What has been missing and is now imperative are these three definitive features: 1) clear, vigorous assertion and incontrovertible proof of the true munificence of stock returns and their surprising lack of risk entailed; 2) inviolable private ownership of assets, and 3) government guarantee of a financial safety net for minimum benefits and in case of early disability or death of those with dependents.

President Bush in his May 2, 2001 appointment of the bipartisan Commission "to study and report specific recommendations to preserve Social Security for seniors while building wealth for younger Americans," and in his accompanying guidelines, more or less included the three features, of necessity indirectly, generally, and broadly. Now, more specificity and trenchancy is needed.

Logic Says Start Over

The mess and complexity, along with the inherited politicization of the wealth-redistribution aspects of Social Security, locked the Commission into a losing box from the outset. If some visionary member were to have said, "What if there were no existing program? What would we recommend if our mandate is to design a brand new system for maximum retirement benefits for all workers and their families at little or no cost to the government, starting next year?"

Your first step would be to identify those investments with the highest returns and the least risks. The return part is easy. Stocks are the clear-cut answer. Risk is trickier, but malleable. The widespread opinion is that stocks are far too risky for use in pension funds, especially one sponsored by the archon of legislative probity, the U.S, Congress. It is important to define the meaning of risk in stocks. Simply, it is the possibility that their prices will be lower, sometimes a lot lower, than what was paid for them, most dangerously at a time when the owner wishes to sell and cash out.

The other side of the coin is that stocks may be higher, a lot higher, and cash out at the time of retirement can mean wealth, possibly great wealth. Thus investors face the beast of volatility which shakes them periodically with alternative paroxysms of exuberance and despair. Not the kind of behavior to be encountered at a time when most hope to enter what will be the tranquil years of their retirement.

Yet time itself soothes this beast. The longer confronted, the tamer it becomes to accommodate our purposes. For example, 93 times out of a 100, it will double stock-invested pension money. One hundred percent of the time since 1870, it has returned at least 333% of stock-invested pension money at retirement age. These figures are derived from publicly available data and prices.

Social Security II

Results like this make it easy to legislate a government guarantee for a minimum benefits-level based on 130 years of U.S. financial history. The nearby chart (click here) shows the dollar returns on pension investments for every year since the first decade of the last century. For simplicity and easy application to real-world numbers, $1 is invested annually every year for 40 years (a desirable working span in a lifetime). The total cumulated investment is $40. At the end of each 40th year, the chart shows what the total investment is worth. Thus, in 1974 (a below-average year), a retiring worker would have a stock portfolio worth $421 after a total cumulative investment of $40, yielding a return of more than a 1000%.*

Translating this chart example to modern times, last year's median wage earner made $32,800. Over the next 40 years, taxes for retirement at 12.4% of wages will total $300,000, assuming 3% wage inflation. At the end, his or her private account will be worth $3,200,000, using the 1974 example, a below-average year. The account can then be converted to an annuity or allowed to continue intact with an annual selected percent-benefit distribution.

The government will be able to act as guarantor of investment performance (or contract the job out to the private-sector) based on the statistical probabilities inherent in the experience to date since 1870. A floor and ceiling can be set, say, at 25% and 1500% returns respectively ($50 and $600 on the chart). The guarantee would make good on any returns less than the floor. The excess of returns above the ceiling would go to the government as collector of premiums to build reserves.

Beyond a certain level of reserves, refunds can be distributed to all workers participating in the plan, or the floor or ceiling levels may be adjusted, or funds may be used to meet other safety-net needs--those related to early disability or premature deaths leaving dependent children. Since 1870, the floor has never been reached. The ceiling has been exceeded 40% of the time. Those are superb odds for the government which harvests each excess.

The Burden of Proof for Private Accounts

Finally, the burden should be on the opposition to prove why these pension-savings accounts should not be the personal private property of each worker in the United States. The President said in his May 2001 Rose Garden announcement, "Personal savings accounts will transform Social Security from a government IOU into personal property and real assets; property that workers will own in their own names and that they can pass along to their children. Ownership, independence, access to wealth should not be the privilege of a few. They're the hope of every American, and we must make them the foundation of Social Security."

Democrats and liberals should pay special heed to this essential feature of the optimum government-legislated pension plan. Paradoxically, it can and will establish one of the biggest social wealth-redistribution plans afoot in the United States since the origination and growth of the federal income-tax code. Further, the lower down the social-economic scale the worker labors and lives, the greater will be the financial benefits that accrue to him or her and their families.

With private accounts under this plan, longevity does not matter. You can live as long as you like. Your benefits, guaranteed, belong to you, and after you, to your family with no strings attached.

The old system should be allowed to run out completely, paying all promises on the books now. Borrow as necessary to complete the process. In the new plan, safety-net benefits related to disability or early death leaving dependent children behind should be funded by borrowing in the credit markets until sufficient reserves and actuarial experience accrue. Until then, a moderate premium charge against contributions may be levied to build reserves and amortize specific related debt. This provision of the new law must have a biennial sunset feature by which it expires automatically unless extended by new legislation. Safety-net benefits may be set at some fixed multiple of median wages or average annual consumer spending.

There will be a hurdle transition period during which federal borrowing may be substantial. It will look like a bell curve, tailing off finally to nothing at the end of 60 to 70 years. The advantages at the end period will be that the new plan is fully funded and will remain so indefinitely for all succeeding generations of participants.

The President's excessive caution on the initial limit of stocks to be voluntarily allowed is inappropriate. Up to 100% (less a minor premium for safety-net reserves) should be permitted. The program is voluntary. Why restrict the freedom of choice of the owners? Especially when the odds are so favorable--for everybody, but specially those at lowest wages--and the specified retirement benefits are guaranteed for all participants.

Milton Friedman called the previous article upon which this one is based "fascinating and the conclusion suggested by (the) calculations striking. . . a very informative set of calculations." Click here for Complete Previous Article with proofs, sources, notes, and tables that underlie the historic examples used here

Note. If you agree that what you have read here is reasonable (based on the historic record since 1871), then write to your U.S. Senator, Representative, and the President at once. Send an email to each, telling them that you actively support their sponsorship of this solution in what they may want to call the "Employee Retirement Wealth Ownership Act of 2009." And get your voting friends and neighbors to support the bill too. Select and copy the URL of this page (in the address-bar window above) and paste it into your message.