Fed study criticizes Social Security plans

Published Jul. 30, 1997|Updated Oct. 1, 2005

Plans to reform Social Security promise lots of gain and little pain, but a Federal Reserve study says they can't deliver.

"Some of the claims made by privatization proponents are indeed too good to be true," said Federal Reserve board economist Randall Mariger in a report, "Social Security Privatization: What It Can and Cannot Accomplish."

Privatization isn't likely to raise savings, lower taxes or boost the economy, according to the study.

Privatization proponents, as defined by the study, look to stock-market investing to increase returns on Social Security taxes but split on whether investments should be made collectively or individually. Social Security now invests only in U.S. Treasury debt. Increased returns are sought because more money will be needed as baby boomers begin to retire.

Mariger warned either stock approach would "implicitly raise taxes and decrease retirement benefits" to put Social Security on a sounder financial footing.

Mariger is especially critical of the so-called "Maintain Benefits" plan, which would direct up to 40 percent of the Social Security trust fund into stock market investments.

"There is little to recommend investing the Social Security trust fund in equities," said the report. In an interview, Mariger said, "There's no guarantee" the stock market won't fall, and he warned any losses would have to be covered by tax increases.

In that case, "individuals may not necessarily be better off shouldering this additional risk" than they would be by simply paying higher taxes to put Social Security on sound footing, Mariger said.

Allowing workers to invest part of their payroll taxes in an individual retirement account isn't a panacea, either, warned Mariger. As with trust fund investments, he said, it would expose workers to risks they don't face now with Social Security.

Another problem: Investing Social Security money in stocks would increase demand for stocks and reduce demand for U.S. Treasury debt. Individual accounts would increase the Treasury debt problem because they would drain off some of the 15.3 percent payroll tax the government uses to pay current retirees. The government would have to borrow to make up the difference, increasing the supply of Treasury debt.

The result? "Upward pressure on the government borrowing rate, necessitating an increase in taxes."

While stocks get most of the attention in any privatization discussion, Mariger expects fixed-income markets would see a far bigger adjustment.

After an initial pop in stock prices, "I conclude privatization would have little change in the price of equities, with most of the change coming in government debt," said Mariger.

Young workers might rush to buy stocks, producing a one-time run-up in prices, but, Mariger said, "it doesn't suggest future returns are going to be any higher."

He expects stock returns will fall over time from the initial boost, making equities less attractive. Meanwhile, "the government bond rate is going to go up" in response to decreased demand and increased supply, raising bonds' appeal to older, more risk-averse workers, he said.

Asset holdings may be altered, but in the end, Mariger said, "it is unlikely that national savings would be much changed by privatization." If taxes rise immediately to cover higher interest payments on federal debt, he thinks savings may increase slightly. "Otherwise, national saving might fall."

Claims that privatization would give a big jolt to the U.S. economy and increase economic growth because of a large inflow of money into the stock market are similarly overblown, in Mariger's view. "That's simply not going to happen," he said.

The Fed economist concedes privatization could make individuals feel "more personally responsible for their own economic well-being" if they had to rely on individual accounts for a portion of their retirement income.