My Analysis of Social Security Privitization
April 17, 2008, 6:00 pm
Filed under: Economics, Poverty | Tags:

The issue of Social Security privatization is one of the most contentious and politicized discussions in contemporary American economic discourse. While at its core a macroeconomic policy decision, Social Security policy reforms have definite implications for individuals as they relate to budget constraints, taxation and issues of adverse selection (in the case of privatization). Most importantly, Social Security concerns consumption and savings for two-periods, the present and the future, an issue which is at the core of microeconomics.

The current program operates under the Old Age Survivors Insurance (OASI) system which protects people against loss of income due to old age or the death of a breadwinner. In 1935, Congress passed the Social Security Act, creating “a system of Federal old-age benefits’ for workers and their families. In 1935, the United States was in the midst of the Great Depression and those most impacted were the elderly, who lost their money but who because of old age, could not work.

What is crucial to point out is that Social Security is not insurance but rather an intergenerational income-transfer program that collects taxes from workers and gives it to the programs beneficiaries. According to the Government Accountability Office, Social Security paid almost $493 billion in benefits in 2004, covering nearly 47 million people nationally. While a large part of the Federal Budget, Social Security has had the tangible result of reducing poverty among the elderly from nearly 35% in 1959 to about 10% in 2003. While Social Security is offered to all seniors who meet the requirement (having themselves put into the system), the people who benefit the most are women, members of minorities and beneficiaries aged 75 and older, who are all more likely to be poorer than the average beneficiary.

When the program began in 1935, there were 16 workers for each beneficiary. At present, that ratio has been reduced to 3.3 workers per beneficiary and it is expected that by 2030, it will decline further, to 2.2. The most vocal supporters of Social Security privatization can be found among the younger generation, who feel that they pay into a system which does not directly benefit them. Workers now are told that while Social Security is a good program, it is flawed and when they retire, they will not enjoy the benefits of the system.

Studies indicate that those now age 40 and younger can expect to earn a real rate of return of about 2 percent on their Social Security tax dollars, substantially less than what they could earn from personal investments. Thus, Social Security has been a good deal for current and past retirees. It is not, however, a very good deal for today’s middle-aged and younger workers.

Does privatization help workers by giving them more control over their saving? The current debate rests on arguments of crisis and efficiency. Proponents of privatization assert that the current system is headed for imminent collapse. The current trust fund bonds which constitute the Social Security program are simply an IOU from the Treasury to the Social Security Administration. Because the government is payee and recipient, the funds ‘net value to the government is zero!’. President Bush argued in 2005 that “By the year 2042, the entire system would be exhausted and bankrupt.” Moreover, because the market is more efficient, allowing workers to manage personal savings accounts will greatly enhance their savings. Ferrara and Tanner posit:

If they took the money that they currently pay in Social Security taxes and invested those funds in standard diversified portfolios of stocks and bonds, average-income families could expect to retire with accumulated savings of nearly $1 million or more.

This paper asserts that privatization debate rests on a shaky foundation. Paul Krugman and other economists debunk the doomsday argument. Krugman points out that Social Security will collapse only in a great fiscal crisis where the federal government is forced to default on all its debts. Obviously if that were to occur, privatized plans would suffer the same fate. Moreover, U.S. government Treasury securities are the safest investment tools in the world. Bush too is wrong. By 2042, their will be enough new money coming into the system to support 73-80 percent of promised benefits. Furthermore, new beneficiaries will still receive more money, in inflation-adjusted dollars, than today’s beneficiaries.

Social Security is an important source of income for more than 80 percent of elderly Americans and indeed, the only source of income for the poorest 40 percent of elderly Americans. Under Social Security privatization, workers face the risk that financial markets can under perform or even collapse. If markets under perform, workers will be forced to work longer and retire later, which invariably will lead to labor market pressures.

What is not considered in the arguments put forth by Cato Institute and other libertarian and conservative economists is that given the current economic decline, the government will have to bail out privatized funds that under perform. Christian Weller asserts that to avoid such large labor market pressures, ‘the federal government would likely have to bail out individual accounts instead’. Based on historical data, Weller estimates that the costs of government bailouts could exceed $900 billion in present value over the next 75 years.

Market fluctuations, such as the one we are currently experiencing, are unavoidable and unpredictable. Such fluctuations can create substantial shortfalls in savings for entire generations of retirees. The government would likely have to implement financial support the impoverished elderly. Wheller asserts that ‘privatization would essentially amount to a system of insured gambling, where the government pays the bill if the market underperforms’.

Moreover, the change to a privatized scheme will undermine the progressive nature of the Social Security system. Proponents assert that Social Security works to the disadvantage of African Americans because African Americas have a shorter life expectancy and thus, while they pay into the system, they die before they can become beneficiaries of their hard work. Not only will a privatized system fix this, but my putting economic decisions in the hands of individuals, privatization actually encourages African American empowerment. This argument is specious as Maya Rockeymoore argues. Even if the rates of return on private instruments are the same, by the simple fact that African Americans earn less and have higher rates of unemployment, privatization will serve to widen the racial income disparities that currently exist.

So what is the appeal of privatization? By the simple fact that the ratio of workers to beneficiaries is declining, one can see that future beneficiaries will have no one to count on. One can see why younger workers can be turned on by the privatization logic. But according to the Congressional Budget Office, ‘to raise the rate of return for future generations by moving to a funded system, some generations must receive rates of return even lower than they would have gotten under the pay-as-you-go system.’ Some generations here means the younger generation, or more precisely, younger workers.

Social Security privatization would do more harm than good. While it would give more power to the individual to make financial decisions, it would create a degree of risk that would undermine the very essence of what Social Security and OASI were created to do. Microeconomics generally rests on the firm foundation that government involvement; whether it is price ceilings, subsidization or most other forms of assistance actually cause harm. Here, one can argue that Social Security, with its accordant market based deficiencies, is nevertheless a crucial tool of preventing many individuals from falling into the pits of poverty.

Government Accountability Office. Social Security Reform GAO-05-193SP. May 2005
George Bush. State of the Union Address. February 2, 2005
Washington Post. No Social Security ‘Crisis’ February 1, 2005
Christian E. Weller. Social Security Privatization: The Retirement Savings Gamble. Center for American Progress February 2005
Maya Rockeymoore. The Social Security Privatization Crisis: Assessing the Impact on African American Families Congressional Black Caucus Foundation. January 19, 2005
Congressional Budget Office report on Social Security Privitization July 21, 2004


2 Comments so far
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Very well thought out argument. What I do not understand is why our government “caps” higher-income earners’ contributions to Social Security? (By “cap,” I’m referring to the fact that only the first um, think it is $102,000? not sure – of income do you pay Social Security taxes on. Earnings above that you do not pay SS taxes on). If they are really worried about Social Security collapsing, just simply raising – or removing – the cap on contributions would bring a huge flux of money into the system. Besides, it’s simply unfair that a person making $102,000 contributes JUST AS MUCH as a person making $200,000, $300,000 or even more. There is something inherently unfair about that, especially considering that those who are earning at or below the poverty level must contribute on every single dollar they earn.

Comment by lauraann

You are correct. As much as those who want to privatize the system lament how Social Security is unfair to ‘individual rights (read: greed)’ the fact is that the system is no where as good as it should be and that the rich do not contribute their fair share. These issues you bring up are excluded from the debate.

Moreover, all the talk about Social Security being bankrupt fails to mention that the government has previously taken money from Social Security to pay off the national debt.

Comment by subalternate

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