Linking Social Security To Stocks: a Good Idea?

The gyrations of the stock market have added a new wrinkle to the debate over how to fix the Social Security system.

For those who favor at least partial "privatization," the market's wild ups and downs in the past few weeks have put them on the defensive.

A range of proposals would put some or all of federal retirement money in stocks and other private investments, to take advantage of returns that have been historically higher than those on government bonds.

But for those who have opposed privatization all along, the market's big fluctuations have provided a timely reminder of the risks of investing.

Still, key senators who have drafted plans for partial privatization maintain that momentum for changing the system remains, and that Congress will take up the issue early next year. According to current projections, the Social Security system will not have enough money to pay all its obligations beginning in 2032.

If nothing else, say observers of the debate, the stock market's wild ride has inserted an important reality check into the debate.

"We were concerned that so many people seemed to think it [privatization] was a magic bullet, that the market would always go up," says Martha Phillips, executive director of the Concord Coalition, a bipartisan group promoting fiscal restraint.

"So for the red-hot advocates of jumping whole hog into total privatization, this is a good reminder to have as we embark on legislation."

In fact, note Ms. Phillips and other analysts, the Social Security debate had already focused considerably in the past six months. Calls for total privatization had moved to the edges, while most plans that are being taken seriously call for taking 2 or 3 percentage points of the payroll tax and putting that money in private investments. The current system is financed by a 12.4 percent tax, split equally by employers and employees.

Protecting inexperienced investors

There's also increasing talk of centralizing the investment management, and limiting investors' choices among three to five baskets of investments, so that inexperienced individuals aren't doing much hands-on investing in markets.

"This maturing of the debate is probably more important than anything that's happened so far in the market," says Martin Corry, chief lobbyist for the American Association of Retired Persons in Washington.

Arguments on both sides

But for hard-core supporters of privatization - and hard-core opponents - the market's roller-coaster act has fueled the debate over which way to go. Dan Mitchell, an economist at the Heritage Foundation and a privatization booster, lays out numbers to make a continued case for putting federal retirement money in the markets, much the way many private employers sponsor 401(k) plans.

By the end of last week, even with the stock market down by 20 percent from its mid-July high, Mr. Mitchell calculates that the average return over the past 12 months is still about 9 percent. If one takes the Standard & Poor's index's average returns going back four, eight, 12, and 20 years, the gains are still ahead of the return on government bonds, which is about 2.9 percent.

"The reality is that even a beginning stock investor knows you're going to have a lot of ups and downs, but what counts is how much money did you put in originally, and how much are you taking out, and calculating the annual average return," says Mitchell.

Dean Baker, an opponent of privatization at Washington's Economic Policy Institute, says the historical performance of the stock market is no guaranteed guide to the future.

In fact, he notes, the reason for projected shortfalls in the Social Security system is that economic growth is expected to decline to less than 1.5 percent a year over the next 75 years, down from an average growth rate of 3 percent between 1923 and 1998.

So, he says, expected returns in the stock market should be cut in half - from 7 percent to 3.5 percent annually. The cost of administering the private accounts and transition costs to a new system also must be factored in, he argues.

"You simply can't make assumptions that the future will be like the past," says Mr. Baker. "We're having these discussions because we're assuming the future's not going to be like the past."

Though Congress won't take up Social Security until next year, at the earliest, the labor movement is trying to use it in the current congressional campaign. In an echo of the debate over the future of Medicare, labor officials are encouraging candidates to suggest that the Republicans want to privatize Social Security and thus put their benefits at risk. In the last election, Democrats were successful in persuading some voters that Republicans would cut Medicare benefits.