What Bush has in store
How much American social security will change under President George W Bush will become clear this year. But in the meantime Wall Street – which recently has been lobbying for privatised pension accounts – is already betting on some changes and on the windfall they would bring to the asset management industry.
Modernisation of social security through personal accounts invested in the stock market was one of the biggest and hottest issues of Bush’s campaign. According to some critics, the way Bush won the election hasn’t given him a mandate. Besides, a Congress split almost equally between Republicans and Democrats is not likely to approve any radical reform.
However, it is also true that Republicans and Democrats have already agreed on some bipartisan measures, approving a pension reform bill under the Clinton administration. It was indeed a very good example of bipartisan teamwork in the US Congress and Bush has promised that he will go on working on such issues as a bipartisan leader.
The last pension bill (at the time of writing, still to be approved by the Clinton administration during the so-called ‘lame duck’ congressional season) grants increased contribution ceiling in IRAs (Individual Retirement Accounts, for the self-employed and roll-overs) and in 401(k) plans (individual defined contribution plans): annual tax-exempt contributions to IRAs will gradually rise to $5,000 (from the current $2,000) in 2003 and the ones to 401(k)s will be up to $15,000 (from the current $10,500) in 2005. Apparently both Republicans and Democrats agree that fiscal incentives are the most efficient way to encourage pension savings: a quite simple recipe, not yet understood by most European lawmakers.
Among the other new measures on pension plans, there is a largest amount of information employers have to provide employees, when companies change pension plan designs and the new design reduces future benefit accruals. When the shift is toward a cash balance plan (an increasing trend in the US, see IPE November 200), limits are introduced to avoid situations in which employees could work for years after the conversion, but not have any more benefits than those they have already accrued under the old plans.
Bush’s ‘radical’ reform claims to be the best way to save social security from bankruptcy. Here are the demographic trends mentioned by Bush: large numbers of ‘baby boomers’ will begin to retire in 2008; the number of workers for every retiree is declining while people are living longer. As a result, by 2025 the amount of social security benefits owed annually to retirees will exceed income into the system and by 2037 social security will be insolvent.
Bush promises neither to change the existing benefits for retirees or near-retirees, nor to increase social security payroll taxes. He doesn’t even want social security to invest part of its funds in the stock market, an idea sponsored by some Democrats and, among financial analysts, by Leah Modigliani of Morgan Stanley Dean Witter. In fact, critics say the latter measure would lead to politicisation of the investment process, with lots of undesirable side-effects.
Bush’s idea is to allow workers to divert a portion of the current 12.4% payroll tax that funds social security and invest it in stocks and bonds, through individual retirement accounts. Bush doesn’t say how big that portion would be, but he mentions that some bipartisan proposals fix it at 2 percentage points. These new accounts would have returns much higher than current social security funds: the real return people get on their pension payroll tax is less than 2%, a lot lower than Treasury bonds, for example, not to mention historical equity returns. Bush’s assumption is that the higher returns of individual retirement accounts will fatten future pension checks, so much so that the mandate benefits would be cut back and social security would be solvent until at least 2075, without having to raise the 12.4% payroll tax.
Some high-profile money managers support this proposal, among them William Shipman, director at State Street Global Advisors in Bosto) and one of the ‘thinkers’ at the Cato Institute (a libertarian ‘think tank’ based in Washington). The partial privatisation of social security is in tune with Bush’s leitmotiv appeal to give more power and more responsibility to individuals and reduce government’s intervention. For example, the Bush programme emphasises that personal accounts would create secure retirement income free from political risk. Under the current system – the reform’s draft reads – individuals do not have any legal right to the amount of money they contribute in payroll taxes. Congress can reduce social security benefits or increase taxes on benefits any time.
Critics say that the transition costs of privatisation are formidable and that the projected budget surplus won’t be sufficient to cover all the expenses planned by Bush. Besides, they stress that social security is meant to be a re-distributive insurance programme, which redistributes a pool of retirement money from those who die early to those who live long and guarantees a decent old age to low-income workers. The new individual account would put at risk these goals.