Are we really fighting over Social Security privatization and reductions again!? A recent Wall Street Journal article by former Reagan advisor and Harvard professor Martin Feldstein has ginned up the debate.

BUT, sound the horns, I agree with conservative economist Martin Feldstein, but only on his main point. Cutting and privatizing Social Security is a bad idea, but we need to supplement Social Security. I call universal accounts that have guaranteed returns.

I depart from Feldstein's call for voluntary accounts that he assumes will earn a ridiculously high rate of return of 5.5% after fees and inflation. After all, the S&P 500 returned -.1% in the first decade of the century and commercial fees can shave  20% of the savings. 

I agree with Professor Feldstein that things will be pretty bad if we don't have drastic pension reform. Retirement readiness is eroding because employers are less likely to sponsor retirement plans. In the United States, in 2009, 46% of employees worked for employers who did not sponsor a retirement plan while in 2000 the rate of non-sponsorship was lower, at 40%.We need to SUPPLEMENT traditional Social Security with a savings vehicles that charges low fees and guarantees returns. To obtain adequate retirement income workers need to save a minimum of 17%.  Social Security gets you over half the way there with 12.4% of pay contributed to Social Security. Fortunate workers who have traditional plans defined benefit plans gererally have savings up to the required level;  but most workers have no accounts at work and those with 401(k)-type plans  aren’t saving enough on a consistent basis because 401(k) - type accounts are voluntary and charge high fees.

I have a realistic proposal for guaranteed retirement accounts. First, the math. An average income worker investing 5% of pay into an account that pays 3% real will supplement Social Security adequately. The only entity that can provide a guaranteed return is the government.  That is why I call for state or federal help to provide a vehicle for ordinary people to save for their retirement, a Guaranteed Retirement Account.

The government can provide a guaranteed rate of return with no extra cost or risk; it will just invest the money in conservative investments and pay annuities to retirees at the time the worker or beneficiary takes Social Security.

In sum, as an economist who opposes Social Security reductions, many may be surprised to learn I agree with Feldstein that we need individual account supplements to Social Security. He calls for workers to save 3% of payroll because he assumes they can earn 5.5% above inflation in commercial accounts. But if we do the math, and look at history, a 3% contribution rate is too low and the savings has to be universal, not voluntary. And employers have to help (along with a transformation of the tax deduction for retirement savings into a tax credit so the government can help workers save 5%) – and the guaranteed rate has to be realistic and guaranteed by the government. A 3 percent real return is more realistic and doable.



Harvard economist Martin Feldstein argued on May 2, 2011 that, because of Social Security, private pensions and personal savings, many retirees are financially secure. Social Security benefits will be about $20,000 annually for older workers when they retire. Without pension reform Feldstein argues things will only get worse. I agree.

He claims every “serious budget analysis” calls for cutting Social Security benefits by increasing the age at which full benefits would be payable and by shrinking the benefit formula. I don’t agree. Many analysts call for an increase in payroll taxes to keep benefits apace with needing order to "face Social Security’s long–term challenges. President Obama in his State of the Union address did call for reform that didn’t make future retirees shoulder the uncertainty in the stock market. I agree with Feldstein we need to create universal supplemental personal retirement accounts that generate an annuity for retirees.

Feldstein identified the challenge “is how to assure that future retirees have accumulated adequate investment-based accounts to supplement Social Security and Medicare.” I do not agree with Feldstein that experience in a wide range of companies shows that a voluntary system can work if employees are automatically enrolled to have payroll deductions deposited into such accounts because inertia is a powerful force. Not enough workers contribute on a steady basis and save enough if they do it alone on a voluntary basis.

Feldstein claims that a 3% payroll deduction for someone with $50,000 of real annual earnings during his or her working years could accumulate enough to fund an annual payout of about $22,000 after age 67 is people earn 5.5% after inflation. (As I argue above, a 3% contribution rate is too low and 5.5% is too high.)

Here is the full article by Harvard economist Martin Feldstein.


Private Accounts Can Save Social Security

Article Wall Street Journal May 2, 2011


Although many American retirees now enjoy a comfortable lifestyle financed by a combination of Social Security, private pensions and personal savings, many other retirees are far from financially secure. Someone who retires now after earning average wages all his life will receive Social Security benefits of less than $20,000 annually—not enough to maintain the middle-class standard of living that he had during his working years.

Without meaningful reform in Washington, things will only get worse. There are now three employees paying Social Security taxes to finance the benefit of each retiree. That number will fall over the next three decades to only two employees per retiree. This would require either a 50% rise in the Social Security tax rate to maintain the existing benefit rules, or a one-third cut in projected benefits to maintain the existing tax rate.

That's why every serious budget analysis calls for reducing the growth of Social Security benefits. The bipartisan Simpson-Bowles Fiscal Commission appointed by President Barack Obama proposed slowing the rise in Social Security benefits by increasing the age at which full benefits would be payable, and by changing the benefit formula so that the ratio of benefits to previous wages gradually declines for most future retirees.

Even Mr. Obama accepts the inevitability of lower future Social Security benefits. In his budget speech last month, he reiterated his State of the Union language indicating a willingness to negotiate lower future benefits. After noting that Social Security "faces real long–term challenges in a country that is growing older," he said that future changes must be made "without putting at risk current retirees, the most vulnerable, or people with disabilities; without slashing benefits for future generations; without subjecting Americans' guaranteed retirement income to the whims of the stock market."

Those words, if read carefully, imply that Mr. Obama accepts reducing future Social Security benefits as long as current retirees and the "most" vulnerable are exempted and benefits are reduced gradually (not "slashed"). And while the Social Security taxes are not to be invested in the stock market, some form of universal add-on investment based account is clearly not precluded. This is not fundamentally different from plans developed by Presidents Bill Clinton and George W. Bush: exempt current retirees, reduce future benefits gradually, and supplement tax-financed Social Security with investment-based accounts.

In short, while slowing the growth of Social Security is a necessary response to the changing age structure, it is possible to do it in a way that protects overall retirement incomes by creating universal supplemental personal retirement accounts that generate an annuity for retirees.

Such universal accounts can also help future retirees deal with the cutbacks in Medicare that will inevitably occur because the aging of the population and the increasing cost of health care per retiree will make the current system far too expensive to finance.

The leading Medicare reform plan is a bipartisan initiative proposed initially by House Budget Committee Chairman Paul Ryan (R., Wis.) and Alice Rivlin, a leading Democrat and former head of the Congressional Budget Office. The Rivlin-Ryan plan would change Medicare to a system in which future seniors would receive a voucher with which to buy private health insurance. The value of the voucher would rise over time more slowly than the currently projected Medicare cost per enrollee, implying that many seniors would want to pay extra to buy more comprehensive insurance than the vouchers would finance.

Mr. Ryan included this plan in his House Budget Resolution last month. A recent New York Times survey found that more Americans approve of it than disapprove. Mr. Obama opposes this approach. He proposes instead that future Medicare costs should be reduced by administrative controls, effectively limiting what Medicare will pay for in the future. Either way, future retirees will want more income to pay for additional health-care spending.

The challenge is how to assure that future retirees have accumulated adequate investment-based accounts to supplement Social Security and Medicare. Experience in a wide range of companies shows that a voluntary system can work if employees are automatically enrolled to have payroll deductions deposited into such accounts. Even though employees have the option to stop depositing, they do not do so. Inertia is a powerful force.

Applying this to the entire population requires a method of dealing with individuals who work in small firms, who change jobs frequently, who have multiple jobs, or who are self-employed. An employer-based plan is therefore less practical than one based on the individual.

Here's how such a system might work. Each individual would designate a broad-based mutual fund from a large list of funds approved by the government. The designation could be done on the individual's annual tax return and could be changed once a year. Employers and the self-employed would send an additional few percent of wages to the Social Security Administration each month in addition to the current payroll tax. The Social Security Administration would then forward those dollars to the mutual fund chosen by the individual. The returns on those funds would be untaxed just as they are in an IRA or 401(k).

With a 3% payroll deduction, someone with $50,000 of real annual earnings during his working years could accumulate enough to fund an annual payout of about $22,000 after age 67, essentially doubling the current Social Security benefit. That assumes a real rate of return of 5.5%, less than the historic average return on a balanced portfolio of stock and bond mutual funds. Someone who was extremely risk averse could instead choose to put all of his personal retirement account into Treasury Inflation Protected Securities, accumulating enough with a 5% savings rate for an annual payout of about $13,000. Different combinations of savings rates and investment strategies would produce different expected benefits in retirement.

The automatic extra payroll deduction could start with a less disruptive 1% or 2% and grow as high as 5%. Since every individual would have the option of requesting a refund of that payroll deduction on the following year's income-tax form, the extra saving is strictly voluntary. It is not a tax. And the good news is that experience shows that individuals who are automatically enrolled in such savings plans do not withdraw their funds but leave them to grow.

Mr. Feldstein, chairman of the Council of Economic Advisers under President Ronald Reagan, is a professor at Harvard and a member of The Wall Street Journal's board of contributors.