Friday, January 28, 2005
Right-Wing Math II: Error Magnitudes in the Heritage Foundation Social Security Calculator
by Tom Bozzo
What problem, a Heritage fellow might ask, does any economist have with getting an additional $61,344 per year?
Nothing, I say, except that no sustainable, non-criminal enterprise would sell me such an annuity.
Under the assumptions I provided, meant to force the "Steady Maximum Earnings" scenario from the Social Security Trustees' annual report, Heritage suggests that I could have a personalized retirement account containing $972,569 at age 67. They claim that could be annuitized to a monthly benefit of $7,922, hence the $5,112 gap.
The Social Security Trustees project the maximum benefit at normal retirement age in 2035 — when I would in fact turn 67 — to be $2754, so while I have no idea why Heritage didn't use the Trustees' projected maximum benefit, the error is a minor $56 in their favor. This ends the good news for the privatizers.
The next question is whether a 67-year-old can actually buy an annuity with a $7,922/month benefit with $972,569. I turned to the federal Thrift Savings Program's annuity calculator. The TSP, which offers federal employees a short menu of extremely low-cost savings vehicles, is often held up as a model for private accounts. I assume that the TSP also insists on low costs from its annuity provider(s).
As a single 67-year-old TSP participant with $972,569 to annuitize, I could get $5,529/month with a subsequent 0-3% inflation adjustment. (The adjustment, as an Yglesias commenter notes, is not as generous as Social Security in high-inflation periods.) This drops the gap to $2,775, 54% of the Heritage calculator's result.
That's not all, though. Social Security also provides a 100% benefit to a normal retiree's surviving spouse. This is costly, as the probability that some beneficiary will live to be very old increases considerably. Indeed, the same amount only buys a $4394/month in a joint life annuity with a 100% benefit for the surviving spouse. The gap now falls to $1,640, just 32% of the Heritage estimate.
While the 3% real Treasury yield assumed by Heritage is consistent with the Trustees' assumed yield on the Trust Fund assets in the intermediate Social Security scenario, you can't actually earn a 3% real yield on Treasuries now. (The 10-year note currently has a real yield of a whopping 0.9% over 2004 CPI-U inflation, and truly whopping interest rate risk under current conditions.)
Knock 80 basis points off the real return and the private account gap is roughly halved again, to $805, since there's 19% less to annuitize. Now I'd just be getting another $9,660 per year, and haven't adjusted anything for risk or privately provided for additional features of real Social Security such as pre-retirement survivor's benefits. That, I can forego.
At this point, if I were what Heritage considers an average earner*, I'd actually be $249/month ahead with traditional Social Security.
If you've gotten this far, you may see part of the problem. Introducing reality rapidly decreases the attractiveness of privatization, but you have to wade through annuity arcana and economic assumptions to get there. The sly marketers at the right-wing think tanks are probably betting that the whopping projected private account balances will light up dollar signs in viewers' eyes such that they'll forget about the rest.
* Heritage assumes the average 37-year-old male earns 156% of the Social Security average wage index.
In the previous post, I ridiculed the Heritage Foundation for running a calculator that suggests I could have another $5,112 per month (2004 dollars) in retirement if only I had a private account, stuffed with the Old Age and Survivors component of my Social Security Tax payments and invested in Treasury IOUs under Heritage's assumptions. This is above the $2,810 I would expect from Social Security and its Treasury IOUs.
What problem, a Heritage fellow might ask, does any economist have with getting an additional $61,344 per year?
Nothing, I say, except that no sustainable, non-criminal enterprise would sell me such an annuity.
Under the assumptions I provided, meant to force the "Steady Maximum Earnings" scenario from the Social Security Trustees' annual report, Heritage suggests that I could have a personalized retirement account containing $972,569 at age 67. They claim that could be annuitized to a monthly benefit of $7,922, hence the $5,112 gap.
The Social Security Trustees project the maximum benefit at normal retirement age in 2035 — when I would in fact turn 67 — to be $2754, so while I have no idea why Heritage didn't use the Trustees' projected maximum benefit, the error is a minor $56 in their favor. This ends the good news for the privatizers.
The next question is whether a 67-year-old can actually buy an annuity with a $7,922/month benefit with $972,569. I turned to the federal Thrift Savings Program's annuity calculator. The TSP, which offers federal employees a short menu of extremely low-cost savings vehicles, is often held up as a model for private accounts. I assume that the TSP also insists on low costs from its annuity provider(s).
As a single 67-year-old TSP participant with $972,569 to annuitize, I could get $5,529/month with a subsequent 0-3% inflation adjustment. (The adjustment, as an Yglesias commenter notes, is not as generous as Social Security in high-inflation periods.) This drops the gap to $2,775, 54% of the Heritage calculator's result.
That's not all, though. Social Security also provides a 100% benefit to a normal retiree's surviving spouse. This is costly, as the probability that some beneficiary will live to be very old increases considerably. Indeed, the same amount only buys a $4394/month in a joint life annuity with a 100% benefit for the surviving spouse. The gap now falls to $1,640, just 32% of the Heritage estimate.
While the 3% real Treasury yield assumed by Heritage is consistent with the Trustees' assumed yield on the Trust Fund assets in the intermediate Social Security scenario, you can't actually earn a 3% real yield on Treasuries now. (The 10-year note currently has a real yield of a whopping 0.9% over 2004 CPI-U inflation, and truly whopping interest rate risk under current conditions.)
Knock 80 basis points off the real return and the private account gap is roughly halved again, to $805, since there's 19% less to annuitize. Now I'd just be getting another $9,660 per year, and haven't adjusted anything for risk or privately provided for additional features of real Social Security such as pre-retirement survivor's benefits. That, I can forego.
At this point, if I were what Heritage considers an average earner*, I'd actually be $249/month ahead with traditional Social Security.
If you've gotten this far, you may see part of the problem. Introducing reality rapidly decreases the attractiveness of privatization, but you have to wade through annuity arcana and economic assumptions to get there. The sly marketers at the right-wing think tanks are probably betting that the whopping projected private account balances will light up dollar signs in viewers' eyes such that they'll forget about the rest.
* Heritage assumes the average 37-year-old male earns 156% of the Social Security average wage index.
