They Could Call It “Social Security”

Felix Salmon, inspired by a new Wade Pfau paper (PDF) talks about optimal retirement strategies:

Pfau makes a very basic calculation that for someone on a constant real wage, saving for 30 years and then living for another 30 years on 50% of their final salary, saving about 16% of your salary each year into a portfolio of 60% stocks and 40% bonds will put you into safe territory.

Of course, real wages aren’t constant over time, and all the other figures are highly variable too. But the bigger message certainly resonates with me: spend less effort on trying to boost your annual returns, when you have very little reason to believe in your alpha-generation abilities, and spend more effort on maximizing your savings every year.

This seems to me like an area where public policy could play a useful role. Say that instead of “saving about 15 percent of your salary” each year, there was a payroll tax of about 16 percent. And then people who’d paid the tax would receive from the government a defined benefit pension, whose generosity would be proportional to the extent of your earlier tax payments and therefore your salary. Since the goal here is essentially to guarantee middle class retirement security, you could put a cap on the quantity of wages subject to the payroll tax and assume that high-income people who want to keep up with the high life in retirement will take some of that untaxed income and invest it in stock or bond markets.

Then you’d have a public program that helps ameliorate people’s short-sighted and weak-willed qualities, thus ensuring a decent retirement for middle class people. And since those who pay higher taxes will receive greater benefits, it has no net impact on incentives. Great idea, right? We could call it “Social Security” since by socializing and spreading the risks, it ensures a decent, secure return for all participants rather than sending everyone to the casino.