Hispanic Workers Should Back Personal Accounts

Earlier this week, the Center on Budget and Policy Priorities (CBPP) released several short reports on Social Security's importance in the retirement plans of Hispanics. These reports, "Hispanics Large Stake in the Social Security Debate" and "Hispanics And Social Security: The Implications Of Reform Proposals," essentially argue that Hispanic Americans' lower average incomes, higher life expectancies, and lower average savings (including pensions) make them rely more on Social Security.[1] The studies' authors go on to argue that reforming Social Security in the way that President Bush has proposed would put Hispanics' retirements at great risk.

The conclusions in CBPP's policy papers just don't add up. For example, the authors correctly observe that average savings and, generally, net household wealth among Hispanics are below those of the general U.S. population. President Bush and other Social Security reformers also have observed that differences in wealth and savings exist, and this guides their reform approach. Because low incomes discourage savings, reformers want to help boost Hispanic savings by using some of the payroll tax that they already pay to fund a Personal Retirement Account (PRA) for each worker.

The CBPP papers argue that Social Security is a more important part of Hispanics' retirements than it is for others' because Hispanics have above-average life expectancies. That is true (at least until the average Hispanic diet and lifestyle reflect those of the average non-Hispanic American), but that is an argument for reform, not against it. The Social Security actuaries have told us for years that the Old-Age and Survivors program will be unable to meet its financial obligations sometime in the late 2030s or early 2040s (currently the date is 2041).[2] After that point, benefits will need to be cut by about 25 percent. Young workers today, Hispanics among them, might think twice about the Center's argument that they should rely more on Social Security as it is currently constituted.

Social Security reformers want a system that allows low- and moderate-income workers voluntarily to build a nest egg for themselves and their children by setting aside some of their own Social Security taxes in a Personal Retirement Account. Our own work on the effects of these nest eggs clearly shows that doing so will make Hispanic retirements more secure, increase Social Security's rate of return for Hispanics (which today is dismally low[3]), and allow low-income families to break out of deep cycles of intergenerational poverty.[4] Because workers would own the sums in their PRAs, they can use the amount that they don't apply to their own retirements as a bequest to their children or grandchildren.

For example, a low-income dual-earner couple could accumulate over $127,000 in their PRA, use about $60,000 to create an annuity to combine with traditional Social Security, and leave the rest in their savings account. Because of their long lives, that amount left in their PRA will allow them to pass on nearly $120,000 in today's dollars to their grandchildren. Enabling low-income workers to pass on such sums will go a long way toward breaking down poverty.

The CBPP reports unfortunately resort to falsehoods and half-truths to perpetuate the claim that today's Social Security-even with its guaranteed benefit cuts-is a better deal for Hispanic workers than a reformed system with personal accounts. For example, the papers cite Heritage's 1998 report "Social Security's Rate of Return for Hispanic Americans" but immediately dismiss it as "widely discredited." This is simply not the case. Our later report "Social Security's Rate of Return: A Reply to Our Critics" describes and responds to the criticisms-mostly technical in nature-leveled against our original rate of return research.[5]To say that our research has been "widely discredited" is to misrepresent the tenor and the substance of the complex and still ongoing debate over the measurement of returns to Social Security. Our 1998 series of reports is still regarded as the benchmark in the field and continues to be widely cited.

To improve the current system's relative merit, the CBPP report bases its analysis of personal accounts on what seems to be a deliberate misreading of investment return data from the Congressional Budget Office (CBO) and analysis from the Social Security Administration's actuary. The report uses a "risk adjusted" yield of 3 percent for the investments that a worker would have in his or her personal account. In the past, CBBP has cited this number to the CBO and claimed that it is the appropriate rate of return to use, taking into account the risks of investment.[6]But CBO disagrees. Commenting on a Social Security calculator developed by CBPP that used the risk-adjusted number,[7]CBO Director Douglas Holtz-Eakin called the usage "wrong" and added, "We assume that equities will return 6.8 percent in the future."[8]With this higher rate of return, workers choosing to open personal accounts would fare far better than CBPP estimates.

The Social Security Administration makes the same point in its publications. The same SSA actuarial memorandum from which CBPP took its numbers runs through two scenarios for account returns: a "low, or risk adjusted," yield and an "expected" yield.[9]The expected yield amounts to 5.22 percent-again, significantly above the number that CBPP decided to use. Inexplicably, CBPP neglects to report or mention SSA's expected returns on personal accounts. This is a significant omission. With the "expected" yield, a worker earning $58,560 per year, for example, would receive 8.1 percent less in benefits per month than is promised today, compared to the 25 percent reduction that CBPP reports using the "low" yield. Interestingly enough, that 25 percent reduction is just below the benefit reduction that Social Security's actuaries say will be necessary if the system is not reformed.[10]

CBPP's failure to use the correct yield on investments has an especially large impact on low-income workers. According to the same SSA actuarial memorandum, a low-income worker retiring in 2075 would receive, with a personal account, almost 8 percent more than the benefits that are promised to him by today's Social Security. According to CBPP, however, that worker would get a 28 percent benefit cut. SSA's numbers show that personal accounts would make Social Security a better deal than it is today for most Hispanic families; CBPP simply chooses to ignore this conclusion.

Finally, CBPP overlooks the effects of the cost of the current system on Hispanic workers. By rejecting changes that would bring the cost of Social Security into line with what the system can afford to pay, CBPP endorses the continuation of the status quo. If the benefits promised today are actually to be paid, however, taxes will have to be increased significantly. One of the most likely means to accomplish this, raising the payroll tax rate, disproportionately discourages savings among low-income families by reducing their disposable income.[11]To save the current system, then, CBPP favors a policy that would make it more difficult for many Hispanic families to save for their own retirements, amass assets, and live the American Dream.

CBPP's policy papers do Hispanics a disservice by misrepresenting the poor returns of today's Social Security to Hispanics and the promise of personal retirement accounts as a means to help Hispanic families and communities build wealth, help Hispanic workers strengthen their retirement security, and improve future generations' standard of living. CBPP would have Hispanics rely on a system that, according to its own actuarial staff, promises significant future benefit cuts or tax hikes and prevents too many Hispanic families from amassing a nest egg.

With their strong family and community ties, Hispanic-Americans are positioned to benefit especially from the promise of personal retirement accounts. Falsehoods and half-truths should not be allowed to conceal that fact.

William W. Beach is Director of the Center for Data Analysis, and Andrew Grossman is Senior Writer, at The Heritage Foundation.