Monday, July 25, 2005

The Galveston Plan is too risky

Are private retirement accounts such as those in the Galveston Plan really superior to the existing Social Security system?

According to Michael Hiltzik, writing in Kevin Drum's Political Animal, the next propaganda push for private accounts by the Bush administration will focus on the benefits provided by the "Galveston Plan." His discussion, based in part on a study of the Galveston Plan by a researcher from the Wharton School of Management provides examples of the trade-offs for both the individual and for society if private accounts are used to replace the Social Security system.

Under an older law that no longer exists, Galveston in 1979 replaced Social Security with private investment accounts. This is a plan established under section 403(b)of the IRS code. In 1999 a researcher from the Wharton School of Business compared the Galveston Plan to Social Security. Key points from the Wharton study (PDF file) are:

  • The Galveston Plan offers higher initial benefits than Social Security offers to individual workers who paid contributions on higher earnings. The benefit is not likely to be so good for workers who have dependents who qualify for benefits under Social Security.
  • Workers with lower earnings will generally get higher initial benefits under Social Security than under the Galveston Plan. Also, as indicated above, retirees with dependents who qualify for Social Security benefits generally get higher benefits under Social Security.
  • The worker has to pay higher contributions under the Galveston Plan than under Social Security.
  • There are no spousal or dependent benefits under the Galveston Plan.
  • A worker who has lower earnings or has dependents (such as a spouse or children) who would qualify under Social Security tends to get lower benefits under the Galveston Plan than under Social Security.
  • Benefits are not adjusted for inflation. The individual worker may get higher initial benefits under the Galveston Plan, but they lose value relative to Social Security over time. This would be especially bad in periods of inflation. The inflation indexing of Social Security was added during the period of high inflation in the 1970's and would have to be added to the private accounts in a similar period.
  • Unlike many other 403(b) plans, The Galveston Plan does not have a waiting period for coverage. Coverage begins the first pay period of employment. Many other 403(b) plans do not provide coverage until an employee has worked for the company for a year.
  • The Galveston Plan offers more pay-out options than Social Security does. Social Security offers only a life-time annuity. The Galveston Plan offers payment in a lump-sum or various annuities lasting different periods of time. - The risk is that the beneficiary can outlive the benefits under the lump-sum or certain fixed annuity payout options. [Note: this is the cost of taking higher risk. You give up the guaranteed life-time benefits offered under the current Social Security system, and there will be losers that society has to deal with.]
  • Benefits are paid to a named beneficiary. While this may give greater control to the worker, it will leave out some spouses/divorced spouses or dependent children. These people will have to be otherwise provided for by society. The price of the greater control given to the worker is higher cost to society overall. This is cost-shifting in order to provide winners and losers at the whim of the worker.

The Social Security system is a plan to provide a guaranteed floor of income to workers (and their dependents) who lose income through retirement or disability. It is also a planned and budgeted system that keeps those people covered under Social Security from being thrown onto the welfare rolls or becoming burdens to their families to the detriment of the children those families are also trying to support. As such, Social Security is a system that provides benefits to both individuals and to society overall.

The Galveston Plan provides greater choice and potentially greater benefits for some workers. That flexibility costs significantly more while it also adds to the risk the worker is taking on. Some of the risks include loss in investments, loss due to inflation, and outliving benefits.

The Galveston Plan also creates new classes of people who are not covered, some of whom will be thrown onto welfare rolls. These include dependents such as spouses and children as well as people who outlive their benefits and people who take higher initial benefits which are cut down by inflation. These additional social costs are not discussed by the Bush administration, but they need to be considered against the apparent possible (but not guaranteed) benefits of private accounts. The people who benefit will the the same people who already are financially able to supplement their Social Security benefits with other retirement plans and with rent and investment income. This is a bad social trade-off.

Private accounts similar to the Galveston Plan will eliminate the social safety net. By doing so, it will create new classes of poor people. The numbers of the people reduced to poverty will be significantly greater than those made more wealthy. A few people will get to drive better cars and live in larger homes -- at the cost of a greater number of people who have no homes and no cars at all. This is the equivalent of abandoning a social safety net for a lottery.

When making a cost/benefit analysis of replacing Social Security with private accounts, the alleged benefit has to also be looked at carefully. Michael Hiltzik makes the following very important point:

The Galveston gang's claim of a rate of return superior to Social Security's also needs a caveat. The figure is pumped up because Galveston doesn't provide benefits that are routinely provided under Social Security, but aren't normally calculated as part of its return to individual retirees.
In other words, the benefits of the Galveston plan are not as good as alleged. Compare this to the costs to society and to the impoverishment of the many individuals that are being ignored by the Bush administration propaganda.

The added burden of private accounts on society will make society overall less wealthy. Even most of the wealthy will suffer in the long run. This is a really bad trade-off.

The following sources provide further information.
  • Does Galveston Offer a Model for Social Security Reform? The Center on Budget and Policy Priorities looks at the negative aspects of the Galveston plan.
  • No Plan is an Island A description of the Galveston Plan from the Christian Science Monitor.
  • Pensions and Penury: The Galveston experiment Prepares to go National. An article from the Guardian on the Galveston experiment. It overlooks the many negatives which the Wharton study referred to above takes into account.
  • Galveston County: A model for Social Security Reform. This is an article by Judge Ray Holbrook. Judge Holbrook was the Galveston County chief from 1967 until 1995, so he is the person who chose the 403(b) system and replaced Social Security with it. It is probably the single most significant decision he made as Galveston County Judge, so his objectivity is nonexistent. He is also not an expert on retirement systems or on Social Security.

    In addition, Judge Holbrook's sole focus is on the success of the plan for (some) workers. He does not consider the requirements of the Social Security system to overall society at all. There is no reason for him to have looked at a such considerations in creating and implementing the plan for the 5,000 workers of Galveston County, nor is there any indication he has the training required to make such judgements for society. Judge Holbrook is very much an amateur in the area of pension planning and social security systems.


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