Saturday, February 05, 2005

"Mr. Senior Administration Official" describes the Administration's plan for private accounts in Social Security to us all.

[Excerpts from the from the full transcript of yesterday's White House briefing as recorded by Federal News Service Inc, via the NY Times.]

MS. BUCHAN: The briefing today is on background, so all of the comments here today are to be attributed to senior administration officials ...

SR. ADMIN. OFFICIAL: Thanks, Claire. Thanks, everybody...

[My note: Mr. Senior Administration Official says several times that he is talking only of intended elements of a reform of Social Security -- not a full plan resolving its long-term funding shortfall and other issues, which will have to be worked out with Congress.]

... the President is going to outline some specifics about the personal accounts tonight, and I'd like to go through a few of them. First of these is that there will be no changes in the current system for people who were born before 1950 -- these are people who are 55 and older now. If you were born in 1949 or before, you would not be impacted by any of the changes envisioned by the President for Social Security. You would not have any changes to your benefits; you would also not be participating in personal accounts.

For individuals who were born in 1950 or later, they would have the opportunity -- the voluntary opportunity -- to participate in personal accounts...

With respect to the structure of the personal accounts, the administrative structure, we would establish a structure that is somewhat similar to the Thrift Savings Plan that federal employees, like myself, participate in.

This is a centralized administrative entity. It should lay to rest any suggestion that we're thinking of privatizing the Social Security system. The thrift savings plan is not a privatized system.

It's actually -- it's publicly administered; it's administered by the federal government. And it enables participants -- like myself and like other federal employees -- to realize the advantages of investment gains by having personal accounts that can be invested in diversified and secure funds going forward, and also a number of safety protections that we want to be able to provide to Social Security participants.

Specifically, the investment options that individuals would have would be somewhat similar to the thrift savings plan. In the thrift savings plan, individuals are given presently a choice of five funds.

There is a stock fund -- a large cap stock fund, a small cap stock fund, an international stock fund. There is a corporate bond fund, and there's also a fund of Treasury bonds. It's a very small, limited number. They're all broadly diversified. And the number of choices that individuals face is very limited, but also very simple. You don't have to be a financial genius to be able to save money in a thrift savings plan. And I'm living proof of that.

The thrift savings plan will also be offering shortly something called a life cycle fund. This is a fund where the proportion of the fund that is invested in stocks declines as an individual ages. And the closer they get to retirement age, the smaller the proportion of the fund that is invested in stocks.

This life cycle fund works on the premise that when you are younger, you would want the higher growth and the more aggressive investment that would come from equity investments; as you get closer to retirement, by the reasoning of the life cycle fund, you would want a more certain -- not as high or aggressive a growth, but a more certain annual return in your investments as you head closer to retirement.

The life cycle fund would simply be another choice that's made available to participants in the Social Security personal accounts.

For those workers who are nearing retirement, it would be offered as the standard choice. If people didn't make a choice to the contrary, they would be -- their standard selection would be deemed to be this life cycle fund. Individuals would have the opportunity to increase their amount of investments in other instruments beyond what is available in the life cycle fund, if they chose. However, they would have to sign some forms and get the sign-off of their spouse, if any, to show that they're aware of the implications of having a different investment mix that close to retirement.

The thrift savings plan has the virtue of offering very low administrative costs, certainly much lower than many have talked about with respect to Social Security personal accounts. For the types of personal accounts that I've just described, we have an estimate from the Social Security actuary of 30 basis points for the administrative costs -- that equates to 0.3 percent of account balances in a particular year...

Participants would not be permitted, under the system, to have pre-retirement access to their personal accounts. The accounts will be held and protected to fund benefits when they hit retirement age. They would not be permitted to make loans to themselves through the accounts, nor would they be permitted to borrow against them.

Upon retirement, upon reaching retirement age, there would be some limitations on how they could withdraw money from the accounts. If an individual had a personal account balance, if they had chosen to take a personal account, they would not be able to withdraw money from their account to such a degree that by doing so they would move themselves below the poverty line.

In other words, there would have to be a sufficient amount coming to them, in terms of a monthly inflation index benefit stream, from the traditional system and the annuitized portion of their personal account to be able to fund a poverty-level benefit.

Now, to the extent that their personal account enables them to have total benefits that are higher than that, they would have flexibility over the disposition of those funds. They would be permitted to leave those funds in the account to continue to appreciate; they could withdraw those amounts as lump sums to deal with a pressing financial need -- and, obviously, any additional accumulations in the accounts could be left as an inheritance.

But the main restriction, again, to repeat, is that people would not be permitted to withdraw money from the accounts to such a degree that by doing so they would spend themselves below the poverty line...

The size of the personal accounts would be limited to 4 percent of a worker's wages from their payroll taxes. But there would be a cap placed on the accounts in the first year -- contributions to the accounts of $1,000. Now, each year that cap thereafter would rise in increments of $100 on top of the natural wage growth that drives the growth in payroll taxes. And what that means is that over time, more and more of the work force would be able to contribute the full 4 percent of their wages to the personal accounts...

With respect to the fiscal effects of the personal accounts, in a long-term sense -- and I know those of you who have talked to me have heard me say this before -- but in the long-term sense, obviously, the personal accounts, as we would structure them, would not create a net new cost for the system.

To the extent that people put money in these accounts and invest in these accounts, there would be a corresponding reduction in the government's liabilities from the Social Security system that is equal in present value to the money placed in the personal accounts up front. So in a long-term sense, the personal accounts would have a net neutral effect on the fiscal situation of the Social Security and on the federal government...

In the near-term, however, of course, there will be transition financing required. Our estimate of the total amount of transition financing for the accounts, according to the schedule that I've outlined before, is about $664 billion through the end of the budget window of 2015. If you assume that -- debt service effects on top of that, that would be another $90 billion...

Q.: And the administrative fees that you talked here, how does that compare with out in the private sector?

SR. ADMIN. OFFICIAL: They're considerably smaller. These are 30 basis points. The private sector tends to be higher. It's not quite as low as the thrift savings plan now has. The thrift savings plan, by different estimates, is about 6 or 8 basis points, reflecting the fact that the thrift savings plan only has to administer the accounts of employees of the federal government. So the Social Security actuaries' estimates are a little bit higher than for the thrift savings plan, mostly from a record-keeping perspective. There wouldn't be any increase in the cost of things like fund management and other things that are controllable by economies of scale.

Q.: So if I had $100, I'm paying 30 cents? Is that correct?

SR. ADMIN. OFFICIAL: That's right.

Q.: You talked about the $664 billion for the near-term costs. There's been a lot of speculation in advance that it would be something like $2 trillion. Talk a little bit more about that. How do you squuare that?

SR. ADMIN. OFFICIAL: ... Obviously, the $2 trillion number is not a number that was ever generated by us or by the Social Security actuaries, or any of the other nonpartisan scoring agencies...

Q.: Can you talk about over periods of time what an average rate of return is on some of these accounts...?

SR. ADMIN. OFFICIAL:... the Social Security actuaries make their own estimates about the portfolio returns on personal accounts. And those tend to reflect an assumption of a blend of 50 percent equities, 30 percent corporate bonds and 20 percent government bonds. And when they put all that together and subtract out administrative costs, they come up with a 4.6 percent above inflation. It's 4.9 percent before the administrative costs, and then 4.6 percent after. That's the actuaries portfolio assumption.

Q.: ... am I right in assuming that in the way you describe this, because it's a wash in terms of the net effect on Social Security from the accounts by themselves, that it would be fair to describe this as having -- the personal accounts by themselves as having no effect whatsoever on the solvency issue?

SR. ADMIN. OFFICIAL: ... that's a fair inference.

Q.: In saying that there is no net added cost to the program, are you implying -- is it implicit that there is a benefit offset of one-third current guaranteed benefit because you're diverting one- third of revenues away from this program? If that's not correct, what would the benefit offset be to traditional benefits, and how would it be calculated?

SR. ADMIN. OFFICIAL: The way that the election is put before the individual in a personal account structure of this type is that in return for the opportunity to get the benefits from the personal account, the person foregoes a certain amount of benefits from the traditional system.

Now, the way that election is structured, the person comes out ahead if their personal account exceeds a 3 percent real rate of return, which is the rate of return that the trust fund bonds receive. So, basically, the net effect on an individual's benefits would be zero if his personal account earned a 3 percent real rate of return. To the extent that his personal account gets a higher rate of return, his net benefit would increase as a conseQ.:uence of making that decision.

Q.: So he would only get a benefit to the extent that his portfolio performed in excess of 3 percent?

SR. ADMIN. OFFICIAL: Right. You can think of it as saying -- if you were making a decision on where to put your money going forward over the next 10 years, and you're saying, should I put it in this account or that account, if you're choosing to put your money over here instead of over here, then the net effect on you, as an individual, is to compare what would be the rate of return you get from this system, as opposed to putting it over here. And that would be the difference between the two.

Q.: Short of 3 percent, would he make whole or would he get less than the current guaranteed benefit?

SR. ADMIN. OFFICIAL: Well, there's a implication at the end of your question which -- you have to remember, the current system can't pay the current guaranteed benefit-- ...

Q.: So people who don't -- people who choose not to take a personal account are not guaranteed the current schedule of benefits, they're --

SR. ADMIN. OFFICIAL: Under the current system, they are definitely not.

Q.: And they're not under this --

SR. ADMIN. OFFICIAL: Under no scenario are they -- could they be. Unless you posit a very large tax increase.

Q.: Can you just clarify whether or not this does address the "crisis," or is this -- are we correct in reporting if you say this is neutral and yet to be decided as to how you'll basically come up with the money to solve the "crisis"?

SR. ADMIN. OFFICIAL: The President is going to talk about the need to take action to fix Social Security. We're not making representation that the personal accounts alone are fixing the system's finances.

Q.: Are they helping at all?

SR. ADMIN. OFFICIAL: The personal accounts help in the sense that the personal accounts enable the worker to be better off in the context of a plan to fix Social Security. You could, in theory, fix Social Security finances without a personal account and then the worker would be far worse off than if you offered the personal account. So it's an important part of the overall plan to fix Social Security, because it's an important part of having a plan that, in the end, treats workers well.

When you consider going forward, what we're looking at, in terms of the gap between the system's promises and its ability to pay them, we could be in a very difficult situation in the 2020s or 2030s, with respect to keeping people out of poverty in old age. It's very important that the personal account be a component of the overall solution, because otherwise we're going to have much worse treatment for workers as the plan is fixed...

Q.: Related to this, what are the opportunities for a worker who may opt in at 18 or 20 or 25, to then decide, based on circumstances, either their own or the market performance, that they want to opt out; and then maybe at 40 or 45, they say, oh, the market is doing better, or, my circumstances are different, I want to opt back in -- what happens?

SR. ADMIN. OFFICIAL: Well, one of the things that it's important to remember about the nature of the election and the investment choices that we're giving people is that people can, in effect, sort of decide the degree to which they want to receive something like the Social Security defined benefit, or pursue a different rate of return through the investment in bond funds or stock funds. Let me give a specific example.

Suppose you had a person who opted for the personal account when they were young, and then they got buyer's remorse later when they were 30, and they decided, I don't really want the personal account. Well, at that point, they could just have the option of leaving all of their money invested entirely in the Treasury bonds because then, by definition, their benefit is not going to change relative to their promised Social Security benefit because the Treasury bond is earning a rate of interest that is exactly equal to the offset they're giving up for taking the personal account. So in other words, if you have someone who opts for the personal account, all they have to do to replicate their current traditional Social Security benefit is just to leave all their money in the Treasury bond fund...

Q.: What's the significance of permanence? That's been said about five times. Why is it so important to make a permanent solution? If they tried to do that in the 1930s when they set this up, we could have never anticipated all the changes in the economy that would have happened. We didn't have computers, we didn't know any of this stuff. Why do we have to do something now to take care of all time? And why is the President so insistent on that?

SR. ADMIN. OFFICIAL: Well, that's a very good question. If you look back at the history of Social Security, you will see a history of frequent and recurring tax increases. The tax rate was 2 percent -- 1 percent employee, 1 percent employer -- when the system was created. It has had to be raised repeatedly, most recently up to 12.4 percent. If we were to do, say, a temporary fix, then 10, 20 years from now, we'd be right back in the same boat that we are now. In fact, in 1983, they did what was categorized as a 75-year fix. But if you look at the projections that took place since then, starting in 1983, the trustees found the system was insolvent again. And here in 2005, we're facing an actuarial deficit that is about as big as they faced in 1983.

If we were to confine ourselves to a temporary fix, then 20 years from now people would be looking at a deficit just as big as we're looking now. And they'd be looking at a lot of tough choices all over again, except they'd be in a much worse position because the costs of the system would be much higher than they are now...

I'll have the fun of making my own observations on this -- and on the various crak'd reactions to it we've already seen in just one day -- on the morrow, after getting a little sleep.

I do have at least one significant problem with the plan as described above, and also with the way the White House is trying to sell it -- but don't want to rush out foolishness as have ... oh, some who shall be chastised later.