47% of the total Social Security Administration budget for administration (i.e., all of the budget that isn't paid out at benefits), which was $3.7B in 2002, is spent on administering the Old-Age and Survivors Insurance and Disbility Insurance benefits and trusts.[1] These are what we think of as "classic" Social Security.
The cost to manage a fund is expressed as a fraction of the fund's net assets, the management expense ratio. 1.5% is a typical MER for a mutual fund. About half of that pays the managers of the fund to manage it. Funds with high churn (selling an asset to buy a different asset) have a high manager component to MER. About a sixth goes to strict administrative costs (records, reports). The rest goes to advertisements.[2]
Index funds, on the other hand, could be (and probably are) managed by computer, and don't have to do much marketing. A good index fund has an MER of about 0.2%, virtually all administrative.
How does Social Security (really, the OASDI trust) compare? It ought to have nil as a manager component to MER, since its assets are wholly contained in special S-series U.S. Treasury Bonds. It does have tremendous churn, however, at least in the sense that about 72% of its income is immediately sent right back out in the form of benefits. Managing the payout of benefits is going to incur substantial costs that a mutual fund doesn't have.
But enough teasing: Here are the numbers.
In 2002, the OASDI trust held about $1.4T in bonds. It had an income of $627B from payroll taxes, and it paid $454B benefits to folks. It had administrative costs of $3.7B.
The SSA calculates its expense ratio relative to its income (0.6%) and its benefits (0.8%) rather than to its assets, but we've got the numbers to calculate its MER as the funds do, in which case the OASDI MER is 0.25%. As it happens, the adminstrative costs arise more heavily from the DI side of the trust, about four times as much. This is as you might expect, since DI cases are usually more complicated, particularly since they have to weed out many more fraud cases.
The OASDI MER is competitive with that of index funds and is six times more efficient than mutual funds.
Because of its active disbursement, OASDI is perhaps more directly comparable to a pension fund than to a long-term investment device like a mutual fund. As you'd expect, non-public pension funds have MERs even higher than mutual funds, averaging 2.35% in Canada.[3] OASDI is even more efficient by that comparison.
The conclusion is simple. Conservative thought advocates a market-based solution to every problem. Let Adam Smith's invisible hand find the best solution, be it to pollution, endangered animals, forest fires, national security, or depletion of fossil fuel resources. Market conservatives would deny that public institutions have any realm in which they are more effective than the alternative. Yet it is clear; more than clear, it is undeniable, that a market-based solution to the impending Social Security crisis will first increase costs. Government, not the market, is simply and, indeed, inevitably, more efficient at managing the OASDI trust fund, specifically because it is not responsible to the market. It need not buy good suits; it should be risk-averse.
Sources
Size of OASDI trust, trust income, and benefits paid taken from The 2003 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (page 2).
Administrative costs taken from SSA FY 2003 President's Budget Fact Card.
Management expense ratio for mutual funds taken from Mutual Funds -- Costs.
Pension fund expense ratio taken from a Simon Frasier University newsletter and a report from NBIMC.com which I may be misinterpreting.
Notes
[1] SSA administrative costs count under the domestic discretionary budget, under something called the "Limitation of Administrative Expenses". This contrasts with income and benefits, which are off-budget items. What this means is that when budget time rolls around in the capitol, SSA administrators get squeezed on costs and personnel, even while the income, benefits, and number of accounts they have to manage rise each year.
[2] Because getting other people to be as stupid as you are about where you put your money is how you keep a pyramid scheme afloat.
[3] I found one source which appeared to suggest an 11% MER for one fund!
Posted by Greg at October 14, 2003 2:17 PM