George W. Bush

Bush's Plan: Indexing Boon or Market Disaster?

George W. Bush

Republican presidential candidate George W. Bush recently proposed a plan to partially privatize Social Security. Would the plan give a healthy boost to the stock market while shoring up retirement returns, or would it inflate the market into a dangerous bubble and spark a bear market that would see a decline not only in guaranteed, but real disbursements to pensioners?

While Bush has publicly outlined very few details regarding his plan, aides have floated the idea of two percent of wages taxed going into such a plan. The remainder of Social Security taxes would continue to flow into traditional benefits. Currently, workers pay 12.4 percent of their salary into Social Security.

With current 1999 Social Security tax inflow of $462.7 billion, that would put a potential of $74.6 billion in tax revenue into private investment if the plan were implemented immediately. Given the worst case (and very unlikely) scenario, all of that money would flow directly into a stock market currently valued at some $16.6 trillion (April 2000 value of the Wilshire 5000). This would amount to 0.45 percent of the current total market value - a huge inflow of capital.

To put this into perspective, however, with the 1999 gain in total market capitalization of over 23.5%, the Wilshire 5000 gained some $3 trillion in value over in 1999. The psychological and economic permutations of a privatization plan are infinite in their complexity. I will leave the arguments regarding the potential effect on equity prices of such an enormous cash inflow in the hands of capable economists.

Suffice it to say, the potential risk to the economy, individual benefits, and Social Security itself, not to mention to Bush's political life are enormous. The consequences of doing nothing, however, are largely known, and almost certainly would be catastrophic to the Social Security system.

In the midst of the longest bull run in history, it is easy to see why many favor building on anemic social security returns that fall below two percent annually with some sort of privatized plan. The question that few have addressed is the potential impact of such a plan on capital markets.

Regardless, something must be done. Social Security is rapidly closing in on a flood of red ink. According to current projections, by 2015, taxes will no longer cover Social Security payments. By 2037, the money will run out, with incoming taxes covering only about 75 percent of paid benefits. While there are presently about 3 retirees for every 10 tax-paying workers, the number will be closer to 5 retirees for every 10 workers by 2031.

Critics noted that neither plan directly addresses Social Security's key problem. "Someone has to pay to bring the Social Security system into balance," says Eugene Steuerle, policy analyst at the Urban Institute. Neither candidate would raise taxes or decrease benefits. Gore's plan would cover the shortfall with a rosily anticipated interest savings while the government pays down the debt, and even then only until 2050. Bush speaks cryptically about the possibility of decreasing guaranteed Social Security payments, with a gradual move to a privatized pension system.

For Bush, it is a bold foray into uncharted waters. Historically, Social Security has been the sacred cow of United States politics. Nothing the government does affects so many people in such a direct way. In testing the waters, Bush said that he has intentially omitted details to get the public to "focus on the threshold question" of whether or not such a plan should be implemented. Al Gore's response has been unequivocal, "You shouldn't have to roll the dice with your basic retirement, and you should not have to pay for others who do." Gore has not invested in any stock in 25 years.

The question for indexers is whether we want a new flood of capital coming into the market. And you thought a price/earnings ratio of 36.5 was high...