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Published: February 6, 2005

EDITORIAL

Read the Fine Print

he more we learn, the worse it gets.

Last Wednesday, as President Bush prepped for his State of the Union address, a White House official gave reporters a background briefing on some of the details of Mr. Bush's Social Security privatization plan. Almost point for point, whatever the president said that sounded good sounded bad when the details were filled in.

For instance, Mr. Bush said, "Personal accounts are a better deal," because "your money will grow, over time, at a greater rate than anything the current system can deliver." But the privatized system actually contains hidden costs that could leave retirees with less. Your Social Security benefit would be reduced, dollar for dollar, by the amount of money you deposit into your private account and an additional charge amounting to 3 percent plus the rate of inflation. All the money that is drained off would presumably go to pay for the enormous upfront government borrowing - $4.5 trillion over the next 20 years - that privatization would require.

That means people whose private accounts steadily earned three percentage points over inflation throughout their working lives would wind up with exactly what they would have gotten if Social Security remained untouched. Anyone who earned less than that would end up with less than is offered by the current system. When asked what would happen to the people who would not have enough income to avoid poverty, the administration official said, "I'm not sure if I'm understanding your question."

The benefit cut is only the beginning. There is still the problem of strengthening Social Security's finances. On its own, establishing private accounts does nothing to solve the long-term shortfall in the system. The president alluded to this fact when he said, "We must pass reforms that solve the financial problems of Social Security." He dutifully listed various benefit cuts that would do the trick, without taking the politically risky step of endorsing any of them.

Neither the president nor his aides have been willing to acknowledge the extent of benefit cuts that would be needed. And no wonder: All in all, they would leave the average worker with a government benefit worth only about 10 percent of his or her preretirement earnings. (Currently, Social Security replaces about 35 percent, on average.)

Various proposals to strengthen the current system's solvency via modest tax increases and benefit cuts - without resorting to costly private accounts - could guarantee a government benefit that replaces about 30 percent of preretirement income on average. But for all his talk about "an open, candid review of the options," the president refuses to consider any plan that excludes private accounts or includes tax increases, no matter how small. His stance makes severe benefit cuts unavoidable.

Even the feel-good tidbits in the president's speech really fail to stand up to close examination. Mr. Bush assured listeners that the government would prevent people from making bad decisions by restricting their investments to a conservative mix of stocks and bonds. But the more restrictions there are, the harder it would be for people to achieve the outsized returns that the administration has generally promoted to sell the public on private accounts.

And the much-touted promise that the private accounts could be passed on to one's heirs, as it turns out, is also less than it seems. That works entirely only if you die before you retire. Under a scheme that is going to take a while for the public to digest, the White House wants to require new retirees to use their private accounts to buy annuities large enough to keep them above the poverty line for the rest of their lives. The most they could leave to heirs, then, would be what is left over after the annuities are purchased.

Mr. Bush is expending tremendous energy to sell his plan - daily impairing his own credibility and shredding whatever confidence remains in the country's fiscal outlook. Members of Congress would do him - and their constituents - a favor by reining him in and moving on to more pressing matters.

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Published: February 4, 2005

Gambling With Your Retirement

By PAUL KRUGMAN

few weeks ago I tried to explain the logic of Bush-style Social Security privatization: it is, in effect, as if your financial adviser told you that you wouldn't have enough money when you retire - but you shouldn't save more. Instead, you should borrow a lot of money, buy stocks and hope for capital gains.

Before President Bush's big speech, a background briefing by a "senior administration official" made it clear that the plan calls for exactly the "borrow, speculate and hope" strategy I described - not just for the system as a whole, but for each individual.

Here's the money quote: "In return for the opportunity to get the benefits from the personal account, the person forgoes 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 rate of return" - after inflation - "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 rate of return."

Translation: If you put part of your payroll taxes into a personal account, your future benefits will be reduced by an amount equivalent to the amount you would have had to repay if you had borrowed the money at a real interest rate of 3 percent.

Peter Orszag of the Brookings Institution got it exactly right: "It's not a nest egg. It's a loan."

For years, privatizers - including Mr. Bush - have claimed that people would do better with private accounts than with traditional Social Security even if they played it safe and invested in U.S. government bonds (which yield 3 percent after inflation).

But the official at the briefing made it clear that his boss was fibbing: if you invested your private account in government bonds, you would face benefit cuts equal in value to your investment, so you would be no better off than under the current system.

The only way to get ahead would be to invest in risky assets like stocks, and hope for higher yields. But if the investment went wrong and you earned less than 3 percent after inflation, your benefit cuts would leave you poorer than if you had never opened that private account.

So people are expected to take a loan from the government and use it to buy stocks, and if that turns out to have been a mistake - well, too bad.

Experts usually tell people to plan for their retirement by investing in a mix of stocks and bonds. They disapprove strongly of speculation on margin: borrowing to buy stocks. Yet Mr. Bush wants tens of millions of Americans to do exactly that.

Meanwhile, what does any of this have to do with the ostensible purpose of the whole thing: saving Social Security?

Here's the senior official again: "In a long-term sense, the personal accounts would have a net neutral effect on the fiscal situation of Social Security." The government would have to borrow huge sums up front to create the personal accounts - $4.5 trillion in the first two decades - but it would supposedly make up for all that borrowing with offsetting cuts in account holders' benefits many decades later.

Color me skeptical: will retirees with private accounts that performed badly really be forced to repay their loans in full? Even if they are, private accounts will at best have a "net neutral effect" - that is, they will do nothing to improve Social Security's finances. Mr. Bush says the system faces a crisis; what does he propose to do about it?

The answer, presumably, is that his plan will also involve major benefit cuts over and above those associated with private accounts. And it's true that you can improve Social Security's finances with privatization, as long as you also slash benefits - just as you can kill a flock of sheep with witchcraft, provided you also feed them arsenic. (Thanks, M. Voltaire.)

Do you believe that we should replace America's most successful government program with a system in which workers engage in speculation that no financial adviser would recommend? Do you believe that we should do this even though it will do nothing to improve the program's finances? If so, George Bush has a deal for you.

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