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academic study offers much less information than it claims. And
sometimes what appears to be an academic study is not even a study
at all. Professor Austan Goolsbee of the University of Chicago, who
has done respected work on other financial issues, has written an
that claims to prove that the system of Social Security personal
retirement accounts proposed by Plan II of the President's
Commission to Strengthen Social Security would result in an
unprecedented "windfall" for financial firms. However, a closer
examination of this article shows that it is riddled with errors,
unjustified assumptions, and sensational but meaningless
rejects the 0.3 percent annual administrative fee that the Social
Security Administration and other reputable experts use to estimate
the costs of the personal retirement accounts that would be
established under the Commission's Plan II. Instead, Goolsbee
claims a 0.8 percent annual fee is more appropriate. This is simply
While that level
would be appropriate for a system of individually managed accounts
with a high level of personal services, this is not what the
President's Commission to Strengthen Social Security would create.
Instead, the Commission called for a simple, centralized investment
plan modeled after the Thrift Saving Plan that is offered as part
of the retirement program for federal employees.
But Prof. Goolsbee
argues that a 0.3 percent fee would only cover "individual accounts
where there is little or no customer service and where individuals
are not allowed to make choices about their investment mix." But
this is closer to what the Commission plan would create than the
accounts Goolsbee envisions in his estimate. Moreover, the Social
Security Administration and Congressional Budget Office have
concluded that these accounts could offer their holders some
investment choices at the 0.3 percent fee level.
A 1999 study by
professional fund managers at State Street Corporation led by Bill Shipman
estimated that a plan similar to the one proposed by the Commission
would have administrative fees around 0.3 percent. The State Street
study is especially important because it estimated the costs of
answering phone calls from account holders, developing the
necessary computer equipment and programs, providing annual
statements, and shifting between investment options.
In short, Prof.
Goolsbee's administrative cost estimates might be appropriate for
one type of personal account structure, but that structure is
vastly different from the one that he claims to be studying. The
President's Commission proposed a system of simple, low service
accounts, for which a 0.3 percent annual administrative fee is more
Based on a
claims that the Commission's Plan II requires account holders to
convert their accounts from a low-cost centralized system to
high-cost private management when they reach $5,000 in assets. He
uses this to justify his assumption of higher fees.
But Plan II
requires no such thing. Instead, it would create a low-cost
centralized system in which workers could remain throughout their
careers. And while the plan recommends examining the
possibility of moving to private managers, that discussion is put
off into the future. And even then, a system based on Plan II would
allow such a move if it proved feasible but would not require
workers to convert their accounts.
Even if a plan
allowed workers to move their personal retirement accounts to a
private manager-at a higher cost-only a few workers would take that
opportunity. First, only a few of potential funds managers could
offer higher returns, after subtracting the higher administrative
fees, than the centralized system could provide. Workers who saw
their earnings fall would promptly return to the centralized
system. Second, when retirement account holders are faced with
choices and are uncertain about what to do, they usually end up
doing nothing. Because workers would have to affirmatively decide
to use to a private funds manager and would not be moved to one
automatically, most would do nothing and remain in the cheaper
Ignores Benefits and
Improved Retirement Security
calculations ignore the benefits that would come from a system of
personal retirement accounts. The first question that should be
asked when someone talks about fees is "What do I get for that
younger worker, today's Social Security offers minimal or even
negative returns. A 20-year-old male can expect a return on his
Social Security retirement taxes of -0.85 percent, while a
20-year-old female can expect a return of 1.91 percent. The
difference is largely attributable to differences in life
expectancy. The female can expect to live until age 84.3, while the
male can expect to live to age 77.3.
On the other hand,
Prof. Goolsbee admits that returns for personal retirement accounts
would range from 4.6 percent under a 0.3 percent administrative fee
to 4.1 percent under his 0.8 percent annual fee. Any positive
return would certainly be an improvement for a 20-year-old male,
and even the 4.1 percent return is more than twice the return that
a 20-year-old female could expect from today's Social Security. In
addition, both of these individuals would receive retirement
benefits based in part on assets that they own, rather than
depending solely on government promises.
In short, the
better return is worth either administrative fee. This is not a
case where the funds managers get fees for doing nothing; their
activities will greatly increase individual worker's retirement
Revenues, Not Profits
Even if Goolsbee's
$940 billion estimate were correct, which it is not, it is still
not an estimate of profit. Instead, Prof. Goolsbee estimates gross
revenues. From that number must be subtracted the costs of keeping
records on 140 million or more accounts, answering questions from
account owners, providing regular statements, processing individual
worker's investment changes, doing research into investment
options, making trades, etc. Altogether, this is not a cheap
proposition, and, significantly, the federal government, not the
financial industry, would undertake many of these administrative
functions. Only a small portion of the total fees would be left for
the financial industry's profits.
study by investment professionals at State Street Trust assumed that,
nationally, a PRA system would annually generate 175 million to 350
million calls from account owners, including 26 million to 52
million calls that must be handled by humans instead of an
automated phone system, 14 million investment fund transfers, and
over 140 million annual account statements.
Administrative fees would pay for all of these services. Calling
the fees a "windfall gain" is both irresponsible and just plain
summary of Prof. Goolsbee's article is filled with sensational
numbers, such as an assertion that administrative expenses for
personal accounts would amount to over 25 percent of Social
Security's anticipated deficit over the next 75 years. Prof.
Goolsbee also makes claims about the impact of his estimated gross
fee on financial firms and the costs workers' personal accounts
would face from the administrative fees. But under close
examination, all of these numbers mean little or nothing.
Prof. Goolsbee's inflated administrative cost estimate with Social
Security's estimated deficit implies that this money could be used
to partly fix the current program. But the money represented in his
administrative fee estimates only results from having personal
retirement accounts. Because these accounts grow at least twice as
fast as today's Social Security, they produce earnings that could
be used to pay administrative fees. Without the earnings from
personal accounts, the money that would be spent on fees simply
does not exist and would not be available to fix Social
that the administrative fees are more than eight times higher than
financial firms' revenue loss between 2000 and 2002 sounds good
until one remembers that he is comparing vastly different time
periods. In other words, all that Prof. Goolsbee's statement means
is that his estimate of total administrative fees over 75 years is
eight times higher than the industry's losses over three years. One
hopes that any industry would earn vastly more over 75 years than
it loses over any three-year period.
that any set fee level reduces a personal account without
considering what would be gained misses the point. Because
administering an investment account is not free, every account has
a cost. Even today's Social Security spends 0.6 percent of its
outlays (about $250 million in 2003) to administer the program. A
more realistic estimate is that fees will reduce the size of an
individual's account by 8 percent rather than Prof. Goolsbee's
estimate of 20 percent. However, even that 20 percent is a cheap
price to pay if the account earns a return that is twice that of
today's Social Security.
Not an Academic
A sure sign that
Prof. Goolsbee's article is primarily intended to influence the
election debate over Social Security is the intemperate language
and exaggerated conclusions contained in the executive summary.
Stating that the revenues that he claims would go to financial
managers would be "the largest windfall gain in American financial
history" without noting that this figure would be gross revenue and
not profits is irresponsible. No real academic study would make
this type of claim.
While Prof. Goolsbee
has produced respected research on fees associated with 529
education investment accounts, this article is not up to those
standards. It is filled with faulty assumptions and sensational
numbers that are designed to confuse the debate over Social
Security's future, rather then to educate the public.
personal retirement accounts are the only way to resolve Social
Security's coming financial problems without massive tax increases
or substantial benefit cuts. These accounts will have
administrative fees, but the fees will be much lower than Prof.
Goolsbee claims. And, most importantly, workers will receive real
value in return.
John is Research Fellow in Social Security and Financial
Institutions in the Thomas A. Roe Institute for Economic Policy
Studies at The Heritage Foundation.
Show references in this report
 Austan Goolsbee, The
Fees of Private Accounts and the Impact of Social Security
Privatization on Financial Managers, September 2004.
Strengthening Social Security and Creating Personal Wealth for All
Americans, the Final Report of the President's Commission to
Strengthen Social Security, December 21, 2001. Available at: http://www.commtostrengthensocsec.gov/reports
(September 24, 2004).
Challenges Confronting Social Security Reform, State Street
Corporation, Boston, MA, March 22, 1999.
A 'windfall' for the financial industry? Get real.
David C. John
Senior Research Fellow in Retirement Security and Financial Institutions
Read More >>
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