Social Security Worth It?
by Jeffrey Folks
Issue 213– October 10, 2012
Increasingly, liberals speak of government spending as “investment,” so it is fitting to evaluate the largest of these so-called investments against a private investment benchmark. How well has government invested the funds paid into the Social Security Trust Fund over the past half century? How does the return on these funds compare to what would have been earned in the private market? At a time when President Obama is pushing for ever greater “investment” in everything from socialized medicine to plug-in vehicles, this analysis is particularly relevant.
The Social Security Administration reports monthly on what it earns on new investment in so-called “special issues,” going back as far as 1937. Any discussion of what Social Security earns on its investments depends not only on the starting point that one selects, necessary for calculating the actual return for individual recipients, but also on what those investments have earned relative to inflation. In 2011, for example, the numeric average return on funds invested was 2.417%, or .783% below that year’s CPI-U inflation rate of 3.2%. In 2008, funds earned an average of 3.365% versus inflation of 3.8%. In other years, such as 2002, new investment earned more than inflation (4.865% versus 1.6%). The average return of funds invested by current recipients has been estimated to be somewhere between zero and one percent above inflation.
Another problem in evaluating the program is the cost of administration (currently .9% of funds invested). While that may seem small, it is far greater than the expense ratio of private bond and equity index funds (as little as .06% for one well-known total stock market ETF). Nor does the .9% figure include the much greater cost to the taxpayer of collecting payroll taxes and other revenues that will be required for government to repay the Trust Fund over the next 75 years as the Social Security program operates in deficit.
Supporters of traditional Social Security point out that the fund’s return is based on “risk free” investment in “special issue” government obligations. One can only answer that government special issues are not risk-free. They represent an intra-governmental promise of repayment that can be negated at any time either by unwillingness or inability to fund repayment of Trust Fund obligations. According to CBO, Social Security is expected to run a $797 billion deficit in 2020. Will the American public continue to fully fund a program that runs annual deficits of that magnitude, requiring vast transfers of wealth from working adults to retirees?
Investment in the private sector, while it certainly involves risk, cannot be negated by the failure of future generations to support the program, that is, unless Congress actually decides to seize privately held retirement accounts. That is conceivable but politically challenging.
Private sector investment does of course involve considerable market risk. At any time, investments in stocks, bonds, and other private securities will fluctuate in value. At the very time when one wishes to withdraw funds for retirement, the market may decline. Between 1930 and 1932, for example, the cumulative loss for a 60/40 allocation of U.S. equities and bonds totaled 30.2% over the three-year period–the worst such period in market history. But wise investors do not withdraw funds during a market decline, and presumably retirees, having watched their funds fluctuate over decades, would not do so. Had those unfortunate Great Depression retirees held their stocks and bonds following the market crash of 1929, they would have seen them flourish. The long-term annualized return of those funds (60% U.S. equities, 40% U.S. bonds) invested between 1929 and the present has been approximately 8%.
Not surprisingly, private sector investment over the past 50 years—and, indeed, over the past 200 years—has offered a real return that historically has far surpassed the 1% (at best) delivered by Social Security. Over a lifetime, an annual investment of $10,000 compounded at 8% would build a retirement nest egg of $6,609,770. And the return of an actual, well-managed balanced portfolio since 1970 would have done significantly better. An all-stock index fund would have done better yet, though with greater volatility. Since August 1976, the Vanguard 500 Index fund has returned 10.55% after expenses (as of 9/14/2012).
There are many careful savers who have actually reaped rewards of this magnitude. If ordinary Americans had been allowed to invest their Social Security funds in similar index funds, they would have accumulated much more than they can expect to receive from the government. Even those with modest lifetime incomes averaging $40,000, paying in $5,000 per year for 40 years with a return of 8%, would accumulate a nominal $4,344,000, or $2,294,000 in inflation adjusted dollars. Not a bad retirement nest egg, especially when compared to the maximum full retirement age benefit of $30,156 allowed by Social Security in 2012.
The above discussion has an important bearing on the debate taking place in the current presidential election over the effectiveness of government versus private sector investment. A comparison of investment return on the part of the Social Security Administration with what that investment would have earned if invested privately demonstrates the ineptness of government allocation of capital. Similar analyses have revealed the ineffectiveness of government investment in health care, education, public housing, job training, energy (Solyndra), transportation (high-speed rail), and other sectors. A fully privatized economy free of unnecessary regulation would raise the living standards of all Americans. A move toward greater government “investment” and increased regulation will only continue to deliver disappointing results.
Jeffrey Folks is the author of many books and articles on American culture including Heartland of the Imagination(2011).