Edward Prescott, the 2004 co-winner of the Nobel Prize for economics, says he has a blueprint that would add individual savings accounts to the Social Security program without...

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Edward Prescott, the 2004 co-winner of the Nobel Prize for economics, says he has a blueprint that would add individual savings accounts to the Social Security program without the tax increases or benefit cuts being floated in Washington, D.C.

For the Arizona State economics professor, who is also adviser to the Federal Reserve Bank of Minneapolis, it’s a matter of rebuilding Social Security rather than reforming it.

“I don’t think there’s a crisis,” he said. “But the sooner we do this [reconstruction], the sooner we can improve benefits.”

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In a paper he will present next month to the American Enterprise Institute’s Tax Policy Project, Prescott offers a plan for a mandatory retirement-savings program that would be partially controlled by participants, trim government liabilities and enhance benefits (assuming a 5 percent real return on savings).

The linchpin of Prescott’s plan is graduated payroll tax rates that would fund the savings accounts: the older you are, the more you pay.

His tax architecture, in theory, would reduce the burden on younger workers because they would save more for themselves instead of just transferring their payroll tax to pay for benefits of current retirees.

“Early in his life, when he [the younger worker] is earning relatively lower wages, he is still forced to submit 6.2 percent of his wages to the care of older Americans, matched by his employer [which of course, is really a tax on the worker’s wages],” says the 64-year-old Prescott.

“He gets little in return for this tax, except for a promise for some future care [retirement benefits] that may not even match current levels.”

“If people are in control of their own savings, and if their retirement is funded by savings rather than transfers, they will work more. And everyone is better off.”

Prescott’s plan suggests Social Security might be bolstered without up to $2 trillion in transitional government borrowing to create a partially privatized system.

“Price indexing”

Under a Bush administration idea touted earlier this month, changing the calculation of benefits through “price indexing,” middle-class workers would see retirement payments cut by almost 10 percent in 2022, according to the Social Security chief actuary. By 2042, middle- and high-income workers would see their monthly checks decrease by 25 percent.

Bush’s privatization proposal has been criticized as creating a bonanza for financial-service concerns, which could reap billions in excessive account-management fees.

Prescott claims he could actually boost retirement benefits through these changes to the present system:

• Before age 25, there would be no mandatory payroll-tax contribution to the government retirement program, so that younger workers could “best put resources toward human capital, like further education, or a young family, or to a mortgage or a car payment.”

• Beginning at 25, workers would contribute roughly 3 percent of their wages into the retirement program. Their contribution would increase to 6.1 percent at age 30 and reach 12.4 percent at 35.

• Investment options would be limited to “relatively conservative indexed” funds that could be managed online.

• For those unable to work, Prescott would offer a “means-tested supplement to ensure that all citizens receive a required payment — just like they receive today.”

While Prescott says his ideas don’t make up a “perfect plan in all detail,” he wants to “provide a means for rethinking our Social Security system.”

By focusing on paring payroll tax rates on young workers and creating a savings program versus an open-ended investment account, Prescott says the economic benefits are significant.

“National savings will increase, as will participation in the labor force, both to the benefit of society,” he says.

“More private assets means there will be more capital, which will have a positive impact on wages, which benefits the working people, especially the young,” adds Prescott. “More capital also means that the economy will have more productive assets, which also contributes to more production.”

Prescott says he favors modeling his individual accounts after the government’s $139 billion-plus Thrift Savings Plan, which covers more than 3 million federal employees with only five low-cost (0.10 percent annually per fund), diversified mutual funds.

Making it work

Is mandatory saving a workable idea? Automatic enrollment, contribution and investment are showing promise in the private sector, although on a small scale.

The Save More Tomorrow program, as designed by Shlomo Benartzi and Richard Thaler, professors at the University of California, Los Angeles, and University of Chicago, respectively, automatically enrolls 401(k) participants and schedules contribution increases when they join a company.

The Vanguard Group, the second-largest mutual-fund company, has more than 200 employer clients who offer such a plan on a voluntary basis.

To date, though, only a relative handful of workers out of more than 45 million in 401(k)s are offered this plan.

Fidelity Investments, the largest mutual-fund company, for example, says that only 100 programs out of the 12,000 401(k)s it administers employ autopilot contributions.

When autopilot plans are offered, though, participants generally contribute more and retain high savings levels.

Automatic-enrollment plan

In an automatic-enrollment plan offered by mutual-fund firm T. Rowe Price, nearly 90 percent of participants keep the “deferral percentage,” or 401(k) contributions chosen by their employers, said company spokeswoman Heidi Walsh.

Employers are free to offer automatic saving, contribution and investment options now, but you need to ask for them, as they aren’t well-known, and companies are reluctant to radically change benefit packages.

In tandem with Social Security restructuring, Congress needs to improve the private retirement system, since half of the U.S. work force isn’t covered by retirement plans. The proposed Universal 401(k) that offers tax credits and government matches for those without a plan is a good start.

Social insurance

Reworking Social Security should be seen as a social-insurance issue. After all, most states require you have auto insurance if you own a car, and lenders want you to have a homeowner’s policy before they provide home financing.

Why not mandate retirement savings through low-cost, diversified accounts with age-based contribution rates in both the public and private systems? This policy may not be foolproof, but it offers much stronger insurance against poverty in old age.