No Einstein

George W. Flunks Math

Now that you’re here, you might as well read this “Readme” column. But when you’re through, you should check out two new Slate features. “Foreigners” is a new column focusing on, well, you know. By dedicating one of Slate’s 597 regular features exclusively to everything in the entire universe outside the borders of the United States, we hope to refute the common charge that America’s media are parochial.

While the author of “Foreigners,” Anne Applebaum, is an American, she will be filing from Warsaw. Dispatches will appear about twice a week. Learn more about Anne by clicking to her first dispatch.

Damned Spot” is a new feature for the election season. Once a week or more, as the campaign heats up, Slate’s Jacob Weisberg and Will Saletan do a Siskel ‘n’ Ebert number on a political TV commercial. The emphasis will be on effectiveness, although lesser considerations such as aesthetics and even accuracy may also be mentioned. The ads, of course, will be available for viewing in a variety of formats. Click here for last week’s entry, and look for a new one on Thursday. 

Einstein makes an unexpected appearance in George W. Bush’s Social Security proposal: “Because of the impact of compound interest, which Albert Einstein called the most powerful force in the universe, diversified personal retirement accounts can be expected to earn nearly 6 percent after inflation—almost three times what Social Security now provides.”

Einstein was wrong, of course. The most powerful force in the universe is stupidity. Then comes political spin. Compound interest may be third.

Class, who would like to point out the error in George’s statement? That’s right: Compounding affects the amount of return but not the rate. Bush can compound 2 percent as often as he likes, but when he stops, it will still be 2 percent.

Increasing the rate of return from about 2 percent to about 6 percent is the essence of Bush’s plan to “save” Social Security. He would do this by allowing people to invest privately some fraction of what they now pay into the Social Security Trust Fund. Six or 7 percent is the historic long-term return on stocks. This is not, as Bush seems to think, guaranteed by the magic of compounding. But suppose it happens—not just on average, but for every individual participant. The numbers still don’t add up.

First, the comparison between 2 percent and 6 percent is phony. If you think of Social Security taxes as an investment and benefits as the return, it may work out to 2 percent. But that’s because current workers are paying for current retirees, not because of where what’s left over is invested. As a matter of fact, the Social Security Trust Fund, in the year ending March 31, earned $56 billion of interest on assets of about $850 billion, which is more than 6 percent. Bush presumes that all the money you put into his “diversified personal retirement accounts” gets to compound away just for you. But he doesn’t say how he’ll replace the money you’re now paying to cover current retirees.

Second, Bush promises to put the current annual Social Security surplus in a ” ‘lock box’ … to be preserved solely for Social Security—unlike the current administration, which has spent $295 billion of the Social Security surplus on other programs.” It’s hard to know what this means. The surplus currently is invested in government bonds. One of Bush’s six so-called “principles” is that “Government must not invest Social Security funds in the stock market.” So would he put it in real estate? Lotto tickets? Does he imagine literally stuffing $2 trillion cash in a safe somewhere? With the government running an overall surplus, it’s no longer even metaphorically true that the Social Security surplus is being spent on other current programs. It’s being used to finance past deficits—mostly those of President Clinton’s two Republican predecessors.

Third, Bush spends his putative privatization bonanza again and again. The first thing it must do, of course, is cover its own cost. Assume, as he does, that people may divert 2 percent of income into their private funds. That’s about one-sixth of Social Security tax revenues, or $80 billion this year. Next, the arrangement has to close the gap between what the system expects to bring in and the benefits it currently promises. Bush says that gap is $2.9 trillion. But Bush also promises to raise the effective rate of return—or, in other words, to provide a bigger payoff than current benefits. And he says his plan will allow even low-income people to “build significant wealth” that they can “pass on to their children.”

This last notion is Bush’s “compassionate conservatism” in self-parody: a government program to divert tax dollars so that every American child can inherit money from her parents. Are yacht stamps next? But if that nest egg is supposed to make up for reduced benefits, it can’t be left for the kids. And if benefits aren’t reduced while tax revenues are diverted, we’ve made the solvency problem worse, not better.

Fourth, what happens when $80 billion or more each year that used to be lent to the government is invested in the private sector instead? The government must close this $80 billion gap. It could cut spending or raise taxes, but Bush mentions nothing about that. So we must assume that the government simply borrows the $80 billion from someone else. Total government borrowing would remain the same and so would total private capital. The economy would be at best the same size as if the program didn’t exist. That means the promised bonanza for Social Security recipients must come at the expense of someone else. Who?

Answer: It is the genius who listens to the president say that government bonds are a terrible investment and stocks are a sure thing and then sells his stocks to buy government bonds. Obviously there is no such single person. But Social Security privatization schemes all do implicitly assume that for every dollar they rescue from the pit of poor returns, the market will supply another dollar eager to jump in. And that this will happen without lowering the return on stocks and raising the return on government bonds, thus defeating the point of the exercise.

Both politically and economically, then, Social Security privatization depends on the most powerful force in the universe. Not compound interest.