Sunday, January 16, 2005

Fuzzy Math

In the wake of the ‘success’ in Iraq, President Bush’s approval numbers seem to be slipping. It seems that in the absence of some great demon to fear, Bush starts to become less appealing to the American public. Luckily, the Social Security system is collapsing. Unless bold action is taken, benefits will run out in a matter of minutes. We cannot wait. We must act now, preferably boldly. We cannot allow the smoking gun to come in the form of a mushroom cloud – metaphorically speaking.

Of course, left to its own devices, the current system unaltered will be able to pay all benefits through the year 2052, according to the Congressional Budget Office. The imminent collapse of Social Security is based on the assumptions that the economy will grow at only 1.7% annually and that none of the money ‘borrowed’ by the government from the Social Security Trust Fund will be paid back.

The proposed fix comes in three different flavors, all involving the creation of private accounts for individuals to ‘invest’ part of their FICA contribution in the stock market. The most often cited involves 2% of taxable income, with a maximum of $1000 annually indexed to inflation. To invest the maximum, you would need a taxable income of $50,000 or more. Bush estimates that these investments would yield 7% annually, as opposed to the estimated 3% currently being earned by the trust fund on its government bonds, or a net increase of about 4%.

We must note that the much rosier projection of the performance of the stock market is based on a much rosier projection of the performance of the economy than that used to predict the looming demise of social security.

But we don’t need to do much math to see the Bush’s plan doesn’t add up. According to his own Commission to Strengthen Social Security, the costs of administering the proposed program will be about 5% of revenues, as opposed to the 0.6% that social security costs now. And it instructive to note that the similar programs in Britain and Chile that Bush is fond of referring to have administrative costs of as much as 15%.

The transition costs to move into Bush’s plan have been estimated to be as much as $2 trillion. Bush’s Commission estimates the cost to be about $0.9 trillion. Bush has categorically ruled out any tax increases to pay for the costs. We’ll take him at his word. So the financing of the transitional shortfall would need to be entirely funded by increased borrowing. That is, during the transitional period, every dollar invested – by virtue of the fact that it would not be available to pay current benefits - would have to be borrowed. In 2003, we paid $318 billion in debt service on a debt of $7.228 trillion, or 4.4%.

So giving Bush the benefit of every one of his assumptions, we have a net increase of return of 4% on the funds invested, less a net increase in administrative costs of 4.4%, less a net finance cost of 4.4% during the transition – for a net decrease in cash flow for social security of 4.8% for the initial investment. Even at a standard cost of 1.4% of assets for fees after the initial investment, the annual carrying costs with debt service would net a loss of 1.8%.

It is both easy and not entirely wrong to say that Bush & Co. intend on pursuing this reckless path anyway out of blind ideology. Critics claim that Bush is ultimately looking to dismantle the entire social security system. While they may harbor that as their secret wish, that is not what is at stake with this proposal. It is something of a frontal assault never-the-less. Pumping billions of dollars annually into potentially risky investments is an assault on the security part of the program. And circumventing the generally progressive nature of the current system plus proposing to make social security investments inheritable is an assault on the social part of the program. And certainly part of narrative supporting Bush’s plan is the idea of trusting the ‘people’ with investment decisions instead of the government or ‘experts’. All of this flows from the Bush philosophy of government – government is always bad, unless its me.

It also doesn’t take too much math to see that the point of the program isn’t for the massive benefits accrued to the individuals directly. $1000 invested per year at the end of each year for 40 years at 7% interest compounded annually is worth only $199,675.11 at the end of 40 years. The same calculation at 3%, the current estimate for the SS trust fund, is worth $ 75,441.26 for a net gain of $ 124,233.85 at the maximum contribution over 40 years.

But we remind ourselves that moneys paid into the social security trust fund are still in the possession of the US government and both the principal and interest earned are there to be paid out in today’s benefits or borrowed against. Whereas the 2% of taxable income or $1000 per year being invested under Bush’s plan is actually paid out and therefore no longer available for current spending.

Here I will make the only assumption that is not maximally favorable to the Bush plan. Until our hands are forced, the US will continue deficit spending indefinitely. This is more of a political than an economic assumption. Our last actual budget surplus was in 1960. Excluding the 20s, there were only seven years since 1900 that saw a reduction in the national debt. The total of all budget surpluses since 1900 (not adjusted for inflation) is $31,861,213,658.71. At the end of the Clinton administration, the mere promise of projected surpluses caused a hue and a cry from the right about “returning” the people’s money. When we run budget deficits it’s with the idea that the “economic stimulus” of deficit spending will increase future revenues and more than pay for itself in the long run. However, should actual surpluses appear, we forget all about our previous rationales. We forget all too easily that tax “cuts” that produce deficits are really tax deferments.

Accordingly, I am making the assumption that every dollar invested in Bush’s scheme represents a dollar borrowed. Neither this money nor the interest that the government might have earned on it is available for other spending, including paying current social security benefits. Even massive spending cuts in other areas would not change this assumption unless actual surpluses appear as a result. And since we’re in the red to begin with, even the money for the debt service needs to be borrowed. So the interest costs are compounded as well. Using the 4.4% figure from above, the $1000 annual investment over 40 years would cost $66,908.05 in interest.

This pays for the interest cost of borrowing $1000 per year and carrying that debt, the interest cost of borrowing previous interest cost and carrying that debt and the cost of borrowing the brokerage fees for making the initial investment (5%, net of 0.6% cost of the current system) and carrying the assets (1.4% annually). At these rates the total administration fees of the plan in excess of the cost of the current system totals $35,921.90 for the $1000 annual investment over 40 years.

In summary, the total value of $1000 invested per year at the end of each year for 40 years at 7% interest compounded annually net the same amount at 3%, net the interest and fees creates a maximum per person benefit of $ 21,403.89. Don’t spend it all in one place. And since only people with taxable incomes of $50,000 or more can receive this maximum benefit, the net gain under these best of assumptions (for the most part) scarcely justifies the costs. We must be reminded again that the investments are private, while the costs remain public.

And this, finally, is the point. I took the IRS’s data on FY2002’s income and taxes and applied the 2% of taxable income, maximum $1000, per year formula to see where the benefits and costs of Bush’s system would fall. I made some important and unrealistic assumptions.
  • The economy would remain steady.
  • There would be 100% participation in Bush’s plan. (Participation is voluntary and in reality would be phased in over time.)
  • People would invest the maximum amount.
  • There would be a 7% return on all investments for everyone every year. (Historical compounded average returns are usually pegged at about 10.7%.)
  • Interest rates would not change.
  • Zero percent inflation.
  • The total cost of administering Bush’s plan would be 5% of the value of each contribution the first year and only 1.4% each of the outstanding value of assets each subsequent year.
  • Incomes would not change. Nor would the distribution of income change.
  • In other words, every year for the next forty years is 2002.
The point is to get a sense of how the plan would play out and not to make any actual predictions for the future.

The first major observation is that the total invested (given all of the above assumptions) for 2002 would be $51,547,245,520. Now we’re talking real money.

Size of adjusted gross income

Number of returns w/ taxable income

Total taxable income (000s)

Ave. max. investment per person

Total 1 yr investment

$1 under $5,000





$5,000 under $10,000





$10,000 under $15,000





$15,000 under $20,000





$20,000 under $25,000





$25,000 under $30,000





$30,000 under $40,000





$40,000 under $50,000





$50,000 under $75,000





$75,000 under $100,000





$100,000 under $200,000





$200,000 under $500,000





$500,000 under $1,000,000




$1,000,000 under $1,500,000




$1,500,000 under $2,000,000




$2,000,000 under $5,000,000





$5,000,000 under $10,000,000





$10,000,000 or more









This $51.5 billion would be invested in some set of private companies, annually. (Note to conservatives: there’s no guarantee that the beneficiaries of these investments will be US companies.) And we’ve just opened up a whole new avenue of corruption. Two of the lessons of Enron are that investments can be lost, massively, and political contributions buy government favors while government favors buy political contributions. Someone needs to decide where these investments are made. It certainly won’t be the person investing 1.28 annually in the stock market through Bush’s plan. The issue of who makes the decisions about who receives the investments has been left conveniently vague. However, it is unlikely that there will be no government involvement in managing these decisions.

It is equally unlikely that the program will not have substantial private management. There are huge fees to be earned here. A conservative 5% of investment nets $2,577,362,276 in annual fees plus the fees earned for carrying the assets. And eventually 1.4% fees for assets carried would dwarf the 5% initial investment administrative costs. Starting from scratch, with all of the above assumptions, the 40 year total paid in administration and fees would be $1,851,675,514,335. And, of course, should our experience be closer that of Britain’s, the program promises to be much more expensive.

Two more important observations: firstly, this program could not be undone. Billions and eventually trillions invested in the private sector could not be withdrawn should we change our minds. With maximum participation approximately 1 dollar for out of every 5 of FICA withholding for social security (1 out of every 10 of total contribution) would be diverted into the program. An Enron style meltdown could be significant for a significant number of people – significant enough that the political costs of allowing the loss is too high. It is likely that substantial losses would not be made up by the government, essentially creating public insurance for private investments.

So what exactly is my problem? The not entirely unrealistic 7% return on investment provides a net benefit – however small – to individuals – as long we ignore the largely unrealistic cost projections. And a net gain is a net gain.

It is an article of faith among conservatives that investment in the private sector produces great and abounding benefits to us all. This, of course was the same rationale behind Bush’s enormous tax cuts, which created a sort of investment in the private sector. However, the benefits have not materialized for the middle and lower income Americans this time any more than when Reagan tried it. Most middle-income families lost ground between 2000 and 2003 and now have less income available to meet their needs. Public investment in the private business sector as a means to producing social benefits has historically proven ineffective.

We’ve got to keep coming back to the public cost / private benefit. At the rate we are going, with 7.3 trillion in debt, if we add $595 billion in annual budget deficits plus another $51 billion in investments out of social security at a debt service cost of 4.4%, with an increase of 1.6% annually in tax revenue, total debt service costs will exceed tax revenue in 2024. At half the deficit rate we have until 2030. Cap the cost of the social security privatization plan at Bush’s 0.9 trillion estimate and we still only have until 2030 (though the rate at which our inability to pay even the interest on the debt decreases after that). And here’s the scary bit. If we assume that our debt will increase only by the amount of the previous year’s debt service cost, eliminating the privatization plan altogether, our debt cost will exceed our revenues by 2041. We need to increase taxes or produce a surplus or the worries about the collapse of social security by 2052 will seem “quaint”.

Rather than addressing the hard realities of our looming debt crisis, Bush’s plan exacerbates the problem. It provides the promise of little net gain for you or I and a short term windfall for certain soon-to-be-lucky corporations and brokerage houses. This, of course, is the real objective of the program – short-term gain for the select few, damn the consequences.

Lost in all of this is our understanding of what the social security program is supposed to be. It is, follow me now, social security. Okay I went too fast for some you in the right of the classroom. The program is meant to provide a degree of security as a social good in retirement or in the event of disability, when we cannot work or shouldn’t be expected to. And in fact, lifting the cap on FICA withholding (currently at 6.4% of income, maximum 5449.80), even without lifting the cap on employer matching contribution would net an additional $92,518,775,511.80 in the social security trust fund (again based on FY2002 data and a few simplying assumptions). Adding that revenue into the current system and comparing it Bush's plan with its increased administration and interest costs, nets an additional per person average of $55,267.81 over 40 years.

Over time we have come to contribute a tremendous amount of assets to the program. And unfortunately that is just too tempting to some who see all that money and smell, well, more money.

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