January 19, 1997
"Could You Trust Wall Street with Your Retirement Savings?"
San Jose Mercury News
By Timothy Taylor
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INVESTING social Security trust funds in the stock market, dismissed as a radical idea just months ago, is gaining respectability. It was about the only thing that all 13 members of the Presidential Advisory Council on Social Security agreed on in their Jan. 6 report.

Presently, the trust fund must be invested entirely in U.S. government bonds. The argument for shifting toward stocks is simple: Stocks pay higher returns, when averaged over long periods of time.

From 1926 to the present, the return on government bonds has averaged .7 percent per year above inflation, while the return on stocks has averaged 8.8 percent per year above inflation, according to calculations of Jeremy Siegel of the University of Pennsylvania. The higher returns from investing part of the trust fund in stocks could help keep Social Security solvent, so that it can make the scheduled payments to those who will retire after 2025.

Stocks do fluctuate more than bonds on a year-to-year basis, so an individual investor with a horizon of, say, five years, may sensibly decide to keep money in bonds. But Social Security as a whole is a prototypical long-term investor, well-positioned to ride out ups and downs of the market. Moreover, bonds are not fully safe either, because they are at risk from inflation. If you buy a bond paying 5 percent interest, and inflation rises above 5 percent, you are losing buying power.

The Advisory Council included all sorts - academics and pension experts, labor and business representatives, liberals and conservatives - and they all agreed that the gains from investing in stocks are too large to pass up. However, they disagreed vehemently over whether the government should invest in the stock market directly, or whether some of Social Security should be transmuted into individual accounts. See, for example, the accompanying article by the AFL-CIO's Gerald Shea.

I favor shifting part of the Social Security toward individual accounts. But the details are certain to be horribly complex, involving layer upon layer of government regulation.

One set of regulations is sure to prevent individuals from taking too much risk with their retirement funds - to avoid the situation where someone wants (or is pressured) to invest all of their retirement savings in one business.

There is broad agreement that individuals would be limited to investing in diversified mutual funds, not individual companies. But how much diversification is enough? What about a mutual fund limited to small startup firms? Or limited to companies in a certain place, like Taiwan or California? Or limited to an industry, like computers or restaurants?

After one set of rules decides which funds are safe enough, a second set of rules will cover switching within and between accounts. How often can you switch investments? What fees and charges are allowable? Individual accounts will trigger a marketing war that will make the battle between long-distance telephone companies look like a skirmish. Prepare for a blizzard of junk mail, media ads and fast-talking mealtime phone calls begging you to switch your retirement investments.

Yet another layer of government policies will consider what happens to the poor in a system of individual accounts. The leading plans for individual accounts all guarantee a stripped-down Social Security payment. But the government might also guarantee that every adult has a certain minimum amount added to an individual account each year. Less defensible rules are sure to be tacked on to a system of individual accounts, as well.

For example, politicians are sure to push for rules that will favor environmentally friendly industries, or companies that produce in America, and penalize companies that lay off workers, or pay large executive bonuses, or are guilty of pollution or discrimination, or those that invest in unpopular countries, or in products like tobacco.

Individual retirement accounts will create a situation where a number of adults will be short on cash, but have tens or hundreds of thousands of dollars in their retirement accounts. There are sure to be proposals that they should be allowed or required to spend some of their retirement account on health care expenses, a house down-payment, legal liability, a divorce settlement, child support, college tuition, or when receiving welfare payments.

Finally, pressure will arise to bail out investors who made decisions that turned out poorly. In Chile, whose Social Security system has been run through individual accounts since 1981, the most successful mutual funds in any given year have to share part of their gains with the least successful funds.

A true blood-and-guts capitalist might oppose all this regulation; just let people save and invest however they want, and those who choose badly or are unlucky will just have to lump it. But the first requirement of sensible social policy is that it be realistic about people.

The rationale behind Social Security - and similar systems in every industrialized country - is that people won't save enough for retirement on their own. Further, as children and grandchildren of the elderly, we don't want to face head-on the issue of impoverished parents and grandparents.

Some believe that once all the regulations and political finagling are taken into account, individual Social Security accounts will be more trouble than they are worth. They may be correct. But there is one overwhelming reason to support individual accounts: They offer a way to increase America's dismal savings rate.

With low personal savings and high government deficits, America's lack of saving holds down investment and makes us overly dependent on foreign capital - neither of which helps our standard of living.

Individual accounts mean that instead of all my Social Security taxes going to support present retirees, some would end up in an account with my name on it. If no other steps were taken, this transfer would create a shortage of funds in the Social Security system.

Any honest plan for individual accounts must explain how it will raise the extra money to make up this shortage and assure that present and near-future retirees receive their Social Security benefits as planned.

For example, one advisory commission proposal for individual accounts would also raise Social Security payroll taxes by 1.6 percentage points.Thus, individual accounts offer an implicit deal to Social Security taxpayers: Agree to put more money into the system to protect the benefits of current retirees and effectively raise national savings. And that way you can have regulated control over an individual Social Security account.

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