POZEN SCHEME:

Pozen's Social Security fix sparks buzz: Plan would combine investment accounts, selective benefit cuts (Charles Stein, March 17, 2005, Boston Globe)

Robert Pozen rose to the top echelons of Fidelity Investments, taught law at Harvard, served in Governor Mitt Romney's cabinet, and currently runs one of the nation's oldest mutual-fund companies.

Yesterday, he finally got his 15 minutes of fame.

At a press conference, President Bush spoke favorably about a plan Pozen has been pushing to fix the Social Security system.

''There are some interesting ideas out there," said Bush, in response to a question about Social Security reform. ''One of the interesting ideas was by this fellow by the -- a Democrat economist named of Pozen. He came to visit the White House. He didn't see me, but came and tossed some interesting ideas out, talking about making sure the system was progressive."

Pozen is actually a lawyer, not an economist, but he is a Democrat. Republicans who like what he has to say are hoping his ideas could form the basis of a bipartisan compromise. Pozen's plan combines small private investment accounts with benefit cuts that protect low-income workers.

The route to real pensions reform: Progressive indexing of retirement benefits by wage level is the key to Social Security reform (Robert Pozen, Jan 6th 2005, The Economist)

In a viable legislative package, personal retirement accounts supply the political sweetener that allows the passage of benefit reform, which reduces Social Security's long-term deficit. That leaves a crucial question: What type of benefit reform?

One logical answer would be to increase the normal retirement age since Americans, on average, will draw Social Security benefits for more years. The normal retirement age is already slated to rise to 66 by 2011 and to 67 by 2027. It could be extended gradually to 70 by 2057. But such an extension would face three practical challenges. First, many senior citizens already have difficulties finding full-time employment. Second, most elderly Americans want to retire earlier rather than later. Third, low-wage workers tend to hold jobs requiring a relatively high degree of physical labour, so they may be physically incapable of working in the jobs available to them over age 67.

A second answer would be to move completely from wage to price indexing in calculating initial Social Security benefits. Price indexing means increasing retirement benefits in line with consumer prices, in order to protect the purchasing power of such benefits. Wage indexing means increasing retirement benefits in line with wages, in order to preserve the portion of wages replaced by benefits. After retirement, Social Security benefits are already indexed to prices through annual cost-of-living adjustments. But at the time of retirement, workers' initial benefits are set by adjusting their average career earnings upwards by average wage growth over their careers.

It was reported this week that the White House is likely to propose a shift from wage to price indexing of initial benefits. Using wage indexing instead of price indexing in computing initial benefits has a tremendous financial impact on Social Security, since wages have, on average, risen more than a percentage point per year faster than prices. If Congress today switched from wage to price indexing of initial benefits, this alone would eliminate the 75-year deficit of Social Security. So why don't we make the switch? Because it would have a devastating impact on low-wage earners who depend almost entirely on Social Security for retirement income.

The third and best answer is progressive indexing. This means the continuation of wage indexing for all workers with average career earnings of $25,000 or less. It also means not touching the benefit formulas of anyone already in or near retirement (workers aged over 55 today). Conversely, the initial benefits of all workers with average career earnings above $113,000 retiring after 2011 would be increased by price indexing. Almost all these workers receive significant amounts of retirement income from company plans and other savings vehicles in addition to Social Security. The initial benefits of workers falling between these two groups would be increased by a proportional blend of wage and price indexing. [...]

[C]ongress should offer all workers the chance to offset most of this slower growth in traditional benefits by allowing them to invest two percentage points out of the 12.4% in payroll taxes they pay on all wages up to an annual maximum ($90,000 in 2005 and rising yearly). This money would be invested in a standard balanced account, with 60% of assets in a broad-based American stock index, such as the Wilshire 5000, and 40% in a high-quality bond index, such as the Lehman Aggregate Bond index.

According to the chief actuary of Social Security, the standard balanced investment account is expected to produce an annual real return averaging over 4.9% per year after expenses—significantly higher than the returns in the current system or from Treasury bonds. Participating workers would receive retirement income from their personal accounts as well as traditional Social Security benefits. Accordingly, the traditional benefits of these workers would be lowered by the total amounts allocated to their accounts plus interest.

This combination of progressive indexing and balanced accounts would cut the long-term deficit of Social Security by half, from a present value of $3.8 trillion to $1.9 trillion over the next 75 years.

the President's dirty secret here is that he wants to do a more progressive plan than the GOP would go for, but needs Democrats to force him to. So far they've been remarkably disciplined in shutting their eyes to the whole topic.

MORE:
The Right Questions on Social Security: A Democrat's Practical, Compassionate Plan (Ruth Marcus, March 9, 2005, Washington Post)

Pozen is a registered Democrat who served on President Bush's Social Security commission and worked for a year, unpaid, as the chief economic adviser to the Republican governor of Massachusetts, Mitt Romney. He is a former vice chairman of Fidelity Investments Inc., the country's largest mutual fund firm, and is now chairman of MFS Investment Management, which runs mutual funds. But surprisingly for someone from the industry, he doesn't see personal Social Security accounts as an end in themselves -- "I'm not a big believer in the ownership society," he says -- but as a "sweetener" to pave the political way for other, more painful changes to the program.

Most of all, he approaches the Social Security debate asking the right questions: What can be done to put the system on a more solvent footing, and how can that be accomplished in a way that reflects the differing roles that Social Security plays among different income groups? Specifically, the one-fifth of Americans for whom Social Security is the sole source of income ought to be treated differently from those for whom Social Security benefits are merely the icing on a retirement cake composed mostly of savings and pensions.

Thus, in striving for solvency, Pozen is reluctant to raise the retirement age beyond the current plan, under which it will rise gradually to 67 by 2027. Although life expectancy is increasing, he notes, raising the retirement age would hurt those who engage in manual labor (and who tend to be among the lower earners) and who, age discrimination laws notwithstanding, may have a hard time shifting into less physically demanding jobs later in life. Similarly, he is wary of simply hiking the ceiling on the amount of earnings subject to Social Security taxation: Why, he asks, should those making between $90,000 (the current cap) and, say, $140,000 be hit with what amounts to a 12.4 percent extra tax on their earnings?

It's tempting to describe the Pozen approach as Bush Lite, because it shares many characteristics of the president's preferred model, though that will surely damn it among Democrats. Perhaps a better phrase would be Bush Smart: Pozen's plan is less radical and more compassionate than the president's. It would let workers put 2 percentage points of the money they pay toward Social Security into private accounts, half of what the president proposes, and protect the benefits of those who need them most.

The personal accounts are supposed to be the "sweetener," though in the current political climate they may have a more bitter effect. But Pozen, brandishing a spreadsheet that shows historical returns from the 60-40 blend of stocks and bonds he proposes, views them as a reasonably safe bet. His argument against the alternative -- having the government take advantage of the equity premium by investing in the market itself -- does not show the usual mystical attachment to personal ownership or abhorrence of government influence over the markets. Rather, he expresses the pragmatic fear that pressure to eschew certain politically incorrect stocks and invest in others would yield diminished returns.

The medicine is something called "progressive indexing," which would change the formula for calculating benefits in a way that shields those at the bottom, strikes a balance for those in the middle and takes the biggest bite out of the benefits of those best able to afford it. Currently, Social Security benefits rise along with the growth in real wages, which is fair in that it allows those who have retired to enjoy the same growth in living standards enjoyed by other Americans, rather than being pushed back to a far lower level. But it is also enormously costly. Shifting entirely from wage indexing to price indexing -- setting initial benefit levels not by the rise in real wages over the retiree's working life but by the increase in the cost of living -- would more than erase the entire $3.7 trillion shortfall that is projected in Social Security over the next 75 years. But benefits for all retirees would fall far below the level currently promised. Pozen would maintain wage indexing for those earning $25,000 or less (about 30 percent of workers), have a blend of both formulas for those in the middle, and switch entirely to price indexing for those earning above $113,000 -- an approach that, by itself, would cut the projected shortfall by two-thirds.

Posted by Orrin Judd at March 17, 2005 12:19 PM