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May 5, 2005

Bogus bureaucratic befuddlement

A reader asked me to respond to the claims by Francis X. Cavanaugh, the former executive director of the Federal Thrift Savings Plan, that implementing personal accounts in Social Security is administratively unfeasible. On first blush Cavanaugh's claims seem to carry a lot of weight, because of his experience at TSP -- often cited as a model for Social Security personal accounts. But upon close examination, his critiques are mostly red herrings that give off the unmistakable odor of a career bureaucrat whose pride has been injured because he wasn't consulted by the Bush administration on this. I had the opportunity to work with Cavanaugh and his staff very closely during the years when TSP was first being put together (my former firm, Wells Fargo Investment Advisors -- now Barclays Global Investors -- has always been the exclusive provider of investment management services to TSP, and I managed the relationship during Cavanaugh's tenure). Suffice it to say that I know whereof I speak when I hint as to Cavanaugh's motives here -- and that I know a thing or two about these administrative matters myself.

Cavanaugh's main critique (there are other trivial ones that I won't address) is that personal accounts would lodge untenable costs and burdens upon millions of employers, many of whom have only a handful of employees. Cavanaugh argues that employers would have to provide much more detailed and timely information about employee contributions than are currently required by Social Security, and that employers would be responsible for educating employees about their investment options. But neither of these things is true. Information about employee contributions only has to be extremely timely if workers are to be permitted to make changes to their investment decisions with great frequency. That is the current standard among corporate 401(k) plans -- indeed, the standard is to permit daily changes (and there are plenty of critics who think that encourages pointless, expensive and risky account activity). But surely there is no reason that it must be the same in Social Security. And surely there is no reason whatsoever why an employer need be responsible for investment counseling, any more than he is responsible today for explaining Social Security benefits.

Based on the false assumption that small employers would have to bear all the burdens of administering a 401(k) plan in order to deal with Social Security personal accounts, Cavanaugh goes on to cite the inevitable "studies" leading to the conclusion that small businesses will be taxed billions of dollars in order to comply. But there's really nothing more for employers to do than they already do to deal with Social Security. So where's the extra cost?

Employers aside, it will not be free for the federal government to implement personal accounts in Social Security. It's not free for TSP, either. It's typical cost is about 7 basis points per year of assets under management. Estimates for Social Security personal accounts are typically 30 basis points -- more than four times greater. If anything, economies of scale suggest that running a plan for 150 million participants -- as Social Security would do -- ought to be cheaper per unit than running one for only 3.3 million -- as TSP does today.

Posted by Don Luskin at May 5, 2005 12:00 AM | Print

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