New Page 1

The issue of Social Security, long considered the untouchable “third rail” of American politics, was avoided by both Clinton and Dole in their bids for the presidency in 1996.[1] The current President, in contrast, seems to sense that, for the first time in 60 years, the political climate is right for the restructuring of this once-unassailable program.

This note seeks to: (1) examine the president’s plan to offer private retirement accounts; (2) consider the counterarguments that have been raised by opponents of the president’s plan; and (3) reflect upon the British experiences to highlight some of the difficulties workers in those countries have faced in retirement. The note concludes with the argument that Americans should reject the president’s plan and insist upon the preservation of Social Security as we know it.

The president insists that the best way to protect America’s younger workers is through the (partial) privatization of Social Security. “As we fix Social Security, we also have the responsibility to make the system a better deal for younger workers. And the best way to reach that goal is through voluntary personal retirement accounts” (Bush, 2/2/05).

Although the White House has still not released the full details of the plan, the president has explained that his proposal would allow workers under the age of 55 to divert up to 4 percent of their current payroll tax contribution into their own retirement accounts.[2] Workers who decided to participate would then depend upon benefits from two sources: (1) the (now lower) guaranteed benefit they continue to receive from Social Security and (2) the market benefit that accrues in the form of gains in their personal account.[3] Those who decide not to establish a personal account are told that they “could stay entirely in the current system” and that their “benefits are fully protected” (A Guide to Social Security Reform, Speech 1, p. 3).

Workers are told that they will come out ahead as long as their personal account earns a rate of return that exceeds the rate of return on the Trust Funds:

But what about the risks? Investing in a personal account means foregoing a portion of the benefits that otherwise would have been received under the traditional system. In addressing these concerns, Republicans have emphasized the prospects for higher returns and downplayed the risks associated with market investment.

Thus, in stump speeches across the nation, Republicans are asking a simple question: Do you want “your” money in a Trust Fund that earns a 3 percent real return, or would you prefer to invest it in a personal account that might yield nearly 7 percent after inflation? Using these figures, they hope to persuade Americans that the answer is fairly obvious. Personal accounts offer better prospects for growth and, ultimately, a more comfortable retirement. This is especially true in the case of younger workers, explains White House spokesman Trent Duffy, because they can get in early and experience “the magic of compound interest” (quoted in Vandehei, 2005).

Finally, personal accounts are said to enable average Americans to participate in an “ownership society,” creating millions of “worker-capitalists with a direct interest in sound economic policy” (A Guide to Social Security Reform, Case Studies, p. 21). And, since workers “own” their private accounts, the government is prevented from spending their contributions. Moreover, any portion of the account that isn’t used for retirement can be passed on to one’s heirs. It is a plan that sounds almost too good to be true: ownership, higher anticipated returns, protection from government, and something to bequeath to one’s survivors.

While the president and his allies have emphasized the potential gains that might accrue through investment and the magic of compound interest, they have downplayed many of the less pleasant aspects of moving toward a partially privatized system, including: cuts for those under 55 years of age, administrative fees that cut into total returns, the costs of financing the transition, and the windfall that might accrue to financial middlemen at the expense of those who choose private accounts. The purpose of this section is to ask whether, in the face of these downside aspects, personal accounts are a good choice for Americans.

Anyone who has heard the president discuss Social Security reform knows how important the images of “choice” and “freedom” have been in the marketing of private accounts. The president has emphasized time and again the voluntary nature of his plan, stressing that it gives workers the freedom but not the obligation to choose a reduction in guaranteed benefits. But this is misleading, for nearly all workers would suffer significant cuts in their guaranteed benefits under the president’s plan. This is because his plan calls for a change in the way benefits will be calculated for nearly everyone in the coming years. Let us consider the implications of the proposed changes.

The “bend points” – the $627, $3,152 and $3,779 – are indexed each year to reflect growth in nominal wages so that when the economy does well, retirees are permitted to share in the benefits economic growth. And, since nominal wages tend to grow over time, the system promises higher benefits to future generations of retirees than it pays to current retirees.

If the President succeeds in redefining the formula, the “bend points” will be calculated using an inflation index instead of the current wage index. At first glance, this might seem like a relatively innocuous adjustment. After all, the historical trajectory for prices is also upward, so benefits will still tend to increase over time. But prices tend to rise more slowly than nominal wages – over the long run – so benefits would increase less rapidly under inflation-indexing.

Baker and Rosnick (2005) estimate the impact of inflation-indexing on future generations of workers. Figure 4 shows their staggering projections.

As Figure 4 reveals, inflation-indexing would sharply reduce the level of defined benefits. Indexing to inflation of, say, 2% instead of nominal wage growth of, say, 3.2%, means that workers must forego the 1.2% real wage growth that previously increased the “bend points” and raised their defined benefits. The longer a worker must endure increases at the (lower) inflation rate, the more severe the cuts will ultimately be. Thus, America’s youngest cohort of workers would be most adversely affected by the President’s plan to introduce inflation-indexing.

On top of these cuts, the president’s plan gives workers the option to further reduce their defined benefit by diverting a portion of their payroll taxes into a personal account – a choice that seems to make sense for those who expect their personal account to earn a rate of return that exceeds the rate of return earned on Treasury bonds (held in the Trust Fund). But does it? Let us look more closely at the implications of diverting withholdings into personal accounts. Chart 1 shows the role of personal accounts in offsetting guaranteed benefit reductions.

When a worker agrees to establish a personal account he is effectively asking the government to lend him part of his Social Security tax so that he can invest it in the stock market.[4]

Democrats are particularly worried about the impact of privatization on low-income workers.[5] In their view, the president’s plan would shift a disproportionate share of risk onto low-income workers, who may not survive through retirement if their personal accounts lose money. Indeed, some Democrats have argued that these groups would be better off under the current system, which can only pay 73% of promised benefits, than they would be under a partially privatized system that might result in much larger cuts.

In sum, the president’s plan calls for both voluntary and involuntary reductions in benefits. The former are incurred only by those who choose personal accounts, but the latter are envisioned for nearly everyone as inflation-indexing replaces wage indexing in the calculation of defined benefits. Thus, unless one meets the government’s (yet-to-be-specified) definition of “low income,” the president plan will reduce guaranteed benefits, even for those who choose not to establish a personal retirement account. This is something Americans must understand.

The portion of current payroll taxes that gets diverted to personal accounts won’t be available to pay current retirees. As a consequence, the government recently announced that it would borrow huge sums in order to help pay for adding personal accounts to Social Security.[6] These costs – estimates range between $1 and $2 trillion dollars – are considered “transitional” because, as current retirees begin to die, costs decline, disappearing altogether (along with beneficiaries) over the longer term.

Both those critical of and those supportive of the president’s plan have raised concerns about the costs associated with transforming the system to include personal accounts. Critics (mainly Democrats) argue that the president's privatization scheme is fiscally irresponsible because it adds hundreds of billions to the federal deficit and, ultimately, trillions to the national debt.[7] Tom Davis R-VA offered a less hostile critique, suggesting that “[f]loating a bond issue of a trillion dollars is not the message you want to send to the markets right now” (Froomkin, 2004).[8] Finally, Alan Greenspan, who has been generally supportive of the president’s plan to introduce private accounts, has admonished the White House, arguing that increased spending to finance the transition to personal accounts may put the federal budget “on an unsustainable path, in which large deficits result in rising interest rates and ever-growing interest payments that augment deficits in future years” (quoted in Hays, 2005).

Others have simply questioned the logic of selling bonds to help facilitate the purchase of stocks, noting that when the government floats bonds in order to finance the transition to a partially-privatized system, it means that investors are exchanging stocks – those being sold to individuals who will hold them as assets in their personal accounts – for newly-issued Treasury debt. This begs the question: why would investors agree to add over $1 trillion in long-term government debt to their portfolios if the stock market is expected to outperform government bonds over the long haul? The implication, as Krugman points out, is that “politicians are smart – they know that stocks are a much better investment than bonds – while private investors are stupid, and will swap their valuable stocks for much less valuable government bonds” (Krugman, NYT, 2005).

While it is not difficult to envision stocks outperforming bonds over the long-haul, it is quite conceivable that stocks will generate even larger short-term gains, as tens of millions of Americans begin buying shares for their personal accounts. The prospect of a sudden surge in the demand for shares has raised concerns about the possibility of a short-term bubble in stocks prices – a consequence of too many dollars chasing too few shares.[9] If privatization puts upward pressure on stock prices, those who already own shares of large cap stocks and those who manage the transactions would reap significant gains, while today’s youth would suffer lower rates of return, as they buy into the market in the midst of a stock-price inflation. Thus, as Kenneth Apfel, Social Security commissioner from 1997-2001 suggests, Bush’s proposal calls for “a radical restructuring that’s not in the interests of the young and old alike” (Apfel, 2005).

But the young need relatively high rates of return in order to compensate for the cuts they would suffer under the president’s plan. And the president insists that the stock market can deliver these rates, telling Americans that “[p]ersonal accounts are a better deal,” because “your money will grow, over time, at a greater rate than anything the current system can deliver” (State of the Union Address, 2005). Specifically, the White House has projected a 6.5 percent real return on private accounts. At this rate, private accounts are projected to yield returns high enough to cover projected fees plus inflation, thereby raising the income and consumption of future retirees.

But, as his critics point out, retirees may actually end up with less if the stock market fails to perform the way the Administration implies that it will. For example, Paul Krugman, a vocal opponent of Bush’s plan, points out that equity serves only as a potential source of future revenue. Equity is a claim on corporate income that provides gains when: (1) the corporation pays cash dividends or initiates stock buybacks, or (2) rising stock prices yield capital gains. Thus, Krugman notes that the Administration’s projected 6.5 percent return is possible only if, in addition to the 3 percent currently coming from dividends and buybacks, inflation-adjusted stock prices increase by 3.5 percent. In the short run, Krugman admits that this is clearly possible. But the Bush plan requires these high rates of return “for at least the next 75 years” (Krugman, 2005, NYT). The problem, he points out, is that the Trustees’ own assumptions about growth, inflation, etc. make this a highly dubious outcome.

If, as the Trustees project, the economy slows from its historic 75-year average growth rate of 3.4 percent to a rate of only 1.9 percent over the coming 75-year period, it will be virtually impossible for shareholders to earn an inflation-adjusted 6.5 percent rate of return in the stock market. With such low growth rates – and hence low profit growth[10] – cash dividends and stock buybacks will account for an increasingly small portion of the total yield on stocks. This, of course, places an ever increasing burden on the portion derived from capital gains. But this would require an increase in stock prices that outstrips profits for the next several decades, something that would push the average price-earnings (P/E) ratio to five times its current level.[11] Thus, based on the Trustees’ predictions about the future course of U.S. growth, Krugman argues that an after-tax annual rate of return on the order of 6.5 to 7 percent “is mathematically impossible” (ibid.). He is also quick to point out the irony in this conclusion: “if the economy grows fast enough to generate a rate of return that makes privatization work, it will also yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come” (ibid.).

Under the current system, less than one cent out of every dollar paid into Social Security benefits goes to pay administrative costs. In contrast, privately managed retirement accounts, like those in Chile and England, “waste 15 cents of every dollar paid out in benefits on administrative fees” (ibid.). Thus, critics maintain that the costs of administering more than 100 million small, private accounts “could dwarf Social Security’s administrative overhead, which currently amounts to less than 1 percent” (Dreyfuss, 1996, p. 3).

The president insists that his plan would contain these costs, estimating that only about 5 cents of every dollar paid out in benefits would go to money managers. But even if the president succeeds in limiting the fees that financial intermediaries can charge to administer personal accounts, Wall Street stands to gain $940 billion or more (in present value terms), according to University of Chicago business school professor Austan Goolsbee.[12] Goolsbee’s findings fueled criticism from Democratic Presidential Candidate John F. Kerry, who claimed that the president was pushing privatization in a quid-pro-quo move designed to benefit Wall Street donors who contributed generously to his campaign – a claim that does not appear to be farfetched.

The serious push for privatization began over a decade ago, with a coalition of conservative ideologues (neo-cons) and Wall Street money managers, determined to dismantle Social Security and replace it with a system of individual retirement accounts. Around this time, the Washington Post predicted that “[b]y 2010, more than $4 trillion a year could be pumped into the stock market from Social Security account plans, generating as much as $44 billion in annual fees for Wall Street under the personal security account plans” (Fromson, 1997). State Street Bank & Trust, a little-known Boston firm, which specializes in the management of smaller accounts, was one of the many firms that wanted a piece of the action. It had its own privatization agenda, but it also began to seed “other research groups with about $100,000 in grants – including about $20,000 to the libertarian CATO Institute’s privatization project” (IAF, 2001).

The mutual-fund industry, which was also poised to capitalize on this opportunity, began “funneling millions of dollars in seed money to think tanks, ‘grassroots’ organizations, and politicians friendly to the ideas of privatization” (Dreyfuss, 1996).

To realize their goal of privatization, these investment companies needed two things – politicians willing to promote their cause and the capitulation of the American public. In the run-up to the 1996 Presidential election, fund managers and heads of major investment banks began greasing the palms of the Democratic and Republican nominees.[13] And, while neither candidate adopted privatization as part of his political agenda in the mid-nineties, Wall Street brokers were not dissuaded.

In the run-up to the 2000 election, Charles Schwab, Dan Cook[14] (Goldman Sachs) and Richard Gilder (a stockbroker) were busy “pouring money into the presidential campaign of George W. Bush” (Silverstein, 2001, p. 1). And so were scores of other brokers and money managers. In total, Wall Street shelled out $10 million in campaign cash to the GOP (ibid.). By June 18, 2001, Treasury Secretary Paul O’Neil was on board, throwing his shoulder into Wall Street’s push for private accounts. At a luncheon high atop the World Trade Center, he served as keynote speaker, helping participants such as Citigroup Inc., Deutsche Bank AG and Morgan Stanley raise money for a $20 million campaign to support the privatization of Social Security (IFA, 2001).

While Republicans insist that Wall Street does not stand to reap extraordinary benefits from privatization, security brokers and investment managers clearly see things differently, doling out staggering sums to politicians, conservative think-tanks and grassroots privatization campaigns, in the hopes that their dream of charging fees and commissions on nearly 100 million new accounts might one day be realized. And when the conservative Wall Street Journal characterizes the privatization of Social Security as potentially, “the biggest bonanza in the history of the mutual fund industry,” you can be sure there is something to the claim (Dreyfuss, 1996a).

It is sometimes said that a fool learns from his mistakes, while a wise man learns from the mistakes of others. In recent years, a number of countries around the world have converted their government-sponsored retirement programs into systems that rely, in whole or in part, on private accounts. The purpose of this section is to examine some of the problems that have emerged as a consequence of privatization in the United Kingdom, where private accounts have been in place for over a decade.

While Americans can learn from the problems that have arisen in a developing country such as Chile, it may be more instructive for them to draw lessons from a large developed country such as the United Kingdom. It is also easier to draw comparisons with the British experience because the U.K. introduced voluntary “personal pensions” as part of a partial privatization scheme. Additionally, the British government switched benefit indexing from the higher of inflation or wage growth to inflation only. Thus, the British framework more closely resembles the model the U.S. government is trying to put in place at home.

The British retirement system has two tiers: a first tier and a second tier. Under both tiers, benefits go to men at age 65 and to women at age 60. The first tier provides mandatory flat-rate weekly benefits (paid by the government) which are independent of earnings. This level of benefits was put in place in 1908 to ensure minimum (i.e. poverty level) benefits to retirees. The second tier, introduced in 1961, provides earnings-related benefits from either public or private pensions.

The introduction of this second tier marked the first phase of privatization, because it gave employers the option not to participate in the public portion of the second tier and, instead, establish a private second tier known as an “occupational pension”.[15] In 1978, the British government introduced the State Earnings-Related Pension Scheme (SERPS), which improved the second-tier public pension by replacing a higher percentage of contributed earnings. Thus, upon retirement, British workers would either receive (1) a small, first tier pension plus a second-tier pension through SERPS or (2) a small, first-tier pension plus an employer-sponsored occupational pension. Under either scenario, workers were protected under a defined benefit plan.

The second phase of privatization came in 1988, when the government allowed workers to voluntarily opt out of either the public SERPS or the employer-sponsored occupational pension and set up tax-deferred, individual accounts.[16] Those who chose to opt out of the second-tier coverage would draw only their small, first-tier pension plus whatever their personal accounts could provide when annuitized.[17] Thus, the U.K. system currently resembles the model envisioned by President Bush, where workers would continue to draw a portion of their benefits from Social Security but would rely more heavily on the annuitized value of their personal accounts.

If we were to measure the success of the British reform simply in terms of worker participation, we would have to conclude that the second phase of privatization was a great success.[18] Roughly 3.1 million people opted out of the SERPS during the first year. And, by the end of the fifth year, another 2.3 million people had joined them in establishing “personal pensions” (Department of Social Security, 1998, Table 26.0). But, of course, success is not so easily judged.

With the passage of time, workers have discovered many of the system’s flaws. First of all, they have come to realize the detrimental effects of inflation-indexing.[19] Since inflation typically increases about one-and-one-half to two percent more slowly than wages, workers who remain in the second tier can expect benefits that are forty to fifty percent lower than they otherwise would have been. Worse, opting out of the second tier hasn’t proven to be much of a safeguard.

Scandals and fraud have plagued Britain’s money managers, delivering a black eye to the very idea of privatized public pensions. In exchange for their services, financial middlemen often gouged workers, charging “not only an initial fee (including a percentage commission and a lump sum), but also an annual fee on invested funds and a monthly flat fee that is generally indexed according to price or wage increases” (Liu, 1999, p. 36). In some cases, these charges were more than 20 percent of contributions. For an estimated 30 to 40 percent of account holders, fees and commissions are so high that workers never earn enough to recover their principal (ibid.).

To reap these fees and commissions, money managers aggressively marketed their services, indiscriminately recommending personal pensions to every generation of workers. In 1992 a random sample of accounts was audited by the Securities and Investment Board. The audit, which was performed against the objections of the insurance industry, revealed that “a staggering percentage of pensions had been sold to those who would be worse off in retirement as a result” (Cohen, 2005, 3).[20] The findings resulted in a scandal that generated enough of a public outcry that the government was forced to act. In the end, some 1.7 million people “sought and received compensation that ultimately cost the insurance industry £12 billion. In addition, hundreds of millions were paid out in fines and penalties. It was the biggest financial scandal in the United Kingdom to date” (ibid.).

Nearly half of British retirees now qualify for additional benefits under a separate welfare program for the elderly. To avoid this fate, more than 500,000 people decided to opt back into the state plan[21] in 2002-03, and another 500,000 joined them in 2004.[22] Another 250,000 are expected to opt back in this year, a trend that is expected to continue into the future. There is a lesson here for Americans. As Robin Ellison, Chairman-elect of the National Association of Pension Funds in the U.K. recently noted, “[i]t is curious that as we’re moving towards one system, the United States appears to be thinking and moving to the system we’re moving away from” (National Public Radio, Record Number: 200502171004). Perhaps failing to learn from the mistakes of others will make us the greatest fool of all.

As Americans, we used to be entitled to certain things – government-sponsored health insurance, education, and various forms of welfare protection. Increasingly, the government is telling us that we are entitled to nothing. Current and previous Administrations have weakened welfare, unemployment and after-school programs and pushed school vouchers, medical savings plans and private Social Security accounts. And, so far, there has been little resistance to many of these reforms. In particular, younger Americans seem unafraid to “go it alone,” perhaps reflecting a shift in their attitudes toward dependency, work and worthiness.

But before America’s youth throw their support behind the president’s plan, convinced of their ability to provide for themselves in their retirement, they should remind themselves that, they, like their forefathers have done the work, paid into the system and earned the right to receive the benefits they have been promised. And they should recognize that some of their security has already been sacrificed, as scores of our nation’s employers continue to replace guaranteed pensions with 401(k) plans. Acquiescing to the president’s plan would simply remove another leg of the stool, reducing their guaranteed benefits and placing their future security in the hands of indifferent market forces.[23]

Social security is a social insurance system, designed to guarantee a minimum income to our nation’s elderly in retirement. It was never intended to help Americans build financial wealth or create “worker capitalists.” Before they allow the prospects of large financial returns to persuade them to support a plan that may significantly undermine their future well-being, America’s youth should remember that “more than half of seniors receive a majority of their retirement income from Social Security” (Tanner, 2004, 1). If this trend persists, odds are, today’s worker will eventually depend heavily on the benefits paid by Social Security. And, if the British experience has taught us anything, it is that the costs and risks associated with private accounts far outweigh the value of the returns they are likely to generate.

But the current debate should be about more than narrow self-interest. It should about the kind of society we want to have. Are we willing to ensure the security of America’s elderly and disabled or are we content to place their fate in the hands of capricious markets? Will we sit idly by as more and more Americans slide into poverty or will we be forced to act when future retirees find it impossible to survive on the annuitized value of their personal accounts plus their reduced benefit payments? In an ideal world the answers would be obvious – Americans would reassert their commitment to our nation’s largest and most successful entitlement program and just say ‘no’ to the president’s plan.

Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance

Baker, Dean and David Rosnick. 2005. “Basic Facts on Social Security and Proposed

Bell, Stephanie and L. Randall Wray. 2000. “Financial Aspects of the Social Security

Birnbaum, Jeffrey H. 2005. “Private-Account Concept Grew from Obscure Roots.” The

Department of Social Security. 1998. Second Tier Pension Provision, 1996/96. 2 Vols.

Dickerson, Marla. 2005. “A Personal Burden.” Los Angeles Times, February 13.

Dole, B. 1998. Statement of Senator Bob Dole, Testimony before the House Ways and

Security Reform. April 1. http://waysandmeans.house.gov/legacy/fullcomm/105cong/4-1-98/4-1dole.htm

Dreyfuss, Robert. 1996. “The end of Social Security as we know it?” MotherJones.com.

_____. 1996a. “The Biggest Deal: Lobbying to Take Social Security Private.” The

Eisner, Robert. 1998. “Save Social Security from its Saviors.” Journal of Post Keynesian

Fromson, Bret D. 1997. “A Safety Net Whets Wall St. Appetites: Social Security

Hays, Kathleen. 2005. “Fed Chief: Expect Social Security Cuts.” CNN Money, March

Hertzberg, Hendrik. 2005. “Untrustworthy.” The New Yorker, Issue of 2005-03-28.

Hudson, Michael. 2005. “The $4.7 Trillion Pyramid.” Harper’s Magazine, March.

Institute for America’s Future (IAF). 2001. “Wall Street and Social Security.”

http://www.ourfuture.org/issues_and_campaigns/socialsecurity/key_issues/money_trail_and_wall_street/readarticle54.cfm

Ithaca Times. 2005. “Social Security Survived in ‘80s: Need for Change Wasn’t

Kaiser, David. 2005. “The Constitutional Protections for the Social Security Trust Fund:

a Letter Commenting on ‘Confusions about Social Security’ by Paul Krugman.”

Krugman, Paul. 2005. “The Free Lunch Bunch.” The New York Times, January 21.

Lazear, Edward, P. 2005. “The Virtues of Personal Accounts for Social Security.” The

Economists’ Voice, Vol. 2, Issue 1, Article 4. The Berkley Electronic Press.

Mitchell, William and Warren Mosler. 2005. “Essential Elements of a Modern Monetary

Intergenerational Debate.” Center of Full Employment and Equity, Working Paper

Rohter, Larry. 2005. “Chile’s Retirees Find Shortfall in Private Plan.” The New York

Times, January 27. http://www.globalaging.org/pension/us/socialsec/2005/chile.htm

Sawicky, Max B. 2005. “Collision Course: The Bush Budget and Social Security.”

Senior Administration Official. 2005. Background Press Briefing on Social Security.

Silverstein, Ken. 2001. “Finance, Insurance & Real Estate: With 67 brokers and

Skidmore, Max J. 1999. Social Security and its Enemies: The Case for America’s Most

Tanner, Michael. 2004. “Social Security’s Tough Transition.” The Cato Institute.

The President's Commission to Strengthen Social Security, Strengthening Social Security

Tucker, Rich. 2005. “Social Security: All Trust and No Fund.” The Heritage Foundation.

Vandehei, Jim. 2005. “Poor are at Center of Debate: Many say Social Security Overhaul

White House Office of the Press Secretary. 2005. “Background Press Briefing on Social

Zuckerman, Diana. “Social Security and Women.” National Research Center for Women

[1] The Washington Post reported that Wall Street interests sent ‘briefing papers’ to both the Clinton administration and the Dole campaign, urging the candidates to steer clear of the issue until after the election (Dreyfuss, 1996). Later, during his second term in office, Clinton reportedly abandoned a serious plan to pursue some form of privatization when it became clear that he was going to be impeached (Birnbaum, 2005).

[2] In its first year of implementation – 2009 – people born in 1965 would be permitted to contribute up to $1,000 annually, and an additional $100 per year thereafter. In 2010, those born in 1978 and earlier would become eligible to participate, and everyone else would be permitted to establish a personal account beginning in 2011.

[3] Clearly, the more they divert into private accounts, the less they will receive in the form of a guaranteed benefit and, hence, the more they will rely upon gains in financial markets.

[4] Investing everything in a government bond fund would be fruitless, since they earn the same rate of return as the Trust Funds.

[5] In 2002, more than 60 million Americans between the ages of 25 and 64 reported incomes of less than $25,000. And, according to government statistics and polling results, many of them are already worried about how they will survive their retired years. This is not surprising, since many low income workers are unable to build up sufficient savings during their working years and tend to have small or no pensions when they retire.

[6] Specifically, the government would issue bonds that would be repaid 20 years later.

[7] Michael Tanner of the Cato Institute disagrees, arguing that while it may cost roughly $2 trillion to cover the transition to personal accounts, the creation of these accounts “will reduce the unfunded liabilities of social Security by as much as half” (2004, p. 1).

[8] Davis estimates that about 10 percent of House Republicans oppose Bush’s proposal to partially privatize Social Security.

[9] The Bush administration disagrees, arguing that two percent of payrolls can be diverted to the stock market (annually) without appreciably raising stock prices. However, Michael Hudson argues that a bubble is just what Bush seeks to manufacture, one “bankrolled by the last safe pile of cash in America today” (2005). Here, the idea is that a coordinated surge in demand is needed to prevent baby boomers from suffering capital losses as they begin liquidating massive quantities of stock in retirement.

[10] Over the long term, profits tend to grow at the same rate as the economy.

[11] The price-earnings ratio, currently around 20, has a historical average of roughly 14. According to Dean Baker and David Rosnick (2004) of the Center for Economic and Policy Research, the P/E ratio would have to rise to around 70 by 2050 and top out at over 100 by 2060 in order for stock returns to hit the Administration’s projected average of 6.5 through 2080.

[12] And the administrative costs don’t end at retirement. Workers who live long enough to reach retirement will be required to purchase an annuity – monthly payment that ceases only upon death. But financial firms typically take another substantial bite out of workers, charging anywhere from 10 to 20 percent of accrued savings to set up the annuity (Baker and Rosnick, 2004).

[13] Merrill Lynch gave a reported $472,930 in political donations in 1996, including $27,150 to Bill Clinton and $36,300 to Bob Dole, while Fidelity Investments and T. Rowe Price began to openly call for Social Security reform (Dreyfuss, 1996).

[14] Cook, a partner at Goldman Sachs, gave $151,000 to Republican campaigns. He also sits on the board of the National Center for Policy Analysis in Dallas. In October 2000, the center ran a nationwide television campaign, touting the benefits of privatizing the entire Social Security system (Silverstein, 2001).

[15] Thus, the second-tier was, from the very beginning, a partially privatized pension scheme.

[16] The legislation creating private accounts was pushed through by British Prime Minister Margaret Thatcher.

[17] Though still technically considered a defined contribution plan, benefit amounts would depend on the contributions paid in, together with the returns earned on the accumulated funds. Importantly, the account holder bears all of the investment risk.

[18] Britain’s Actuary Department forecast that private accounts would only be beneficial for the very young, who would reap the benefits of compound interest over a longer time-horizon, and for the very rich, who are not dependent upon a government pension for the bulk of their retirement income – roughly 500,000 in total. Five years after personal accounts were introduced, ten times that many people had opted for them.

[19] When inflation indexing was implemented in 1980, it generated little political fanfare.

[20] Older workers, who would have fewer years to allow their contributions to accumulate compound interest, were most disadvantaged.

[21] The state plan, formerly SERPS, is now known as State Second Plan (S2P).

[22] Many of those opting back into the state system are doing so on the advice of private account managers, who did not want to risk further allegations of improper advising.

[23] Unlike the large brokerage houses that manage their accounts, workers can lose big when the market swings against them; the profits of the financial middlemen tend to be more buoyant, rising even when the market turns bearish. This happened in Chile in 1995, when a lull in the stock market caused workers to lose 4 percent of their investments. At the same time, the firms that managed their accounts earned profits of more than 20 percent (Dreyfuss, 1996).