Last week, Felix Salmon wrote a post on SB 1234, a bill before the California state legislature that would create a Golden State Retirement Savings Trust:
The point here is that the state of California itself is a good employer, providing retirement benefits to its employees. But not all Californian employers do likewise, and many Californians, especially those on low wages, have no retirement savings at all.
SB 1234 would change that, by asking employers to place 3% of their employees’ paychecks into the Golden State Retirement Savings Trust. This would be an opt-out scheme: if you didn’t want to take part, you wouldn’t have to, but the default would be that you would. The money would be invested conservatively; one detailed paper reckons that the mix might be 47% Treasuries, split equally between bills, notes, and bonds; 43% in the S&P 500; 7% in small-cap stocks; and 3% in corporate bonds.
Felix flags a number of potential problems, or “distractions,” e.g., the state government would have to guarantee modest returns (in the neighborhood of 0% to 2%) and whether or not the money will be invested well. But he maintains that the guarantee would be relatively cheap and that the returns generated by the Savings Trust would almost certainly beat those individuals could generate on their own.
In Felix’s view, this state-based Savings Trust could serve as a model for the country that would provide “a simpler, better, cheaper alternative” to private-sector savings vehicles. And he offers thoughts as to how it might be structured:
Like DC plans, the amount you got out would entirely be a function of the amount you put in. But like DB plans, more would go into calculating your final payout than simply the investment returns on your money. Instead, there would be some kind of a collar: in return for giving up infinite upside, you would be protected on the downside. For instance, the returns might have a floor at 2%, and a ceiling at 8%. The scheme could simply pay excess returns over 8% into a reserve fund which would be used to protect the downside for savers seeing returns of less than 2%.
Similar products exist elsewhere in the world: Denmark, for instance, has a nationwide mandatory defined-contribution pension plan with a minimum return guarantee. This is America, so a mandatory program wouldn’t fly. But a voluntary, opt-out program could. Let’s give it a try.
A friend, who flagged Felix’s post for me, noted that something like the Golden State Retirement Savings Trust could be an excellent complement for Social Security reform. Indeed, it is easy to imagine state-based programs like it plugging into Andrew Biggs’ proposal:
Biggs’s proposal, an early version of which appeared in the AEI contribution to the Peterson Solutions initiative, creates a universal flat defined benefit (a predictable, stable minimum benefit that would eliminate poverty among the elderly, regardless of lifetime earnings); universal defined contribution retirement accounts (this would shift the system away from pay-as-you-go, and it would tend to strengthen work incentives), and the accounts would be automatically annuitized on retirement; COLAs for the minimum benefit would be set on the basis of chain-weighted CPI; the payroll tax would be eliminated at age 62 to encourage continued labor force participation; and the Retirement Earnings Test (RET) would be eliminated.
My sense is that a national universal defined contribution program would have significant advantages over state-based programs. California has an obvious scale advantage over, say, the Dakotas, but there is also the question of interstate mobility. This isn’t necessarily a problem, as beneficiaries wouldn’t be actively managing their accounts. But a national opt-out program with national standards would simplify matters. That said, state-based programs could encourage constructive experimentation.
The political challenge is obvious. Felix envisions the Savings Trust as a supplement to the existing Social Security system, which is sensible. Given rapid increases in life expectancy in retirement, many older Americans will need more to retire comfortably than they currently anticipate, and certainly more than Social Security will provide. The problem, however, is that Social Security’s fiscal imbalance is larger than is commonly understood, as Charles Blahous recently observed at Economics 21:
The historical high-water mark for a comprehensive bipartisan rescue was the 1983 Social Security amendments. The program was then saved from the brink of insolvency. Benefit checks had literally been just months away from being interrupted. Both sides agreed on the urgency and immediacy of the crisis, yet very nearly failed to reach agreement.
The program’s long-term shortfall in 1982 was measured as 1.82% of the program’s tax base. Today it’s measured as 2.67% — much larger even on the surface. Yet many don’t realize that the trustees’ methodologies were changed in 1988 to make the shortfall appear smaller. If we still measured as was done in 1983, today’s shortfall would be 3.5% of the tax base — nearly twice as large as the 1983 gap. [Emphasis added]
So we might have little choice but to require more affluent households to bear more of the burden of providing for their retirement security.