Social Security

Some proposals to restructure Social Security include individual retirement savings accounts that would either supplement or partially replace the current program's benefits. Proponents say that such accounts would substantially improve retirees' rates of return. Opponents say that the rate of return concept should not be applied to Social Security because it is a social insurance rather than an investment program. Implicit rates of return on Social Security contributions vary significantly by birth year, reflecting the program's income transfers to the first generations of retirees from subsequent generations, and by earnings level, number of dependents and survivors, and life expectancy--characteristics that vary by race and gender. Rates of return on private market assets vary substantially, depending on the risk of asset price volatility and the risk of firms' defaulting on obligations. Individuals' choice of assets in a portfolio and timing of investment decisions ultimately help determine their returns and risks. A simple comparison between rates of return for the current Social Security program and private market investments would be misleading because it would not reflect all the costs associated with a new system of individual accounts. Rates of return would be tied to the payment of unfunded liabilities; costs for managing and annuitizing the new accounts; future market investment returns, which could differ from historic averages; and differences between Social Security and market investment. Comparisons should be made instead between comprehensive return estimates for specific reform proposals that include both individual accounts and the Social Security components of the resulting system. However, this is only one criterion for comparison; other criteria that limit comparisons include the adequacy and predictability of benefits, the extent of solvency improvement, and the effect on the federal budget and national saving.

GAO noted that: (1) implicit rates of return that workers receive on their social security contributions vary significantly across a number of dimensions; (2) the variations mostly reflect several types of income transfers that the program is designed to provide as part of its social insurance function; (3) implicit returns vary by birth year, reflecting the program's income transfers to the first generations of retirees from subsequent generations; (4) implicit returns that workers receive also vary on average by their earnings level, by the number of dependents and survivors, and by their life expectancies; (5) these characteristics vary by race and gender and therefore rates of return do also; (6) rates of return on private market assets vary substantially, depending on the investment risks associated with those assets, particularly the risk of asset price volatility and the risk of firms defaulting on obligations; (7) the choice of assets in a portfolio and the timing of investment decisions ultimately help determine the returns individuals receive and the risk they bear; (8) a simple comparison between the Social Security program and market investments would not reflect all the costs associated with a new system with individual accounts; (9) in particular, the returns individuals would effectively enjoy under a new system would depend on how the unfunded liabilities of the current system would be paid off; (10) costs for both managing and annuitizing the new accounts would reduce actual retirement incomes and therefore the effective rates of return workers enjoyed; (11) future rates of return for either market investments or social security as it is currently structured could differ from their historic averages; (12) risks differ between the Social Security program and market investments; (13) instead of making simple comparisons between social security and historical market returns, one should make any rate of return comparisons among comprehensive return estimates for specific reform proposals that include both the individual accounts and the social security components of the resulting system; (14) such return estimates would accurately measure the relationship between all the contributions and benefits implied in each proposal, including both the social security and individual account components; (15) in particular, they would reflect the effect of measures taken to ensure the sustainable solvency of the system; and (16) however, such rate of return comparisons among reform proposals have some limitations of their own and address only one of several criteria on which to compare proposals.