Study Shows Something Two Sides Can Agree On

November 22, 2000

The delay in deciding the presidency creates an opportunity to go into greater depth on some of the recent literature on Social Security reform. A newly revised study by two economists who have worked on both sides of the political aisle shows one thing they can agree on: the overwhelming majority of workers would be better off under a system of personal retirement accounts.

The study's authors are Martin Feldstein, a top Social Security advisor to the Bush campaign, and Jeffrey Liebman, former special assistant to President for economic policy who coordinated the Clinton Administration’s Social Security reform technical working group. Both Feldstein and Liebman are currently professors of economics at Harvard University and associated with the National Bureau of Economic Research.

In "The Distributional Effects of an Investment-Based Social Security System," Feldstein and Liebman simulated both the full and partial privatization of Social Security. Under full privatization, each worker would have a personal retirement account in which he deposited 9 percent of his wages, to be invested in a portfolio of 60 percent stocks and 40 percent bonds. Upon retirement, the account would be converted to an annuity paying monthly benefits for life. Disability and survivors' benefits would continue to be delivered through the current system.

What the authors found is shown on in the chart on the following page. To summarize, in all race, gender, and educational groups, no less than 95 percent of workers saw gains from private accounts. Many workers more than doubled their retirement benefits, and the risk of poverty in old age - particularly among high risk groups like minorities, high school dropouts and women widowed or divorced at an early age - was often cut by 60 percent or more.

Unlike many other simulations, Feldstein and Liebman did not use “composite” workers created with hypothetical ages, salaries, work histories and life expectancies. Instead, they used Census Bureau data on thousands of actual workers, letting them see how real people - with all the different events taking place in their lives and in the markets they would invest in - would fare using personal accounts.

The chart to the left shows the benefits individuals would have received under privatization (vertical axis) versus the current system (horizontal axis). The diagonal line indicates equality between the two systems, with those falling above the line doing better privately and those below the line doing better under Social Security. Obviously, the vast majority of individuals would receive substantially higher benefits with personal accounts. And most of the workers who do worse privately than under the current systems have incomes so low that payments from Supplementary Security Income (SSI) would lift them to the Social Security level or better. In practice, Feldstein and Liebman say, very few workers face lower retirement incomes through privatization.

Some critics of privatization have argued that due to high current stock market valuations and a projected slowdown in economic growth, future market returns will be lower than in the past. (For reasons why these arguments may not matter, see "Social Security: Is It A Crisis That Doesnt Exist?" by Andrew G. Biggs.) Feldstein and Liebman answer these critics by re-running their simulation assuming market returns of just 3.5 percent annually, which they calculate to be worse than 90 percent of market outcomes in the postwar era. Doing so does not substantially change their conclusions: even "with a 3.5 real rate of return, the mean PRA benefit for all retirees would be $10,938, about 18 percent higher than the mean pay-as-you-go Social Security benefits. Thus in more than 90 percent of the possible rate of return outcomes, the pure PRA system would produce a mean benefit for all retirees that exceeds the corresponding mean of the traditional Social Security benefits."

Some argue that Social Security privatization is unfair or even harmful to the poor because wealthier workers, whose higher wages mean larger deposits to their accounts, would make larger dollar gains over the current system. But when one considers other things of value - particularly the benefit of a greatly reduced chance of retiring in poverty - these objections seem misplaced.

In summary, this paper by top advisors to Gov. Bush and the Clinton administration shows that the risks of privatization are vastly overstated and the benefits - particularly to the most vulnerable in society - are great.

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