January 18, 2005

Incentives To Work

While talking about the "philosophy" behind Social Security, Chris Sullentrop channels the National Review's views on the topic:
National Review, in its response to [Michael] Kinsley's (in their words) "ingenious argument against reform," suggested that personal accounts would "increase incentives to work" and "induce people to save more."
Let's think about this for a second, because I think there's a non-trivial point lurking in the background here. Under the current system, Social Security really does reward work—the higher your average salary throughout life, the higher your benefits. Personally, I think that's a feature worth preserving, and an argument against making the system more progressive by slashing benefits for high-income earners.

But notice there's a twist to all this. Social Security calculates your benefits by looking at the highest average earnings over the highest 35 years of your life. It can be any 35 years. If you start working right out of high school, fine, benefits will depend on three decades that you earned the most. By contrast, if you wait a few years to further your education with college and postgraduate work (in the hopes of a higher salary down the road), then again, fine, benefits will be calculated over those later 35 years in life. If you want to take time off to raise a child, again, fine. Ditto for spending two years doing Teach for America, or Peace Corps, or whatever. You can make it up later on in life.

Private accounts, by contrast, favor only one possible sequence. Everyone will need to start working as soon as possible, in order to get your investment compounding in your account over the course of a full lifetime. If you go off to school for eight years and only then start working, you better hope that your new starting salary is enough to make up for those lost years when you had nothing invested in the stock market. If you take a few years off to do parenting, your retirement fund could take a huge hit. Ditto if you want to try to switch careers. You're in a race against the math of compound interest, and there's little room for error. Social Security, by contrast, leaves all sorts of room for error, and development, and pursuing other life choices. So long as you're earning a decent salary for any 35 years of your life, you'll have enough to retire on comfortably. The effects here won't necessarily be dire, but I don't think they can be completely dismissed, either.
-- Brad Plumer 5:08 PM || ||