Friday, January 28, 2005

Right-Wing Math III: More Devils Meeting Details

by Tom Bozzo

Max Sawicky contributes to the Social Security privatization calculator debate by coming up with a ballpark figure of 9% for the above-current-market interest rates needed for the annuity calculation in the Cato Institute's private account calculator. A commenter there raises a technical issue regarding the distribution around the mean life expectancy and wonders if there might be a "reasonable" interest rate that makes the calculations work out.

Assuming some shooting-from-the-hip risk, I'll say not quite. In this case, good candidates for "reasonable" interest rates above those currently prevailing would be the rates assumed in the Social Security Trustees' projections. These range from 5.5-6 percent (nominal); see Table V.B2 in the 2004 Trustees' Report.

Earning 6% instead of the current 4.125% (the TSP annuity rate index) would not quite produce enough income to make up the difference between an indexed TSP single annuity ($46,476) and Cato's claimed maximum private benefit ($64,873) for my steady maximum earnings scenario.* So they must either be assuming a higher interest rate than is assumed in the long-range Social Security projections, or lower annuitization costs than are available through the TSP, or some combination thereof. (If someone knows more about TSP annuities, please chime in!) This is at least stretching the definition of reasonable. Things would be no better for the Heritage Foundation's calculator.

Even if your definition of reasonable is broader than mine, that you can't currently get an annuity on the terms the calculator assumes should itself sound a cautionary note.

Cato's calculator also somehow returns a somewhat smaller real Social Security benefit ($28,910) in 2035 than the $33,047 projected by the Trustees for a steady maximum earner.

Last, as Max notes, Cato excludes — explicitly, in a footnote — any allocation of transition costs, which makes the calculators' results immediately bogus. Cato's plan does set aside half of payroll taxes to cover transition costs, but that would nevertheless require some combination of large-scale borrowing (deferred taxes) or infusion of income tax revenues into the legacy system. Obviously, paying the transition bill would thoroughly dig into Cato's already rather meager privatization gruel.

* The extra 187.5 b.p. would mean $1,064/month in interest on the $681,252 PRA balance at retirement. And note, a TSP indexed joint annuity with 100% benefit to the survivor would only yield $36,528 presently.
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