• printer friendly
• mail this article
• iPod format
• digg

Anderson is an emeritus professor of finance at UCLA.

By Theodore A. Andersen

UCLA students have an important stake in the planned reform of the U.S. Social Security Program. These reforms will strongly affect the tax rate that students will be paying on their job income, now 12.4 percent, and the benefits they will be receiving upon retirement.

The Social Security Commission, headed by Sen. Patrick Moynihan, D-N.Y, and Richard D. Parsons, co-CEO of AOL Time Warner, has two major goals.

The first goal is to achieve an increase in the Social Security Trust Fund to about $3 trillion by about 2017. Secondly, an additional $1 trillion is needed to finance the transition of the partial privatization of Social Security contracts.

All told, the Fund needs to run a surplus of about $2.7 trillion over the next 15 years. This additional $2.7 trillion plus the $1.3 trillion surplus it now has would provide the needed $4 trillion.

The surplus of $2.7 trillion would, in all probability, be generated if the yearly Social Security surpluses of more than $100 billion were invested using the same principles as those followed by the government-regulated corporate pension funds, life insurance companies and state employee pension funds.

These groups diversify their investments into both stocks and bonds and achieve an overall yield of about 8 percent over the long term.

It is recognized that overall stock values show periodic declines, such as during these past 12 months, and they always go up over longer periods. Since the inception of Social Security in 1935, stock returns have always been at least twice that of U.S. bonds when periods of 10 or more years are considered.

There are major long-term economic forces at work that produce superior returns for those who own broadly diversified portfolios of common stocks.

Following broadly accepted principles of diversified investing, the Social Security Trust Fund could accumulate a surplus over the next 15 years of about $2.7 trillion.

This sum, along with the present surplus of $1.3 trillion, would be enough to finance the $1 trillion transition cost of the planned partial privatization and leave $3 trillion to finance the increased liabilities of the Social Security Trust Fund that will occur when the “baby boomers” begin to retire in large numbers after another 15 years.

Partial privatization, accompanied by careful regulation, would provide substantial benefits to participants in the Social Security Program who are 50 years of age or younger. Privatization would reduce both the unfairness and risk in the program as it is presently constituted.

The unfairness results from the fact that an unmarried participant could make payments into the program for 45 years. But if he or she died at the age of 65, their heirs would receive nothing. As it is, participants need to live for a very long time to get back at least part of what they have paid in. Participants who make payments for a period of time less than 10 years receive nothing.

Secondly, retirees may have a strong financial need for much more than their income from Social Security provides. In contrast with privatization, the average worker could accumulate $1 million in financial assets by the age of 65. This sum could, of course, do much to help meet financial needs during the period of retirement.

The $1 million could easily be accumulated as follows. An average 20-year-old worker, with an annual income of $21,000 growing at 4 percent per year (the same growth rate that has been experienced for the past 10 years), could regularly invest the 2 percent of his 12.4 percent payroll tax now going to Social Security, into a broadly diversified portfolio of common stocks. With stocks continuing to provide the same future returns as those for the past 50 years, namely 10 percent, the value of the portfolio would amount to $1 million when the worker retired at the age of 65.

Because the program is seriously underfunded, improvements are very necessary. The underfunding could be cured by diversifying the investment of the funds being received.

This would be similar to what almost all retirement funds do. Additionally, partial and regulated privatization would reduce the program’s present unfairness and inadequacy of returns.