Economics With A Face

All the money you receive is going to have to come from future taxpayers, and unfortunately there won't be enough of them to pay the governments obligations when the bill is due. Right now the federal government has promised to pay out $72 trillion more than it expects to take in from future tax revenue. The article continues:

Kerry pointed to a study by Austan Goolsbee, a University of Chicago business professor, who studied a model that proposes workers set aside a small percentage of their pay in private accounts as a method to adjust Social Security to a rapidly graying population.

Goolsbee concluded that fees charged by financial companies could reap them hundreds of billions of dollars and eat 20 percent of the benefits in an account held by a worker making an average salary.

Here is Goolsbee's CV and I'd be interested in taking a look at the study once I find it. Will financial companies "reap" hundreds of billions of dollars over the next century if workers have the option to put part their money in private accounts? I think the appropriate term would be earn. There is no doubt that financial companies have earned billions due to the advent of IRAs and 401Ks. But they earn billions precisely because they deliver trillions of dollars in value to their customers. The average fee of a mutual fund is around 1% of assets under management. If companies were charging more than that you could always switch to another fund or even put it in your local bank.

The Social Security system is not only broken but it's a fraud. Kerry's ranting may "reap" him votes among senior citizens in Florida, but if these tactics do put him in the White House, he will need to start dealing with the facts of this crisis instead of playing on voters' emotions.

Update: Here is the Goolsbee report referenced by Kerry.

Glancing through it the analysis looks pretty weak.

With regards to fees eating up 20% of retirement benefits here is the text from the report:

In each year, the real rate of return pre-expenses is 4.9 percent, so the net yield is 4.6 percent with 30 basis points of expenses, 4.1 percent with 8- basis points and 3.8 percent with 110 basis points. The calculation is done for a worker who starts earning at age 21 and retires at age 65 and is compounded annually. The results show reductions of less than 10 percent in the 30 basis point scenario and 20 to 26 percent with the higher fees. This compares to the results in Congressional Budget Office (2004) and Government Accountability Office (1999) that expense ratios around 100 basis points would reduce account values by more than 20 percent.

So the fees knock down the real return from 4.9% to between 4.6% to 3.8%. Clearly the investor would prefer to get the full 4.9% but do you expect the people investing your money to work for free?!?! There is a reason you would agree to these fees and voluntarily opt into the private accounts: you get a higher real return even with the fees.

Here are some number from the NCPA: low income workers can expect a 2.6% real return from the current Social Security System, median income workers can expect a 1.8% real return, while high income workers can expect a 0.03% return.

So take your pick, 1) a minimum real return of 3.8% paying fees or 2) a maximum real return of 2.6% without fees. Tough choice.

It also should be mentioned that a 4.9% real return is a very conservative estimate. Fees are fixed no matter the real return on your portfolio. So if you were able to get a 8%, 9% or 10%+ return the fees would be much smaller relative to your capital gains.

Goolsbee's report also states:

The collapse of the financial sector from the end of the bubble during 2000-2002 reduced revenues by $117 billion. The increase in revenue from the individual accounts would have a positive net present value more than 8 times larger than this collapse.

Come on!!! Comparing a three year loss to a future income stream over a 75 year time period! This is apples and oranges.