February 03, 2005

Privatization In Three Graphs

There's a lot of confusion going around about how the privatization scheme works. Here are some graphs to refer to that should help clear it up.

First, remember how the benefits are calculated. Social Security basically looks at our lifetime Social Security contributions, adjusts it for average wage growth, and constructs a monthly benefit for us. That's vastly simplified, but good enough for the purposes of this discussion.

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Now for the privatization part of the plan. The plan would allow us to divert up to four percentage points of our payroll taxes to invest in a variety of ways.

The "benefit formula", however, still calculates our benefits assuming the entire 12.4% goes to Social Security.

Finally, the cash that we diverted - plus an interest rate that matches the performance of US Treasury Bonds - is proportionally subtracted from our monthly benefits.

That means that for the privatization to be worth it on an individual level, the performance would have to outperform US Treasury Bond rates.

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Points to argue:

  • How likely is it that everyone is going to outperform US Bond rates? Have your investments outperformed Bond rates over the past five years? Ten years? Mine sure haven't.
  • If Social Security is unstable, then why are we looking at implementing such a costly program? Who's going to pay for this?

Now for step three. Bush acknowledges that he plans additional benefit cuts to help pay for privatization. This will most likely mean reducing the formula; changing it so that it pays reduced benefits. All payroll tax payments will still be applied to the formula, but it would mean a lower raw benefit amount for everyone - even the people who don't participate in the privatization.

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Points to argue:

  • Why so large a cut? Wouldn't it be cheaper to just not privatize?
  • We paid payroll taxes to finance Social Security in future years, and the general government has been spending that money for tax cuts for the rich. Shouldn't the money come from them, rather than be cut from my benefits?

The proponents argue that privatization is worth it because the privatized money should outperform the bond rates. But this is dishonest, because the truth is that for in order for this to be worth it, the privatized money would have to perform well enough to make up for both the interest rate of the Treasury Bonds, and the extra benefit cuts.

How much is that? A lot. For proof, examine this table from Atrios's site. It figures in the most likely "extra benefit cut", and the extent at which privatization falls short in making up for it.

Posted by Curt at February 3, 2005 10:41 PM