Privatizing Social Security (National Bureau of Economic Research Project Report)

Inequality in an OLG economy with heterogeneous cohorts and pension systems

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Privatizing Social Security

University of Chicago Press: E. About Contact News Giving to the Press. Planters, Merchants, and Slaves Trevor Burnard. Insurgent Democracy Michael J. The Intended and Unintended Effects of U. Agricultural and Biotechnology Policies Joshua S. Graff Zivin. The Lysenko Affair David Joravsky.

This volume represents the most important work to date on one of the pressing policy issues of the moment: the privatization of social security. Although social security is facing enormous fiscal pressure in the face of an aging population, there has been relatively little published on the fundamentals of essential reform through privatization. Privatizing Social Security fills this void by studying the methods and problems involved in shifting from the current system to one based on mandatory saving in individual accounts.

An extensive analysis of how a privatized plan would work in the United States is supplemented with the experiences of five other countries that have privatized plans. Table of Contents.

Preface Introduction by Martin Feldstein I. The revenue lost through this exclusion could be offset by revenue from the federal budget surplus. The additional revenues resulting from raising the cap on income subject to the payroll tax, plus the payroll tax increase, would be transferred to the U. Treasury in exchange for treasury bonds. Inasmuch as the government will soon be running its own surplus, it should use the additional Social Security proceeds to pay down its own outstanding bonds — the publicly held national debt.

This will reduce expenditures for interest on the debt and, when the time comes for the Social Security Trust Fund to redeem the bonds for cash, the government will have a greater capacity to borrow all or a part of the money it will need from the private market. It would also provide funding for critically needed and long postponed public investments in education, training, infrastructure, and technological development. These kinds of investments would increase economic growth and future incomes, making it even easier for future generations to pay the costs of Social Security and Medicare.

This leaves the most common sense solution to the Social Security problem with little support in Congress or the White House.

The Social Security program will use these funds to purchase treasury bonds. Funds received by the treasury from the sale of these bonds to the Trust Fund will be used to pay off the federal debt held by the public. The scheduled payment to Social Security would be made even in years in which there are no surpluses by cutting other spending, raising taxes, or borrowing. Stock holdings would be kept below Because the plan assumes that returns from the stock market would average 6. His proposal provides the assets that the Trust Fund will need in order to maintain the current level of real benefits far enough into the future — 50 years — to satisfy any reasonable standard of projected Trust Fund solvency.

It also prepares for future cash needs by proposing to pay down the national debt now, which will give the government of and beyond another option besides just raising taxes to cover the redemption of the bonds. But the plan has several flaws. First, devoting a large part of the federal budget over the next 15 years to Social Security and debt reduction means that other pressing public needs will continue to be ignored and that discretionary domestic spending will be insufficient to provide an adequate level of services — particularly when combined with the increased military spending that the president and congressional Republicans favor.

Inasmuch as domestic federal spending tends to redistribute resources to low- and middle-income people, these proposed discretionary spending restrictions mean that the needs of lower-income Americans will be sacrificed now for the benefit of retired Americans two decades from now, whose incomes will be substantially higher. Moreover, public investment in education, training, infrastructure, and technology — necessary to assure a healthy economy in the first half of the 21st century — will not be made, reducing future incomes and making the future burden on taxpayers greater than it would ot herwise have been.

A more consistent projection of returns does not justify the relative risks and potential hazards of investing Social Security funds in the stock market. The Clinton proposal assumed an only slightly more modest future return of 6. But if the Social Security trustees are correct in their projection of a slowdown in economic growth, profit growth will also slow. If profits slow down, so will stock market returns.

So not only are the likely returns on stock only slightly higher than those on bonds, but the risks from investing in stocks are far greater. With stocks there is a real possibility of unwise or unlucky investments and stock market downturns. If, on the other hand, the Social Security trustees are wrong and growth for the next 75 years equals growth from the last 75 years, then one-third of the projected shortfall disappears anyway. In that case, the added revenue from investing in the stock market — along with the added risk — is no longer needed.

Finally, there is the potential for government investment in the stock market to distort the goals of national economic policy. To the extent that maintaining Social Security payments requires the national government to bet on a rising stock market, then a rising stock market will tend to become a more important objective of economic policy than keeping the unemployment rate low, for example.

The interests of those whose primary income comes from investing in the stock market and the interests of working Americans are not always the same. Indeed, it has become commonplace to see Wall Street greet a rising unemployment rate as good news. A majority of Americans are better off if full employment rather than a higher Dow Jones is the primary objective of economic policy.

In broad outline, the Clinton proposal has much to recommend it. Increased revenue from removing the cap on earnings subject to the Social Security payroll tax could make up the difference in revenue. Privatization proposals A recent proposal by Martin Feldstein and Andrew Samwick has received much attention and is illustrative of the privatization alternatives supported by most congressional Republicans.

It differs primarily in that individual accounts will be funded by the federal budget surplus, not out of existing payroll tax revenues. Feldstein and Samwick argue that their plan would eliminate the long-term shortfall in the Trust Fund with no changes in benefits or taxes. These contributions would be funded by the federal government surplus.

When a worker reached retirement age, his account would be converted into an annuity. Feldstein and Samwick claim that the reduction in outlays from the Social Security Trust Fund would extend its life beyond the year planning horizon. To reach the same level of savings one would accumulate from an initial investment of 5. This plan therefore does not cover the Social Security deficit, and would require either increased taxes, reductions in other federal spending, or expanded budget deficits. The savings to the Social Security Trust Fund would be reduced by the same amount.

In contrast, administrative costs of the U. Individual accounts that permit account owners to place their money in a wide range of investment vehicles raise the likelihood of fraud and abuse in the sales of stock.

Kent Smetters | IDEAS/RePEc

Workers are guaranteed basic Social Security benefits under this plan even if they lose all the money in their individual account through poor investments. Workers receive only one-quarter of the gains made on an individual account since, for every dollar received, 75 cents is given up in basic Social Security benefits. Because there is just a small penalty for investment losses while very big investment gains are required to produce any noticeable rise in retirement income, risky investments which have a high potential for large losses but also for large gains will be very attractive.

Decisions about the future of Social Security must not be based on overestimates of future returns in the stock market nor on a less-than-complete understanding of the added costs and risks associated with individual accounts. Conclusion The essential problem facing Social Security is less dire or complicated than it may seem from the hyperbole produced by the current debate.

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The fact that people will live longer than their parents is a cause for celebration. And the obvious implication — that they will spend more time in retirement receiving Social Security and therefore have to pay a little more in taxes to support the program — should not be unbearable for most voters to accept. Unfortunately, neither the White House nor congressional leaders seem to be willing to make this simple, honest case to the people.

The Republican congressional proposals to privatize the program by providing individual accounts do not seriously address the problem. Privatization is a reckless gamble, vastly increasing the chances of impoverishing large numbers of retired Americans in the first part of the 21st century. This would provide an opportunity for lower-paid workers to create private pensions but would have no effect on the Social Security program.

Social Security Works

Goss, Stephen C. Washington, D. January Feldstein, Martin and Andrew Samwick. Cambridge, Mass.

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