Brad DeLong is quoting a long explanation of the Bush Social Security plan by Matthew Yglesias
The White House says the average worker can expect a 4.6 percent real rate of return on his private account. Under explanation two, this makes borrowing the money at a 3 percent rate turn out to be a smart investment move. You get a 1.6 percent net return. Under explanation two, it’s a little hard to see why taking the private account is the right move, but the math comes out the same way, a 1.6 percent net return. Thus, having already implemented phases one and two, the private accounts are a good deal for workers. Phase two and — especially — phase one, however, are terrible deals for workers. The cuts undertaken in step two (and made necessary by phase one) are bigger than the gains you can make by starting your account.
Not that I’m in favor of the Bush plan (Anyone who’s read my earlier rants knows I’m not), but it seems to me that Yglesias is making a significant error. He’s comparing the 4.6 percent REAL return to the 3 percent interest rate. The real return takes inflation into account; the interest rate does not. If you’re going to compare these two figures, you need to either adjust the interest rate for inflation or look at the non-adjusted return on investment.
If the real return is 4.6 percent and the interest rate is 3 percent, the actual difference will be more than 1.6 percent. As many have pointed out, however, if the real return on stocks is 4.6 percent for the next 75 years, we’ll have experienced such amazing growth that the Social Security “problem” will have vanished whether we adopt the Bush plan or not.
The real problem is that Bush is advocating margin investment as a way to bring the lower income sectors into the stock market. Not a good idea. Another huge problem, which Yglesias hints at, is assuming the interest rate will remain stable at 3 percent. Not a very good assumption, given the huge increase in borrowing that will be necessary to pay for this program. Even if we do see such astonishing economic growth over the next three-quarters of a century, some people will come out in the hole. Some people will be hit with the double whammy of Bush’s Social Security cuts and the personal debt they owe to cover their private accounts. Instead of a social security program we’ll have a social lottery program.
Regardless of the state of the economy in 75 years, the Bush plan will never guarantee that everyone has a liveable benefit. Someone will lose out: in order for the average real return to be 4.6 percent, some people will have to earn much less. If, as seems likely, the economy does worse, then many more people will be left out in the cold, and the price we’ll all pay to undo the damage will be even greater.