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The Feb. 11 Social Security editorial cited actuarial projections about the effect of personal accounts but mistakenly ascribed them to President Bush's proposal. These calculations were based on a reform model developed by the president's Social Security commission in his first term and differ in magnitude from the administration's current proposal.

Mr. Bush's Personal Accounts

Friday, February 11, 2005; Page A24

WHETHER SOCIAL Security is in "crisis" or not, everyone agrees that the system faces a deficit. There is less agreement, however, on whether the personal Social Security accounts advocated by President Bush in the State of the Union speech would reduce the funding problem. The administration's critics have seized on comments in a briefing given by a senior official: "Personal accounts would have a net neutral effect on the fiscal situation of Social Security," the official conceded. Armed with such quotations, Mr. Bush's opponents accuse him of pushing an irrelevant non-solution for ideological or political reasons.

But the quotations have been taken out of context. It's true that personal accounts, by themselves, would not reduce Social Security's deficit. Mr. Bush's proposal gives workers the option of diverting part of their Social Security taxes into personal accounts; in return, workers who exercise that option accept a cut in future payments from the traditional Social Security system. This exchange is designed to be financially neutral for the government: hence the official comments. But this doesn't mean that personal accounts have no impact on Social Security's solvency. By investing partly in stocks, personal accounts would boost benefits for the average retiree -- and hence make it politically easier to take the tough steps necessary to fix the solvency problem.

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To see how this might work, consider analysis by the Social Security Administration's nonpartisan actuaries. The actuaries have worked out what would happen if, as the president suggests, individuals were allowed to divert as many as 4 percentage points of their payroll taxes into personal accounts. The average worker retiring in 2075 under these rules would have accumulated personal savings sufficient to generate a monthly pension worth half of her currently scheduled benefit. In return, she would have accepted a cut from the traditional Social Security system; under the terms announced by the administration last week, this would be worth 30 percent of her scheduled benefit. The difference -- a profit to the individual equivalent to a fifth of the scheduled benefit -- would cushion the shock of any separate benefit cut imposed to fix the solvency problem.

This profit exists because equities outperform bonds over the long term. Under the current system, payroll taxes reduce the government's borrowing requirement, so the effective "return" on Social Security savings is the government bond rate, which the Social Security actuary projects to be 3 percent above inflation. Personal accounts, by contrast, could be invested in a mix of assets; on the assumption that they were 50 percent in stocks, 30 percent in corporate bonds and 20 percent in government bonds, the Social Security actuary projects that the return after administrative costs would be 4.6 percent above inflation.

Even though these projections are produced by nonpartisan scorekeepers, the administration's critics claim that the promise of extra returns from personal accounts is somehow illusory. They argue that, if investors are rational, there can be no real "equity premium": The proposition that you can conjure up money by shifting Social Security resources into equities presupposes that the sellers of those magical equities are idiots. Yet equities are a good bet for retirement savings not because the sellers of equities are dumb but because retirement plans, which have long horizons, can absorb the volatility of equities better than most investors.

The critics also argue that mass Social Security purchases of equities will drive their prices up. So even if equities are a bargain at the outset, they soon won't be. But Social Security purchases of equities would not be big enough to trigger serious price moves in the nation's extremely deep and liquid capital markets. Goldman Sachs researchers recently noted that annual equity accumulation by personal account holders would peak at 0.6 percent of the value of the market. That modest spike in demand for equities would be swamped by potential swings in the supply. In some years over the past two decades, firms have issued new equity worth as much as 2.5 percent of the value of the market. In other years, share buybacks have reduced the supply of equity by as much as 4 percent.

In short, the equity premium is real even though its precise size is unknowable; it amounts to a strong argument in favor of personal accounts. But reform would also carry risks. It would transfer investment uncertainty to individuals, the poorest of whom may arguably be ill-placed to shoulder it. It would transfer resources out of the traditional Social Security program, which is attractively progressive. These and other pitfalls have plagued some experiments abroad. They will be the subject of our next editorial.

This is one in a series of editorials examining Social Security and its future. Others can be found at www.washingtonpost.com/opinion.

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