The Stock Market and Social Security Reform

August 9, 2002 • Commentary

Does a falling stock market mean the end of efforts to add personal accounts to Social Security? It shouldn’t. Today’s stock market presents a good test for personal accounts. And despite the gloating of critics as market indicators fall, accounts pass that test with flying colors.

Imagine you were offered the following deal: You could invest part of your Social Security taxes in a personal retirement account, similar to an IRA or 401(k). However, your account could hold nothing but stocks. You couldn’t diversify to bonds or other stable investments as you aged. Making matters worse, you would retire during the biggest bear market since the Great Depression, with the S&P 500 stock index falling from 1500 in April to 900 today.

It sounds like a sucker’s bet, but I would take it in a minute. Because even in a market tailor‐​made for opponents of reform, personal accounts would pay substantially higher retirement benefits than the current Social Security program while giving workers ownership and control over their savings. Barring Armageddon, you can’t lose.

Stock returns have averaged 7 percent after inflation throughout American history. Even after the recent market drop, a worker retiring today and holding only stocks would have received about 6 percent annual returns, far above the 2.5 percent return an average couple can expect from Social Security (even after including all survivors and disability benefits). Higher rates of return, compounded over decades, could double or even triple a worker’s retirement nest egg.

One reason personal accounts can weather market downturns is time: However bad the market’s recent performance, a worker retiring today would have begun investing in the late 1950s, when the Dow Jones index resided at one‐​tenth its current value. Over periods of 20 years the stock market has never once lost money, a boast supposedly “safe” government bonds cannot make. Even a worker retiring in 1933, in the depths of the Great Depression, would have received a 4 percent real average return.

Even so, today’s stock market is scary. That’s why most workers diversify as they age. According to a 2000 study, a typical worker in his 60s has only 40 percent of his assets in stocks. Such a worker would have lost just 3.25 percent last year, since bond prices rose while stocks fell. Low‐​wage workers, who hold smaller portions of their holdings in stocks, would actually have made money last year. That’s the power of diversification.

Finally, personal accounts would be voluntary. No worker is forced to take an account, and no worker with an account is forced to invest even a penny in the stock market. Under plans from the President’s Commission to Strengthen Social Security, all workers over age 55 would remain in the current system and receive every penny they’re promised. Current and near‐​retirees have nothing to fear from reform, while younger workers would finally have a choice.

It’s that element of choice, control, and ownership that keeps Americans supporting personal accounts even when the politicians and pundits get the jitters. A Zogby International poll conducted for the Cato Institute July 8–12 — a period when the Dow Jones Industrials Index fell almost 700 points — shows 68 percent of likely voters supporting voluntary personal accounts. That’s up from 54 percent support in July 1999, when the Dow was almost 25 percent higher than today.

Despite the market, 55 percent of working‐​age voters think personal accounts are less risky than the current system, which can remain solvent only with substantial tax increases or benefit reductions. By a two‐​to‐​one margin, likely voters think the lesson of the Enron scandal is that workers need more control over their retirement savings, including personal accounts for Social Security — not that markets are dangerous and that accounts shouldn’t be allowed. Individual control is a recurring theme: Voters cited it as the main reason for favoring personal accounts, even over higher benefits and the ability to pass on the account to their heirs.

An idea shows its strength when times seem the toughest. For a proposal to let workers invest part of their Social Security taxes in the stock market, these would seem to be tough times. But even today, personal accounts would increase Americans’ retirement income. And even today, Americans support them.

Social Security reform opponents crow that personal accounts would have lost billions in the last four years. What they don’t mention is how much workers would have gained over the past 40 years. Not just in dollars, but in control, ownership and personal security.

About the Author
Andrew G. Biggs
Former Social Security analyst and Assistant Director of the Project on Social Security Choice