Social Security reform
Privatizing Social Security
Social Security was established as a promise to the people of continuation of income into retirement. Well the road to hell is often paved with good intentions, because that promise now has the country in economic uncertainty. The guarantee that workers will be taken care of in their old age if they paid their Social Security tax, is no longer guaranteed. If we don’t come to a unanimous decision as to a plan of reform; financially our country is doomed.
Social Security has always struck me as a socialist program. Returning to our capitalist roots is where we will find the solution to this problem. Privatizing Social Security offers solutions to our current problems, and empowers the people with ownership and a voice in their financial future. At first such a plan sounds drastic, but when examined closely is a sound solution. I believe it is important to provide some background to the Social Security crisis, before weighing the solution.
Social Security was established in 1935 offering retirement income to workers in their old age. An alluring idea to a country emerging from the Great Depression. Social Security is based on the taxation of income to generate revenue. Currently Social Security tax is a little more than 12 percent, and is capped at ninety thousand (www.whitehouse.gov). The cap is a ceiling on income tax. So it doesn’t matter whether you make ninety thousand or nine hundred thousand you pay the same dollar amount on income tax. The generated revenue is immediately paid out in the form of benefits. Benefits include retirement pensions and disability benefits. Pensions replace a percentage of workers wages once retired. Disability benefits support those unable to work due to physical or mental impairments, or survivors of the deceased that are too young to enter the workforce. This is referred to as a pay as you go system. Meaning every dollar paid into Social Security is immediately paid out. This pay as you go system is based on the assumption that the working population and retirement population increase at parallel rates. Essentially it is assumed that as more people retire more people will be entering the workforce and paying taxes. So the amount paid out as Social Security benefits is assumed to be offset by the steady increase of taxable income. Thus, creating a delicate balance between the workforce and retired.
Social Security revenue is recorded through different trust funds. In recent years the trust funds have run a surplus (taking in more than they pay out). The government has borrowed against this surplus, to pay for other government expenditures in the national budget, each year; and writing itself IOUs. By 2012 the government will have borrowed 3 trillion dollars from the trust funds (www.socialsecurityreform.org). The unexpected surplus is attributed to the entrance of baby boomers into the workforce.
At the end of World War II mass numbers of soldiers were discharged from the military, and looking to start a family to make up for lost time. The population explosion this created is known as “The Baby Boom”. When the baby boomers entered the workforce, there were more people working and paying taxes than was needed to cover Social Security benefits. Thus, creating the surplus that we see today. Not all baby boomers had children, and the ones that did had fewer children than previous generations. When the baby boomers are ready to retire; there won’t be enough workers to support promised benefits.
In as early as 2012 it is estimated there will only be two workers paying taxes for every one recipient of Social Security benefits. At that time the surpluses generated each year will cease, and Social Security will begin to run a deficit (paying out more than it takes in). The government will then have to begin paying back the money borrowed from the trusts, plus interest. Since no money has been saved for this purpose, the government will be forced to increase the national debt, cut spending, or raise taxes. “Even worse, unless something is done, the entire Social Security system will use up its government IOUs and go bankrupt by 2037” (www.socialsecurityreform.org).
We’ve known about the approaching Social Security troubles for some time now. Numerous plans of reform have been proposed by Senators Gregg, Moynihan, Kerrey, Representatives Porter, Sanford, Smith, and the Federal Reserve Bank of Cleveland, State Street Bank, the CATO Institute, National Taxpayers Union Foundation, and the Center for Strategic & International Studies, and the Advisory Council of Social Security. Due to politics, no president has touched the issue. Even though we’ve known about the problems in Social Security, no president has ever attempted reform as it isn’t a current problem. Therefore it has never been a priority for those needing votes to stay in office. Now that we are as close as seven years to recalling the IOUs, the issue is rapidly progressing into a crisis. Even if we found a solution to Social Security’s inherent flaws, many people are worried it is too late. “One study shows that more people age 18 to 34 believe in UFOs than believe they will ever collect Social Security benefits” (www.socialsecurityreform.org).
President Bush currently has a bill believed to address the problems within Social Security, privatizing. Although there are many versions of a privatized Social Security system, the basic model is a proven solution to our current pension problems. Many countries all over the world have already switched to privatized systems. Chile switched to a privatized system in 1981. Once installed, the new system promoted increases in pensions, income, national savings rates, and provided investment capital for the economy. It also decreased taxes, national debt, and the average age of retirement. The United Kingdom also implemented a partially privatized system in 1978 (wwwncpa.org). Also, Sweden, Singapore, and multiple countries throughout Latin America have experience with privatization of Social Security.
A privatized system isn’t as foreign to America as you might think. It would work Similar to the already popular 401ks we are all familiar with. 401ks have succeeded in the private sector for years. In a privatized system tax revenues would be deposited into individual mutual fund accounts and compound interest until a worker retires. Workers would own their pensions and could pass them on to beneficiaries. Workers would also have a choice of a variety of funds to invest in. A portion of tax revenues would be paid as disability insurance, for continued support of the disabled. Another small portion would cover the administrative fees associated with managing the funds. It would also be necessary to raise funds to cover costs for converting to a privatized system. Since so many people will be dependent on the current Social Security system, a large portion of tax revenues would also have to be paid out to cover promised benefits. This would be similar to the current pay as you go system, only on a much smaller scale.
A privatized system would require a minimum contribution, but that minimum would be lower than the current tax rate. This would increase the average wage. In Chile prior to privatization payroll taxes were as high as 25 percent. Once privatized the minimum contribution to the private pensions was half that, at 13 percent. Once income tax was lowered, take home income increased by 18 percent (www2.bc.edu). Lowering income taxes not only increased workers’ wages, but lowered employers’ costs, which promoted job creation. And by requiring a contribution minimum privatized systems insure a steady flow of investment capital into the economy. Of course workers would have the option of contributing more than the minimum.
Offering workers ownership and control over their own pension promotes increased savings. The privatized system motivates people to save more and opt for a higher standard of living in their old age. In Chile the national savings rate increased from less than 10 percent in 1986 to 29 percent in 1996. Singapore’s retirement system has been private since it’s inception in 1955. As a result it has the highest savings rate in the world. Singapore also has the highest ownership rate; with 85 percent of the population living in homes they own (www2.bc.edu)
Privatizing Social Security would also replace a higher percentage of a workers income. In the United States Social Security is meant to replace 42 percent of a worker’s average lifetime income. In Chile their old system was supposed to replace 70 percent of a workers income. By the 1970’s Chilean benefits were replacing closer to 20 percent. In today’s system their average income replacement rate is 78 percent. What is even more impressive is such high returns are reached on rather small contributions. Remember Chile’s income tax dropped, once a privatized system was implemented, to 13 percent of income. 3 percent of income is spent on administrative expenses. Leaving only 10 percent of total income invested. In the United Kingdom between 1986 and 1995 the average interest returned on the private pensions was 13.3 percent, per year (www2.bc.edu). So by privatizing Social Security we will be practicing what is already preached about 401ks, IRAs, and government TSP accounts.
By privatizing Social Security the public pension burden would decrease as years progress. In Britain the private pension accounts will save their government 2 billion per year on pension spending. Chile also has had similar effects on their national debt. This would free up funds for better usage; such as higher contribution rates, paying off national debt, or decreased income tax further.
Many believe that there is no crisis, and Social Security only requires minor reform. If we did decide to stay with the current pension plan the government would have three choices. One, to increase the national debt by 10.4 trillion dollars, in order to survive the baby boomer hick-up. That is almost twice the combined wages of every working American in 2004, and would virtually bankrupt our government. Two, is to decrease benefits by 27%. Social Security constitutes 90 percent of income for one-third of Americans over the age of 65. Also, taking into consideration that Social Security only replaces as high as 42 percent of their lifetime income average. By decreasing benefits we would be forcing the retired into poverty. Unless you like the taste of dog food, that’s not a feasible solution either. Three, the government could increase income tax to 40 percent, not a favorable solution (www.whitehouse.gov). Not to mention all of these solutions are only temporary fixes. The economy always runs the risk of experiencing another hick-up, putting us right back to where we are today.
Then there are those that believe switching to a privatized system would create a tremendous financial burden on the public. The burden would be in the form of conversion costs and to pay promised benefits to those already in or too near retirement for private pension to have an affect. Some of the propositions to raise such funds are similar to the three mentioned in the subsequent paragraph. In a privatized system there would initially be two tiers. One tier would consist of the private pension funds. In the beginning switching to the private pensions would be optional. Consequently, creating a choice for the people in their financial future. The second tier would resemble our current system. A portion of income taxes would have to be contributed to pay the promised benefits. Other fail safes could be implemented in order to keep costs down or even zero them out. Such as rolling back President Bush’s proposed tax cuts. The most popular idea is to raise the Social Security income cap to one hundred forty thousand, restoring taxed wages to that of 90 percent of the workforce (www.socialsecurityreform.org).
Others argue that privatizing Social Security is a drastic and risky solution. Many hate to let go of the longest running anti-poverty program in America’s history. Furthermore they feel investing their entire future in the stock market could be a mistake. Well change is never easy. Yes privatizing Social Security is drastic, but less drastic than the tax increases necessary to overcome the baby boom hick-up. Also, less drastic than one-third of Americans over the age of 65 plunging into poverty. And even less drastic than increasing the national debt by 10.4 trillion. But privatizing Social Security is hardly risky. Investing in the stock market for the long run has always will always be a safe bet. Since its inception, investing in the stock market over long periods of time has always produced positive returns. Also, the successful privatized systems in Chile, the majority of Latin America, the United Kingdom, and Singapore are proof of its stability.
It has also been speculated that workers will have little control over assets. Although, workers could freely transfer pensions from one mutual fund to another; investments are similar across the funds. In other countries funds have required tight regulation in order to guarantee returns. In Chile if a mutual fund’s return is less than 2 percent of average return for all mutual funds available; the managing company is required to make up the difference out of its own assets (www2.bc.edu) Such tight regulations on returns necessitate mutual funds to only invest in reliable companies, which tend to be similar. Such an approach to regulation is in place for the investors’ safety. These regulations guarantee high returns for investors. Those guarantees further provide proof of a privatized system’s stability.
One of the true risks are high marketing costs tend to be associated with decreased returns. In some countries the companies responsible for managing funds often advertise and offer incentives for investors to transfer pensions to their mutual funds. Offering free cellular phones and bikes are common tactics. Incentives combined with high marketing costs decrease the returns for mutual funds. But such tactics could easily be regulated against, in order to keep returns high.
Another true risk is high administrative fees. In Chile administrative fees are 3 percent on total income taxed. Despite these high fees Chile’s average income replacement from private pensions is 78 percent. And even with high costs, Britain has seen high returns; averaged at 13.3 percent annually. So despite high fees returns have remained high.
The biggest argument against privatizing Social Security is that it tends increase inequality. Women and low wage workers tend to produce less income, there by contributing less to their private pensions. Also, low wage workers change jobs more frequently; disrupting steady contributions. Therefore returns for women and low wage workers are often less than for high wage workers, whose contribution rates are considerably higher. The fallacy here is assuming women and low wage workers will make even less in a privatized system. They too, will pay less income tax. Their wages will increase along with everyone else’s. They too, would see high returns on their pensions; such as Britain’s 13.3 percent. Which would still produce a higher income replacement; like Chile’s 78 percent. Compared to the current U.S. income replacement of 42 percent we are all looking at a higher standard of living in retirement, not just the high wage workers. Women, low wage workers, and high wage workers all stand to benefit from privatizing Social Security.
President Bush’s bill for implementing a privatized system (in the year 2009), is similar to what we’ve discussed here. But not taking action until we are three years away from running a deficit may be too late. Social Security may not be a crisis yet, but it is rapidly becoming one.
The flaws with our current pension plan affect every American. It is an issue in which we all should be concerned, and active in the solution. After all you and I are paying into a pension system that very well may not be there to support us, when we are ready to retire. Privatizing Social Security is a sound solution, it’s a proven solution, and offers a chance for a better life for all Americans. Change is never easy; but in this case, worth it.
Author unknown. Social Security Reform Center Web Site. 10 February 2005
Author unknown. Presidential Action Web Site. 10 February 2005
CATO Institute. Project on Social Security Choice Web Site. 10 February 2005
Goodman, John C. Social Security Reform: Other Countries Leading the Way. 10 February 2005
Concord Coalition. Social Security Reform Plan Summaries. 10 February 2005
Williamson, John B. Social Security Privatization In Other Nations: Lessons For The United States. 10 February 2005
Luskin, Don. Social Security Choice. 10 February 2005
Gleckman, Howard, Dunham, Richard S. “Social Security: It’ll Take A Helluva Sales Job”. Business Week 7 February 2005
Frank, Thomas. “The Trillion Dollar Hustle”. Harper’s Magazine June 2002