How should Social Security be reformed?
August 5, 1998
in this forum:
Is there really a social security crisis? Is privatizing the only alternative we have to raising Social Security taxes? What risks do you see with privatization? What are the advantages of privatization? What happened to all of the money collected in the past?
Alison Dutch of Connecticut, asks: What are the advantages of privatization?
Carolyn Weaver of the American Enterprise Institute responds:
There are many advantages to a system of personal retirement accounts.
First, there would be substantial economic benefits from moving away from our current low-yielding system of income transfers--which shifts the cost of elderly transfers to workers and future generations--toward a fully-funded pension system in which workers save for their own retirement and reap the benefits of real capital investment. Prefunding social security's benefit obligations would increase national saving and investment and boost labor productivity, resulting in higher wages for American workers and ultimately higher living standards.
Second, as with an IRA or 401k plan, workers would own their accounts, meaning that they would have a legal claim to their contributions and investment earnings that is secured by the force of law. As a result, they would have the peace of mind of knowing that the money they put away for retirement was theirs, period, which would greatly facilitate long-term planning. Presently, individuals and families have little way of gauging what social security will offer decades in the future and thus how much and what kind of additional financial protection they require. While workers would take on investment risks with personal accounts, risks that would need to be managed effectively, they would shed considerable political uncertainty about the size and cost of future benefits.
Third, workers at all earnings levels, rich and poor alike, would be given the opportunity to accumulate real wealth and to build estates with which to better their own lives and the lives of their children and grandchildren. (Unless prohibited by law, families could inherit any balances remaining in a worker's account at death.) Every worker would become a shareholder and thus a stakeholder in the U.S. economy, directly involved in the investment decisions that so vitally influence their future wealth and income. Opportunities to accumulate wealth that now exist mainly for higher income Americans would become available to all Americans.
Fourth, with personal accounts, there would be a direct link between the taxes workers pay and the benefits they can expect to receive. Payroll taxes would become true contributions, like deferred compensation in the private sector.
Fifth, allowing workers to invest in broadly diversified portfolios offered by a wide range of financial institutions would expand choices and opportunities, spur the development of new financial institutions and products, and provide valuable information about what workers value at what price. It would do so, moreover, without distorting the allocation of capital in the economy. The funds available for capital investment would flow toward their highest-valued uses, without political interference or manipulation.
Finally, a system of personal accounts would fundamentally transform the financing base of social security, eliminating the funding crises that have become the norm. Personal accounts would be fully funded at all times. The system's fortunes would no longer be tied inextricably to uncertain demographics and to uncertain political actions and reactions.
Henry Aaron of the Brookings Institution responds:
Most Americans save little or nothing voluntarily. Only 20 percent have liquid assets greater than their annual earnings. Providing universal private accounts could help educate people about the virtues of saving.
Since defined-contribution accounts by definition have reserves as large as their future obligations, individual accounts could raise national saving. There would be leakages, however, as individuals could save less in other forms or borrow more. Furthermore, employers might find that workers became less interested in private pensions and reduce or cancel pension plans that now also generate saving. Furthermore, Congress might succumb to pressures to give people access to their "retirement" saving well before retirement, as they have already done with other tax-sheltered "retirement" accounts.
Furthermore, building large Social Security reserves could also boost saving, particularly if Social Security accounts were excluded from budget resolutions and budget reporting.