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Should Social Security be Privatized

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Should Social Security be Privatized?

Many people don’t understand how the Social Security system really

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works. There are no separate Social Security “accounts” set up for each

taxpayer to which he contributes his Social Security “tax” each year. Many

people believe these accounts exist, that the money they pay into their

accounts grows each year until retirement, and when they retire they get

back what they paid in with interest. This is not true. Most people are

unaware of the fact that our current Social Security system is a

“pay-as-you-go” program, which means that the revenue the federal

government raises each tax year for Social Security benefits is paid out

Many economists believe that our Social Security system is in need of a

major overhaul if today’s workers are to receive future benefits.

Thomas R. Saving, Director of the Private Enterprise Research Center at

Texas A University says, “What is wrong is that the Social Security

system was never set up to be a sound investment-based retirement system.

Karl Borden, professor of financial economics at the University of

Nebraska recently wrote, “Social Security is an unfunded pay-as-you-go

system, fundamentally flawed and analogous in design to illegal pyramid

schemes. Government accounting creates the illusion of a trust fund, but,

in fact, excess receipts are spent immediately.”

Robert M. Ball, former commissioner of Social Security said, “Some of

the trust fund money should be put into the stock market. I want to do it

to get a better return for the Social Security system. Historically,

long-term government bonds have had a real return, after inflation, of 2.3

percent a year, compared with 6.3 percent for stocks.”

Paul W. Boltz, economist for the T. Rowe Price mutual fund said, “When

we examine the pending financial crisis of our Social Security system, we

find, in effect, the characteristics of a government sponsored Ponzi-type

Michael H. Cosgrove, of the Dallas-based newsletter, The Econoclast

says, “People need to take the responsibility of investing their own funds

for their retirement. The Social Security system assumes people can’t make

that decision and government can do it better. The result is a bankrupt

These economists believe that by investing in the private market,

someone currently entering the labor force and retiring at age 65 can

expect to receive an inflation adjusted retirement benefit from 1.5 to 5.5

times the current social security benefit.

Increasing life expectancy and decreasing birth rates have combined to

create the crisis the system is now facing. For example, in 1950 there

were 16 workers for every social security retiree, while presently there

are only 3.3 workers for every retired worker drawing benefits. Estimates

are that by 2030 there will be fewer than two workers for every retiree.

Privatizing social security sounds extreme, but it has been done

successfully in other countries like Chile. Jose Pinera, who was Chile’s

minister of labor, privatized the state pension system in 1981. It is now

giving retirees generous pensions while fueling investment, growth and

improving living standards in that country.

The heart of the Chilean system is a mandatory savings plan. All

workers under age 45 contribute 10 percent of their monthly earnings in

special accounts, known as AFPs (Administradoras de Fondos de Pensiones).

Workers between ages 45 and 65 could shift to the new system at their

option. The funds in AFPs are professionally managed and invested in

stocks and bonds. The money may not be touched until retirement, at which

time the worker may begin phased withdrawals or purchase an annuity. At

the end of 1995 more than $25 billion was invested in AFP accounts. The

old Social Security system is being phased out. By 2030 Chile’s Social

security will entirely be privatized.

This system ensures the money a taxpayer pays for retirement goes to

helping that taxpayer retire (not others). It ensures the money paid in

taxes is invested and grows. It also gives taxpayers choices over their

plans and the age at which they want to retire.

If the US were to adopt a system like Chile’s, we could save our own

failed Social Security system and provide real security and peace of mind

to everyone. The money paid into these individual retirement accounts is

invested, meaning more capital is available to the business sector for

investment. An individual would have their very own pension, with their

name on it. The government would no longer control the money that the

individual paid in to it. It is the individual’s account, just like an

IRA. It is essentially a government mandated IRA. Only difference is your

tax payment goes into an individual’s account instead of going to the

government. Your income would not change because you already pay the tax.

You would simply redirect the payment into an IRA. People would be living

off their investment income and not a transfer payment funded through

economic growth-slowing taxes. The government would only need to cover

those people whose pension did not provide an adequate income. This would

be a much lower percentage than the current system of near 100 percent.

Politicians have been extremely reluctant to change Social Security

because any misstep could provoke explosive reactions from the program’s

43 million beneficiaries. Even Ronald Reagan at the peak of his popularity

pledged a defense of the present public system and in 1983 signed

bipartisan legislation to shore it up.

But this year the issue has surfaced in political debates. It provoked

a bitter exchange between the two candidates for the Republican

presidential nomination, Steve Forbes and Sen. Bob Dole.

When Forbes suggested that a part of younger workers’ payroll taxes go

into private retirement accounts, Dole ran television advertisements

denouncing the idea as “a radical untested plan that would end Social

Security as we know it.” But since then Dole has expressed interest in the

Since the creation of Social Security in 1935, money paid into the

program has been invested exclusively in interest-bearing government

securities, mainly long-term bonds. But you could obtain a higher return

on investment and increase retirement savings for the baby-boom generation

by channeling some of the money into the stock market.

But there are many questions such as: How much Social Security revenue

should be invested in stocks? Who would manage the investments? How many

private investment options should be allowed?

Economists also disagree on how stock markets might be affected by the

infusion of huge amounts of money. The financial services industry would

presumably benefit, but banks, mutual funds and insurance companies have

In a Ponzi scheme, money from new investors goes out to satisfy claims

of early investors. What else can you call Social Security? The current

retirees are paid much more than they put in, so the younger generation

has to pick up the tab. The system’s funds are invested in low-yielding

Treasury securities. Over the last 50 years, such investments have

returned 5.8 percent a year, while the Standard & Poor’s 500 has provided

In 1994, a poll was published indicating that more people in their

twenties believed in UFOs than in Social Security. Many simply do not

believe there will be anything in Social Security when they retire. A Wall

Street Journal/NBC News poll showed that 29 percent of all Americans now

expect to receive nothing from Social Security when they retire. Another

37 percent expect to get sharply reduced benefits. Among those under age

35, nearly half expect nothing whatsoever from Social Security.

Unfortunately, there is good reason for skepticism. According to the

latest report from the Board of Trustees of the Social Security Trust

Funds (OASDI), Social Security tax revenues will be insufficient to pay

current benefits as early as the year 2013. By 2020 tax revenues plus

interest on the Trust Funds will no longer be adequate to pay for promised

benefits. As more and more of this generation reaches retirement age,

Social Security expenditures rise sharply. By the year 2030, Social

Security outlays will have completely exhausted the Trust Funds and

current revenues will be short of expenditures by about 2 percent of the

annual gross domestic product. In order to meet such expenditures without

cutting benefits, the Trustees estimate that the payroll tax would have to

rise from the present 12.4 percent (half on employer and employee) to 19

In a recent Cato Institute paper, William Shipman of State Street Global

Advisors estimates that a worker born in 1970, investing all of his or her

payroll taxes in stocks, would be able to retire in 2035 on $11,729 per

month (in 1995 dollars), compared to an estimated Social Security benefit

of $1,908. For this reason, there is a growing consensus that at least for

younger workers there needs to be an alternative to Social Security. This

would necessarily require some movement in the direction of privatization.

Rep. John Porter, R-Ill., and Sen. Bob Kerrey, D-Neb., have suggested

partially privatizing Social Security by cutting the payroll tax rate by

1.5 to 2 percentage points and requiring that the tax savings be invested

in a form of individual retirement account.

The World Bank now urges developing countries to adopt Chilean-style

pension systems. In a 1994 report, “Averting the Old Age Crisis,” the bank

noted the positive impact of private pensions on saving, capital

formation, investment and economic growth. Also, by shifting from a

pension system in which people had no confidence to one that is fully

funded, the effect is to actually reduce the burden of payroll taxes. Two

recent studies have looked at the potential gains to the United States

from switching to a private system. Harvard University Professor Martin

Feldstein estimates that the value of future pension benefits would rise

by 60 percent, from $11.3 trillion to $18 trillion. Boston University

Professor Laurence Kotlikoff also found large potential gains in output

and living standards from privatization.

While everyone would be better off in the long run from a privatized

Social Security system, it would cost several trillion dollars to, in

effect, buy out the current generation of retirees. Thus while a private

Social Security system would clearly make sense if we were starting from

scratch, the cost of switching today may be too great. While the American

Association of Retired Persons will no doubt fight to the death to stop

privatization, in the long run its position is untenable. Social Security

is going broke and will eventually be replaced with a private pension

system. The sooner we at least start moving in that direction the better

it will be for future generations as well as today’s economy.

Privatization does contain pitfalls. The present Social Security system

is pay-as-you-go. It uses the receipts from today’s payroll taxes to

finance the checks for today’s retirees. If those tax receipts were

diverted to a new, privatized system, there would be an immense shortfall.

The loss would have to be made up either by hiking taxes, increasing

borrowing or drastically cutting benefits to current retirees. The

present Social Security system faces a long-term shortfall of between 1

percent and 4 percent of total payroll, depending on your projections of

future economic growth. But the existing pay-as-you-go system could be

rendered solvent by a judicious combination of increasing the retirement

age by two or three years and slightly

Also there is the question of whether to privatize the whole system, or

whether to add a second tier. We might keep the basic system but

with self-directed IRA-like funds. The basic tier would be redistributive

and pay-as-you-go. The supplementary layer would be private and based on

A further question is who bears the risk when investments go sour.

There is no such risk under the current system. The stock market looks

like a great retirement vehicle in the 1990’s, but it wasn’t so reliable

in the 1970s and 1930s. The program was deliberately designed as a social

guarantee of retirement income, not a system of government-mandated

Cite this Should Social Security be Privatized

Should Social Security be Privatized. (2018, Jun 29). Retrieved from https://graduateway.com/should-social-security-be-privatized-2/

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