Social Security election fantasy

Statistics and studies produced by political campaigns are notoriously unreliable. The Kerry campaign is now distributing one of the greatest whoppers of all time in regard to Social Security.

The claim is that allowing personal accounts for Social Security, as President Bush proposes, would result in $940 billion in administrative fees going to private financial management firms (read Wall Street) over the next 75 years. This figure was concocted for John Kerry by Professor Austan Goolsbee of the University of Chicago.

But to reach this conclusion, the good professor assumed the administrative fees for the personal accounts would run 0.8 percent yearly, or 80 basis points. This is a gross overstatement of the administrative costs for efficiently structured personal accounts, becoming particularly absurd as the accounts grow to huge levels over 75 years.

The chief actuary of Social Security, in scoring personal account reform plans, assumes an administrative fee of 25 basis points (0.25 percent) for well-structured personal accounts, such as those proposed in legislation recently introduced by Rep. Paul Ryan, Wisconsin Republican, and Sen. John Sununu, New Hampshire Republican. On this basis, Mr. Goolsbee’s calculation overstates the administrative costs more than threefold. At 25 basis points instead of 80, Mr. Goolsbee’s $940 billion becomes $312.5 billion (again over 75 years).

But even this is an overstatement. For the accounts would grow to huge levels over time, and the administrative fees as a percent of total accounts assets would decline sharply. The administrative costs for the federal employee Thrift Savings Plan, for example, are only 9 basis points. The personal accounts in the Ryan-Sununu plan would operate quite similarly to this Federal Thrift Savings Plan.

After the first five to 10 years, as the personal accounts grow over time to trillions of dollars, administrative fees would fall from the initial 25 basis points assumed by the chief actuary, to 10 points or even less. At 10 basis points, Mr. Goolsbee’s $940 billion becomes $117 billion (again over 75 years).

These administrative fees need to be put in perspective. The chief actuary projects the personal accounts proposed by Ryan-Sununu, for example, would grow to more than $7 trillion in the present value dollars used in the Goolsbee calculation. This would be money workers directly owned in individual accounts.

At standard, long-term market investment returns, workers would earn returns on those funds of $385 billion (assuming half invested in stocks and half invested in bonds). At 25 basis points, administrative fees for the year would be $17.5 billion, leaving workers with a net gain of $367.5 billion for the year.

But $17.5 billion in fees for one year is still a stupendous amount, far, far more than would be needed. At 10 basis points, the fees would be $7 billion for the year, leaving workers a year’s net gain on their $7 trillion of $378 billion.

But $7 billion for one year of fees is still huge, and even that may be more than necessary. That is why estimates of administrative fees of more than 25 basis points become so absurd as the funds grow to huge amounts over time.

Under the Ryan-Sununu bill, the federal government would retain control over the amount of administrative fees chargeable for the personal accounts. Consequently, over the long run, there is just no way those fees will be more than roughly 10 basis points, or 0.1 percent.

The best work ever done on the administrative costs of personal accounts was that of William Shipman, a former principal at State Street Global Advisers, one of the world’s largest asset management firms. Mr. Shipman used the internal pricing programs of State Street to calculate what it would charge to manage well-structured personal accounts.

Mr. Shipman found that with workers allowed to shift only about 2 percentage points of the total 12.4 percent Social Security payroll tax into the accounts, the administrative costs would start at roughly the 25 basis points assumed by the chief actuary of Social Security. But after five to 10 years, even these costs start declining sharply, ultimately to less than 10 basis points.

With larger accounts allowing a shift of 6 percentage points of the tax, similar to the accounts proposed in Ryan-Sununu, the administrative costs start out at only 7 to 12 basis points. As the accounts grow huge over time, even this declines sharply.

That is why the blather about administrative costs for personal accounts is just an overhyped campaign fairy tale.

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