I just received the following analysis of the president’s Social Security plan (at least what he’s made public so far) from a reader in New York. Unlike most of us who have been talking about this in the comments section these past few weeks, he’s got over 20 years of experience working in banking and finance, and is currently employed as a bond analyst at a major financial firm. I found his thoughts to be useful and hopefully you will too.

Let me start by opining that there is no immediate crisis. The aggregate payroll taxes deducted each month from worker salaries far exceed the aggregate monthly payments to retirees, and will continue to do so for the next 18 years or so (the official estimated “crossover” date keeps changing).

It’s true that the government currently borrows this monthly excess from the SS Trust Fund to use for other budget purposes (e.g. Iraq, etc.), but it gives Treasury bonds to the Trust Fund in exchange. Despite what some critics may argue, these are money-good … the government would never fail to repay any of its Treasury bonds.

So, after the initial 20 years … due to demographic changes (i.e. aging population) aggregate monthly payroll taxes will begin to fall short of the aggregate monthly retiree payments … but government payments on the Treasury bonds will supplement/cover the shortfall … probably for another 20 years or so. After that (i.e. around 2043) there will probably be a more significant shortfall problem … although nobody is really sure because these are such long-term forecasts and a lot can change. But, assuming there is going to be a problem, this is what Bush is now calling a crisis. In my view, the nation does face fiscal crises on several fronts (don’t get me started) … but SS is not one of them. It is a substitute or diversionary issue … akin to Iraq on the foreign policy front. It is also a relatively small issue in dollar terms than many of the other issues it is pushing out of the headlines. It truly seems ridiculous that this should be pushed as the major domestic agenda item of the United States in 2005.

Now for the Bush reform concept, which is simple. First, the future monthly benefit promise must be cut … and/or the normal retirement age (currently 67) must be pushed back further … and/or more payroll taxes must be collected now (exchanging the surpluses for more Treasury bonds). As an example, the promised monthly retirement benefit for a given worker might be cut from $2000 to $1,500. This is the only way the government eliminates future shortfalls and “fixes” SS.

Second, EVEN FURTHER cuts in promised monthly benefits will be made for workers who avail themselves of an optional “privatized” retirement account. The additional benefit cut would be sized so as to be break-even with a private account earning a compound annual investment return of CPI +3% (i.e. inflation rate + 3%). That is, the promised future retirement benefit for a worker who takes this option would be cut to, probably, less than $500. In exchange, they’d get around $2,000 a year set aside for them in their private investment account … which, if it earns CPI + 3% compounded over many years, will produce supplemental earnings that bring them back to the $1,500 level of the worker who doesn’t take the private account option. Of course, both workers are still taking a big cut from $2,000 under the current system. I’m not sure what the investment return needed to get back to $2,000 would be … but let’s just say there is significant chance that the large majority of participants will not come close. The government will probably restrict the investment options to simple index funds, so as to prevent the exploitation, but there will still be significant investment performance risk. What is the point of this complicated second step? It allows the whole deal, including the cuts, to be seductively marketed as “privatizing” SS. As if this was somehow safer or more reliable than the existing program. The “ownership society” bullshit.

Let’s assume that a lot of workers do opt for the private accounts … where does the money come from to seed these accounts with $2.000 per year? It comes from a good chunk of these workers current payroll taxes … thus reducing the excesses that the government is borrowing from the SS Trust Fund each month in exchange for Treasury bonds. As a result, the government will need to sell many more Treasury bonds (several trillion dollars worth) in the global capital market … which Greenspan just testified could be “disruptive”. In other words, the U.S. would need to finance more of its budget deficits in external capital markets as opposed to internally via the payroll tax/SS Trust Fund.

I think Greenspan was being kind. It seems pretty clear that ignoring our nation’s other fiscal problems … and simultaneously adding several trillion $ more external borrowing for this SS experiment … will not be viewed favorably by the purchasers of U.S. Treasury bonds. Our currency will likely fall in value, interest rates will go up, and taxes will rise (or gov’t services will be cut). Oh, and what about the workers who blow it with their private investment accounts … or if there is a major stock market investment meltdown that affects everyone? The gov’t will either borrow more or raise additional taxes to bail them out. This nation is not politically ready to tolerate massive poverty among its elderly citizens … that’s why we have social security to begin with.

He also suggested that we look to The Center on Budget and Policy Priorities, a well-known, non-partisan policy think-tank in Washington, for more information.