February 2005
Stock Market Dilemma:
The President’s plan for Social Security reform will allow workers to divert a portion of their payroll taxes into a private account that will be invested in stocks. The problem with this is that Social Security is a “pay-as-you-go” system. This means that the money coming into the system in the form of payroll taxes is immediately going out of the system in the form of benefit checks for current retirees. If money is taken out of the system for the purpose of investing in stocks, there will not be enough money left over to pay the promised benefits. Therefore, the government must borrow money by issuing government bonds in order to finance the conversion to private accounts. The Social Security Administration estimates that it will cost more than $2.3 trillion over a period of 75 years in order to finance Model 2 of the President’s plan.
According to the President’s Commission report entitled “Strengthening Social Security and Creating Personal Wealth for All Americans,” the stock market has had an average annual appreciation of 7% over the past 200 years. However, the past 200 years have encapsulated the formation of one of the greatest civilizations in history. It only stands to reason that stocks would have experienced an extended growth period while this civilization was being built. Not to mention that the majority of these market gains have occurred during only the last 50 years. During this time, small privately owned and individually operated companies were replaced with large national and international corporations. However, now that corporations have taken root and America is largely built up, there are not as many opportunities for continued future growth. Until America shifts its focus from being a net importer to a net exporter, stocks will prove to be a poor long-term investment when taken in context of the stock market as a whole. Therefore, historical returns have little future value.
The true problem is that for every dollar invested in a private account, another dollar must be borrowed in order to pay out the currently scheduled Social Security benefits. As of January 31, 2005, the average annual interest rate on all interest-bearing debt is 4.551%. While a private stock account may return 7% in a given year, the debt it creates will cost at least 4.551%. Since taxpayers are responsible for making the interest payments on the national debt, the real return on a privatized account will be only 2.449% if stocks continue to appreciate at an average rate of 7%. Therefore, the real return will only be the amount that exceeds the cost of the debt. It actually makes more sense to invest in the debt, because then an investor would receive guaranteed interest payments of 4.551%. A privatized stock account would need to return more than 9.102% annually in order to achieve better results than an investment in the national debt.
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