Should We Privatize America’s Social Security System?

By Serena Peck

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There is currently much debate over the Social Security system in the United States. Many economists have predicted and feared that the current system is inadequate, and that funding will be close to exhaustion by the year 2030 (Stephenson, pg. 7). In order to prevent such a catastrophe, many have suggested privatizing Social Security in America, a step that many other countries have already taken. Privatization has been proposed in many different forms, ranging from the investment of the current Trust Fund in equities, as well as the creation of private, individual retirement funds for each worker (Stephenson, pg. 16). There are arguments both for and against privatization, each of which are viable and salient. Regardless of where one falls on the issue of privatization however, it remains clear that the current system needs to be altered in some way.

The reasoning behind the current discussion of privatizing Social Security stems from research claiming that the current system in not viable in the long run. Because of the baby boom, the number of retirees in the upcoming years is expected to increase by a large margin, outnumbering those in the workforce. Thus the current funding provided by the Social Security system will deplete. "Unless future generations of the young prove willing to pay taxes on a scale seen nowhere in the present century, the young adults of today cannot expect as they reach old age a treatment comparable to that which they are now giving the aged, let alone a return commensurate with their many times greater lifetime contributions." (Johnson and Faulkingham, pg. 145). Statements such as these highlight the growing concern of economists that the current system needs to be reformed. Privatization of the Social Security system is the most prominent solution.

Before determining whether or not privatization should be considered for the Social Security system, it is necessary to outline the proposals for such an initiative. The first is a more broad approach to privatization. The current Social Security Trust Fund, which is partly responsible for distributing Social Security benefits to each individual, would begin to invest in equity markets (Stephenson, pg. 15). Those in favor of such an initiative claim that the government’s position in the stock market as a long-term investor would reduce the volatility of the market, and serve as a stabilizing force. However, if such steps were taken, the government would own a large amount of stocks, blurring the lines between the public and private sectors. There is also the argument that the stocks selected by the government could potentially be politically influenced, or determined by partisan or other political loyalties.

The second broad proposal for privatizing the system advocates the creation of individual, personal retirement accounts. Employees would have to contribute portions of their incomes into such accounts. However, these personal accounts would have the option of investing in the stock and bond markets (Gramlich, pg. 61). Thus payments from these accounts depend on what has been accumulated, and thus they are referred to as defined-contribution benefits, as opposed to the defined-benefit systems explained in the paragraph above.

A necessary step that the government would have to take in enacting a defined-contribution, individual account system would be to compensate those already participating in the current Social Security system. This would have to be enacted by the issuing of government recognition bonds equal to the value of what each individual would be entitled to (Feldstein, pg. 11). This would initially result in government debt. However, there are some that argue that this debt could be relieved with Fiscal policy, cutting government spending or increasing taxes. Initiatives such as these could result in an increase in savings (Mitchell and Zeldes, pg. 366). Feldstein argues that during the first year of privatization, because the government does have to pay off its debts, there would be no increase in capital stock accumulation. Eventually however, once the system was in place, net capital investment would increase, and thus capital accumulation would increase (Feldstein, pg. 11). According to his calculations, this increase in capital accumulation would result in a 2% increase in the GDP.

In determining whether or not the United States government should privatize the Social Security system, one must first look at the benefits of the current public system. According to Stephenson, Horlacher and Colander, there are two major reasons why a public system is beneficial. The first is that it protects the funds from market failures (Stephenson, pg. 5). The second is that a public system promotes altruism, prevents free riders, and upholds the good of society as a whole (Stephenson, pg. 6). Mitchell and Zeldes also comment on the benefits of the current system. Public Social Security allows for an account to be set up that can not be spent before retirement age. It also insures against earning loss. The system also redistributes income from the more privileged to those in need. Social Security is currently pay as you go, controlled by the government and not by inexperienced individuals, and it is a defined-benefit system (Mitchell and Zeldes, pg. 363).

There are two sides to the issue of creating individual retirement accounts. Those who support the initiative, do so for a number of reasons. One justification for privatizing the Social Security system in such a way is that it encourages financial responsibility and allows one more autonomy in deciding how their retirement money will be accumulated (Gramlich, pg. 61). This autonomy would allow individuals to choose more successful stocks, and increase the effectiveness of their fund. However, this autonomy may also disadvantage many individuals. People do not always know how to make wise investment choices, and investing in the stock market can be a risky endeavor. By investing in the Private sector, Americans are subject to volatility and shocks, which can have detrimental effects on the success of a retirement fund.

Another reason why some economists support privatizing Social Security is because they believe that it will be more lucrative, and will lead to greater return on their retirement funds. Feldstein argues, " The rate of return that individuals earn on their mandatory Social Security contributions is far less than they could earn in a private pension of in a funded Social Security system."(Feldstein, pg. 2). He examines a phenomenon that he calls the "deadweight loss", in which individuals are currently being forced to pay more for their retirement incentives than they should. Because of the current system, Americans are receiving a 2.6% increase in return on Social Security. He determines that from the years 1960-1995, if Social Security were to have been privatized, then Americans would have received a 9.3% increase. This has resulted in a deadweight loss of 1% of the GDP, as of 1995 (Feldstein, pg. 3).

Mitchell and Zeldes argue against this idea in part, by addressing whether or not privatization results in higher returns. The authors claim that one can not make a comparison between returns generated from private sector investment and returns generated from the current system. First, they assert that along with the higher returns of equity investment comes higher risk. Second, the current system has the burden of paying retirees what they have promised, which is true in both systems (Mitchell and Zeldes, pg. 366).

The issue of savings, both on the national level as well as the household level is raised by both sides of the debate over privatized Social Security. Mitchell and Zeldes determine, however, that the effects of privatization on savings are not necessarily as sound as some economists might wish. In terms of household savings, the reduced political risk that a less "governmental" program would induce could potentially lower household savings due to precautions. However, there is the reverse possibility that the decreased governmental involvement and thus the sense of insurance that is lost with autonomy may increase household savings. Thus there is no concrete conclusion as to the effects of privatization of Social Security on household savings. With respect to national savings, Mitchell and Zeldes argue that privatization would have no effect. As was mentioned earlier, the only way in which national savings would increase would be due to fiscal policy changes in response to the debt incurred by the issuing of government bonds.

In conclusion, it is clear that there are two opposing sides to the issue of Social Security privatization. If it is in fact true that the current system is not viable past the year 2030, then changes and alterations need to be made to Social Security. However, privatization may or may not be the answer. Although it has the potential of drawing more revenue, one would have to come to terms with the fact that the stock market is risky. The American public will have to wait to see how the issue resolves itself. However, it seems that most of America is relatively uninformed about the need for change in the current system, and until there is widespread public support for privatization, one has to wonder when and if it will be enacted.

Serena Peck

Bibiliography

1) Kevin Stephenson, David Horlacher and David Colander, "An Overview of the U.S. Social Security System: Problems and Options" in Social Security Time for a

Change, edited by Kevin Stephenson, JAI Press, 1995, pp. 3-23.

2) Paul Johnson and Jane Falkingham, "Public Pensions, Government Expenditures and Intergenerational Transfers" in Ageing and Economic Welfare, Sage

Publications, Newberry Park, California, 1992, pp. 124-151.

3) Edward M. Gramlich, "Different Approaches for Dealing With Social Security", The Journal of Economic Perspectives, Vol. 10, No. 3, Summer 1996, pp. 55-66.

4) Martin Feldstein, "The Missing Piece in Policy Analysis: Social Security Reform", American Economic Review, Vol. 82, No. 2, May 1996, pp. 1-14.

5) Olivia S. Mitchell and Stephen P. Zeldes, "Social Security Privatization: A Structure for Analysis" American Economic Review, Vol. 82, No. 2, May 1996, pp.

363-367.