On June 18, 2007 an article titled "What If Social Security Were Completely Scrapped?" was posted on the Ludwig von Mises Institute web site. It was written by D.W. MacKenzie who teaches economics at SUNY Plattsburgh. Referring to Social Security, MacKenzie states that "Opposition to authentic privatization, which means elimination of the program, derives from a combination of faulty reasoning and collectivist ideology". Addressing one of these examples of "faulty reasoning" he states:
The idea that ordinary people save too little to fund their retirement is unfounded. Several recent studies indicate that most people make adequate provisions for their retirements, and some supposedly save too much. Economists Paul Smith, Lucy McNair, and David Love have found that 88 percent of all households with breadwinners over age 51 have accumulated enough assets to avoid poverty in their retirement. Of course, 12 percent of these people are risking poverty in their retirement, but the vast majority of people appear to be acting in a personally responsible manner, and the motives and aims of the remaining 12 percent are not clear. Some of these 12 percent may be shortsighted and irresponsible, but others may intend to work late in life, or may not have particularly high life expectancy. Also, some of these 12 percent may have had unexpected expenses that impinged upon their savings plans. In any case, the idea that people generally cannot be trusted to save their own money is not generally true.
The study is titled "Is There a Savings Crisis? Measuring the Adequacy of Household Retirement Wealth" and can be found at http://www.albany.edu/econ/Research/fall06/1027.pdf. The following excerpt is from page 4 of the study:
Our definition of comprehensive wealth begins with the usual categories of stocks, bonds, savings, retirement plans, businesses, housing, and real estate. We then add broader categories, such as the actuarial present values of Social Security, defined benefit plans, annuities, insurance, welfare, and, for current workers, future wages and other compensation. These present-value sources of wealth are often excluded from studies of household wealth, even though they are a central component of retirement resources. And indeed, our results indicate that a substantial portion of comprehensive wealth, particularly among the less wealthy, is accounted for by these broader wealth categories—for example, combined Social Security and DB wealth account for about 30 percent of comprehensive wealth, on average, and about 60 percent among the least-wealthy households.
Hence, the study of retirement wealth includes Social Security, the very program that MacKenzie wants to scrap. Rereading his description of the study above, however, a reader would be unlikely to guess this pertinent fact. In any case, MacKenzie goes on to describe another study:
John Karl Scholz, Ananth Seshadri, and Surachai Kitatrakhun published a study in the Journal of Political Economy, which found more than 80 percent of households headed by Americans born between 1931 and 1941 have accumulated their optimal wealth targets for retirement. Once again, most people have acted rationally in their own interests.
This study is titled "Are Americans Saving 'Optimally' for Retirement?" and can be found at http://www.ssc.wisc.edu/~scholz/Research/Optimality.pdf. The opening sentence of the study is "We solve each household’s optimal saving decisions using a life cycle model that incorporates uncertain lifetimes, uninsurable earnings and medical expenses, progressive taxation, government transfers, and pension and social security benefits". Hence, this study is likewise including Social Security benefits and, once again, MacKenzie makes no mention of this fact.
MacKenzie goes on to mention studies by economist Lawrence Kotlikoff and Ty Bernicke. In fact, the first four studies mentioned in MacKenzie's June 18th article are the exact same four studies mentioned in an article titled "Rethinking Retirement Savings (or Not)" by Laura Rowley that was posted at http://finance.yahoo.com/expert/article/moneyhappy/24438 on February 15, 2007. Since MacKenzie does not mention this article, it's unclear if he used it as reference material. In any case, he would have arguably done well to include some cautionary words such as the following excerpt from the Rowley article:
But before you trade in your 401(k) contribution for a whirlwind vacation, consider a few problematic factors. First, don't confuse "optimal" wealth accumulation with opulence. Some people have enough to retire on only because they've had very low incomes throughout their lives, and Social Security replaces a sizeable chunk of their earnings. About one-third of retired workers depend on Social Security for 90 percent or more of their income.
For example, Scholz found that in the generation he studied, householders with the lowest lifetime earnings had an average of 4.6 children. "Suppose you have five children. When the kids are in the house, they're eating all of your resources," Scholz says. "Once the kids are out of the house and you adjust the consumption needs of the remaining couple, their optimal wealth accumulation is next to nothing. Social Security is replacing 60 percent of income. This rosy language of ‘optimal' still may mean people have austere standards of living in retirement."
In addition, Scholz's study examined people born between 1931 and 1941 -- a demographic group greatly influenced by the lessons of the Great Depression. One could argue that the event would inspire them to save more prodigiously than the baby boomers born between 1946 and 1964.
Moreover, if 88 percent of people over age 51 have saved enough to retire, as Smith, McNair, and Love's study indicates, why are so many people in their 70s getting up and going to work every day? The percentage of men age 70 to 74 who are still in the workforce has risen five percentage points over the last decade to more than 20 percent, according to an analysis by the Population Reference Bureau. Of that group, more than half were working full-time.
Later in the article, MacKenzie talks about economist Alice Rivlin. Following is an excerpt:
Rivlin favors Social Security as a redistributive scheme. As such, Rivlin has deviated from value-free economic analysis, and is instead offering value judgments. In other words, she is not speaking as an economist, but is making a political statement.
While her opinions will surely offend those who value individual liberty, Rivlin is flatly wrong about the redistributive affects of Social Security. As a leftist, Rivlin obviously wishes to redistribute from rich to poor. Social Security does not do this. The rate of return that anyone gets from Social Security depends upon life expectancy. People with higher incomes tend to live longer than those with low incomes. Consequently, Social Security tends to transfer income from poor to rich.
It is MacKenzie who is "flatly wrong". It is true that life expectancy is a factor in the rate of return. But, once again, MacKenzie commits the sin of omission by failing to mention any of the other factors, many of which counteract the life expectancy factor. For example, the article at http://assets.aarp.org/rgcenter/econ/fs59r_ssbenefit.pdf describes the Social Security benefit formula. It describes how the PIA (Primary Insurance Amount) is equal to 90% of the first $606 of AIME (Average Indexed Monthly Earnings) plus 32% of the AIME over $606 and through $3,653 plus 15% of the AIME over $3,653. It goes on to state that "By applying the 90 percent, 32 percent, and 15 percent rates or “weights” to the AIME, the benefit formula ensures that low-wage workers will receive proportionately more from their Social Security contributions than average- or high-wage earners". The percentages remain the same from year to year but the "bend points" change. According to the 2007 OASDI Trustees Report, the bend points are now at $680 and $4,100.
The progressivity in the OASDI benefit formulas can be seen in the graphs at this link. These show the OASDI Internal Rate of Return by Earnings Level for various groups. As can be seen, lower-wage earners have a higher rate of return than higher-wage earners for all groups. This is likewise the conclusion of a study titled "How Effective is Redistribution Under the Social Security Benefit Formula?". An abstract and links to the study can be found at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=216672. It states:
This paper uses earnings histories obtained from the Social Security Administration and linked to the survey responses for participants in the Health and Retirement Study to investigate redistribution under the current social security benefit formula. We find that as advertised, at the level of the individual respondent, the benefit formula is progressive. When individuals are arrayed by indexed lifetime earnings, own benefits are significantly redistributed from those with high lifetime earnings to those with low lifetime earnings.
Toward the end of the article, MacKenzie addresses the return from Social Security stating the following:
Yet Social Security is an odd type of Ponzi scheme. In the original Ponzi scheme, those who got in early enough made a high rate of return. Older Americans can expect only about a 2–2½ percent rate of return if they reach their life expectancy. This is below the minimum of 3–10 percent rate of return that Mr. Weller tells us we can expect from the stock market. In other words, we all lose from the Social Security system.
The graphs at this link do show that, everything else being equal, earlier retirees tend to receive better returns than later retirees. However, they also show that MacKenzie's "2–2½ percent rate of return" for "Older Americans" is greatly at odds with the rates released by the Social Security Administration. They show that retirees born in 1920 received from 2.26 to 9.04 real rate of return. The only group that received returns in the range given by MacKenzie were single males who earned the maximum wage taxable by Social Security. In addition, it is important to note that this is the "real" rate of return, that is the return after subtracting inflation. Finally, MacKenzie's comment about "if they reach their life expectancy" is misleading. The rates of return given by the Social Security Administration include all retirees, regardless of whether of not they reach their life expectancy. Those who do surpass their life expectancy tend to receive more than the stated average and those who fall short of their life expectancy tend to receive less.
Social Security does have problems and is arguably in need of reform. However, the way to fix those problems and achieve that reform is surely not via the type of misstatements and flawed conclusions that inhabit MacKenzie's article. Hopefully, he will check his statements and conclusions and correct those that are most obviously flawed.