by Ibbotson and Associates.
In the real world, John Q. Taxpayer's Personal Retirement Account would have peaked at a whopping $825,936 back in 2000. Since then the drop in the market would have brought the value of his account down to about $600,000 as he reached retirement age. But his Personal Retirement Account would still have enough funds in it to pay him around $74,250 in annual benefits, over four times as much as our current Social Security system, which pay the graying John Q. Taxpayer only $17,623 in annual retirement benefits.
Moreover, John's investment experience would not end just because he retired. His Personal Retirement Account would continue to be invested and grow to support his future benefits. He would then be able to gain the advantage of the eventual rebound in stock prices that is likely to occur.
The point of Personal Retirement Accounts is not to get workers to invest in the stock market; far from it. John Taxpayer could also have beaten Social Security by a wide margin simply by investing in corporate bonds and earning the average returns that were actually earned on them these past 43 years. Though he would have done better investing in a well-diversified portfolio of stocks, even a diversified stock and bond portfolio would have handsomely beaten the returns from Social Security.
But the real question is: Why are the returns from a Personal Retirement Account so much higher than from Social Security? The answer is really quite simple. Such an account is invested in real private capital, capital that on average produces income equal to the risk-adjusted before-tax rate of return required to attract it.
Social Security, by contrast, is primarily a redistributive, pay-as-you-go system that does not involve any actual savings or investment. Even during surplus periods, around 90% of the funds paid into Social Security are immediately paid back out in benefits, leaving nothing leftover to be invested. And when there is a surplus it usually just supports higher government spending elsewhere.
Such a system produces no new income or capital gains and thus cannot ever hope to keep up with the returns and benefits produced by a fully-funded private investment system. The only way Social Security can pay any return at all, is by taxing greater and greater numbers of people and larger and larger incomes over time. It is in fact a giant Ponzi scheme. Anybody who tells you different is simply lying.
That is why Social Security promises most of today's young workers a real return of less than 1% a year. For many young people, the promised benefits will carry zero or even negative returns — bad news for John's children.
By contrast, the long-term real annual return on established stocks is over 7%. The long-term returns on broader stock indices are even higher. Moreover, the long-term real annual return on corporate bonds is over 3%.
The enormous gulf between the market returns just cited and what Social Security offers shows just how overblown fears are about the risks of Personal Retirement Accounts. While stock returns do vary widely from year to year, there is no realistic chance that a fully-funded system of well-diversified stocks could produce a return of zero percent over an entire lifetime, which is all the purely redistributive, pay-as-you go Social Security system produces. Moreover, any private retirement system could still be backed up by some sort of social safety net at reasonable cost.
Aside from myself, there is not a single candidate for U.S. Senate who is doing anything but pledging to maintain the status quo, which is to say, keeping workers' retirement funds forever "locked" into Social Security, with its miserable returns, utter lack of personal control, and no freedom of choice.
Isn't it about time we changed the rhetoric and abolished this medieval work-fare system? I say it is.