Compulsory Old-Age Savings
Brian Gongol


Before adopting President Bush's proposal for private savings accounts as an alternative or accessory to the existing Social Security old-age benefit, the entire concept of compulsory old-age savings deserves review.

It's easy to forget that savings isn't some abstract issue of dollar bills and stock certificates. It's a question of storing enough resources (whether it's sacks of flour or the dollar bills that can be exchanged for sacks of flour) now that we can use those resources in the future. Resources cannot be legislated into existence. That's why the government can't simply print more money when people retire so that we can all be rich; some resource, whether it's food or water or anything else, has to exist that we value enough to purchase.

The only way to increase the amount of resources available is to encourage productive behavior. Human ingenuity really is the only "free lunch" in all of economics -- tangible resources themselves are in limited supply, but our ability to use them in better ways or to make new ones is unlimited. What makes the difference between a sensible plan for savings and a ridiculous one is whether the plan is causing us to think about creating new resources for the future. If the plan doesn't do anything to create new resources, then we're simply eating the seed corn -- using what we should be preparing for the future in order to satisfy our present-day greed.

Rather than considering the proposal as a binary yes-or-no proposition, we as taxpayers deserve a thoughtful review of the full range of possibilities.

Plan As Discussed Considerations
No Plan for Old-Age Savings Strident philosophical libertarians and others do not believe that the government has any obligation to provide a social safety net, and may in fact believe that any such form of welfare is a violation of the compact between the individual and his or her government. It may be suggested that any government plan for old-age savings is unconstitutional or otherwise unacceptable, no matter what form it takes.
Unfortunately, people are disinclined to save enough for old age. In economic terms, the socially optimal level of savings for old age is much higher than what is naturally likely for people to save. By nature, we as humans like to enjoy immediate gratification more than the uncertain level of satisfaction we may receive in the future from having saved judiciously. Having money in the bank might make us happier in 40 years, but ice cream tastes really good right now.
Keeping the Present System Some advocates are quick to argue that the present Social Security system can be kept intact for decades to come. They may or may not admit that in order to preserve present levels of benefits, the US will have to either expand the population dramatically, raise taxes to punitive levels, or cut benefits.
The present system is consumption-driven. The pay-as-you-go system now in place for financing Social Security's old-age benefit is concerned only with today's immediate needs and places little or no consideration on what the long-run consequences will be. The result is that the system does little or nothing to encourage investment in productive behavior for the future. This is eating the seed corn at its worst.

The present system is not reasonably sustainable. One of the "big three" will have to change: Either the working population will have to grow considerably, benefits will have to be cut sharply, or employment taxes will be increased painfully high. Social Security's own trustees have clearly admitted the problem; politicians and pundits arguing otherwise are either diabolical or morose.
Private Accounts with Limited Choice President Bush and others have proposed investment programs that would allow income earners to put some of their employment taxes aside into managed private savings accounts. The President and others have suggested that there would be a short list of programs and investment opportunities available, mainly within conventional Wall Street securities, like stock market index funds.
If nothing else, this kind of a plan would divert money from inefficient government spending into private investment, which by its nature has to do something productive.

Investment accountability is stronger in the private sector, when accountability is taken to mean that the funds invested are placed where they can reasonably be expected to deliver the most satisfying reward. Public investments beyond those for basic infrastructure needs are often unaccountable to the will of the public itself -- voters have very little recourse over the allocation of their tax dollars to specific purposes. Once the tax money has been raised, elected officials and bureaucrats have virtually carte blanche to do with them as they please. Private investment, to the contrary, is accountable both to those doing the investing (who usually have a lot of latitude with which to withdraw those dollars) and to those with whom it is invested (who may choose from a rather large universe of prospective options).

Private accounts would increase enfranchisement in the corporate system, offering individuals a stake in the "corporate America" that so often is criticized in political speech.

In a sense, though, private accounts with strictly limited choices for the investor lend themselves to the charge that they are a form of involuntary redistribution from taxpayers to those firms that are deemed "qualified" by the regulatory or political authorities. As with any system that involves a subjective evaluation of merit (in this case, the government's evaluation of a firm's suitability as an investment vehicle), there is a considerable hole through which influence-peddling and corruption could walk right through. Such is the risk of government stock-picking.

Offering only limited choice would have the unfortunate consequence of inflating the relative size and influence of already-large firms. If billions of dollars are moved into the capital markets but can only be invested in, for example, the S&P 500, then businesses outside that particular capital market (the non-S&P 500 companies) are punished simply for not being "big enough."

Private accounts do have a reasonable hope of delivering the necessary financial results needed to make old-age savings a viable long-run project in the U.S.; certainly they have better odds at delivering a reasonable return on investment than the fictional Social Security "trust fund."

Limiting the range of options for personal savings accounts to only large, "stable" businesses rewards bigness rather than efficiency. It's a maxim of investing that smaller firms are more volatile but offer larger prospects for long-run growth. If private accounts are invested solely in firms that are already large, that money will be invested less wisely than if it is given access to a wider range of businesses, including small firms and start-ups.

Unfortunately, a private-accounts system with limited choice has little defense against accusations of corporate welfare. It would be an ironic and unfortunate consequence if an opportunity offering great potential to the ordinary taxpayer were abused in such a way that it only further alienated belief in the American entrepreneurial ethos.
Private Accounts with Wide Choice Americans are presently allowed a wide range of investment options when using programs like Individual Retirement Accounts. Private accounts using employment taxes could be opened to a much wider range of investment options than has been proposed by some reform advocates.
Investors could spread their investment across a much wider range of firms and productive activities throughout the economy, rather than just in Wall Street firms.

Americans could expect higher rates of return from their investments than from either the conventional pay-as-you-go Social Security system or from private accounts with limited choice, since they would have access to a much more diverse range of potential investments.

There would be a higher degree of investment risk volatility -- some investments could go flat broke while others could be astronomical in performance. The degree of volatility could be too much for many Americans to comfortably stomach. Instead of adapting to a higher-risk environment, it is likely that some people would instead try to find political or legal means of enforcing some "right" to higher returns.

Widening the universe of private account choices to the full range of SEC-regulated securities would have the very fortunate benefit of improving scrutiny of investment options. The real opportunities for theft, fraud, and abuse exist when no one is paying attention. Should 2%, 4%, or even 6% of payroll income suddenly be diverted into private investment accounts, the amount of "sunlight" shining on the securities markets would increse dramatically. The popularization of a thing inevitably means marked increases in attention paid to it -- which is why privacy is impossible for the Hollywood star, even if half the country is disinterested in tabloid reporting.

Industries would be grown around the provision of investment advice to every kind of investor as well as around the capitalization of small firms -- especially those that today do not stand a fighting chance in the equity markets, but would were those markets to win access to a much larger supply of investment capital.


Ranking the Choices
In a world of philosophical purity and true individual responsibility, governments would take no part in old-age savings. But with perpetually-increasing life spans and the human instinct to provide a safety net for the poor both unavoidable facts of life, we really don't have a choice: Compulsory old-age savings programs of one flavor or another are here to stay. So the "no plan" plan is out as a viable option.

Because the present system with its pay-as-you-go design cannot be reasonably distinguished from a classic Ponzi scheme, it's mathematical foolishness to say that the present scheme can be kept intact. Thus, keeping the present system is out as well; we must look to other options.

In the end, the question really comes down to whether private accounts should be limited in order to "protect" the investing public or much wider, despite the higher risks. Realistically, it's disingenuous to suggest that the American public isn't capable of evaluating investments without government hand-holding: Half of U.S. households already own private equities. Were that a grave threat to the nation's well-being, then the dog-catchers have been sleeping while Rover's been astray.

Arguing against widespread choices for private investments is also a painfully disingenuous act by a government that is responsible for the labyrinthine Federal income tax code. It's a terrible act of either short-sightedness or impaired imagination not to see that the same entrepreneurial spirit that offers the Average Joe affordable tax advice from places like H&R Block and Jackson Hewitt could easily deliver him equally-affordable retirement-investing advice.

Opponents of private accounts often make a very serious mistake about the very concept of encouraging an environment in which individuals guide their own accounts. They loudly and wrongly proclaim that many people simply aren't sophisticated enough to invest wisely for their own retirement. Ironically, the present Social Security system already forces most Americans to handle their own investments, and the incentives are all wrong: Consequently, the very same system that is supposed to "protect" people from having to make difficult investment decisions actually forces those people to do most of their long-term investing in home equity. If Americans are smart enough in general to finance their own homes, then they should reasonably be considered smart enough to adapt to and learn the basics of financial markets. If Americans are smart enough to pay taxes, own property, and handle the rest of their investments, then why would they not be smart enough to manage their own long-term investments?

Thus, on their merits, the private-account options are the only ones to seriously evaluate. Given the advantages and disadvantages of each above, it seems logical to conclude that the bias should be in favor of wider investment choices rather than a smaller, supposedly "safer" list of options.

Risk Shouldn't Be a Bad Word
It's the same soft-headedness that irrationally seeks to protect children from every possible scratch or bruise that wants adults to be nannied right out of a fair chance to gain some kind of benefit from risk. It's axiomatic to the principle of investing that whatever requires greater risk than the mean must also deliver proportionately higher returns. The public deserves better than to be fooled into believing in a world without investment risk. As circumstances would have it, a long-run investment category like old-age savings is ideal for the sorts of higher-risk, higher-return investments about which the prospective nannies would raise so much fear.

The smart way to approach risk is to adapt to it in ways that allow the individual to spread the chance of loss out over enough choices and enough time that even the occasional isolated disaster doesn't do murder to the long-run outcome. A large basket of small, high-risk firms held over a long period of time is a virtually certain way to do two things: Experience occasional losses from individual firms, and win great profits from the endeavor as a whole. The sirens wailing about the doom of risk are really meritless fools or liars who serve only to make us think that the "risk" involved in putting a few dollars behind a bold business venture is really that much more dangerous to our well-being than the "risk" that pioneers took a century or more ago when they crossed the plains and the mountains in horse-drawn wagons. If we don't have the stomach for at least a little bit of risk, then we really don't have our wits about us.