Any discussion of reform should begin by recognizing that the current retirement system is already a mixture of public and private plans. The public plan is universal but skewed toward protecting low-wage workers. Private or employer-sponsored plans cover about half the full-time work force, but they tend to leave part-time and lower-wage workers uncovered.
Advocates of privatization see a number of advantages in increasing the size of the private system and shrinking the size of the public one. For some proponents of privatization, ideological concerns are paramount. They are fundamentally opposed to public provision of retirement benefits.
More common are people who see important economic advantages in privatizing Social Security. They believe workers will receive larger pensions and the economy will grow faster under a private rather than a public retirement system.
Finally, some advocates of privatization believe the United States is more likely to take needed steps to prepare for a rising aged population if the retirement system is reformed to include a bigger private role. A few critics of Social Security, who are particularly distrustful of public intervention, believe it is an unwarranted intrusion on personal freedom to require workers to contribute a fixed percentage of their pay to a retirement plan.
Libertarians who hold this view oppose all mandatory saving schemes for retirement, whether or not the retirement funds are placed in private accounts. Most advocates of privatization acknowledge that it makes sense to compel workers to save for old age, disability, and early death. In the absence of mandatory saving, many workers would save too little and could become destitute and be forced to rely on public aid when they stop working. Most privatization advocates believe that decisions about the investment of retirement saving are best left up to workers and their employers.
Nearly all advocates of privatization try to appeal to these interests. They argue that pension contributions would be more affordable or benefits more generous if the nation moved toward a private retirement system. Stated crassly, most workers could expect a better deal under a private system than they can obtain under Social Security. This argument is based on a straightforward calculation.
If workers invested Estimates are displayed for workers born in a variety of years who earn steady wages at three different earnings levels. The low-wage worker is assumed to earn roughly the minimum wage; the average-wage worker earns the average covered earnings under Social Security; and the high-wage worker earns about two-thirds of the maximum taxable wage.
The Actuary then computed the interest rate that would be required so that the discounted value of real tax payments would be exactly equal to the discounted value of real benefit payments. Two facts about Social Security stand out in figure 2.
Low-wage workers get a better deal than high-wage workers, and workers born before get a much better deal than workers born later. Even more striking than the disparity between low-wage and high-wage workers is the difference in returns enjoyed by people born before and after The high return enjoyed by workers born before helps explain the current popularity of Social Security, especially among older voters.
In particular, workers born around enjoyed two pieces of good fortune. When they entered the work force in the early s, the combined employer-employee tax rate was just 2 percent. More recently, the tax rate has been raised to cover much more generous pensions to a far larger number of retirees. Workers born in , for example, faced a combined contribution rate of People born in were also fortunate in enjoying rapid wage growth throughout most of their careers.
Real annual earnings climbed 2 percent a year between and , rising about percent over four decades. Rapid growth in real wages produces a good rate of return in a pay-as-you-go pension system. Unfortunately, real wage growth slowed dramatically in the mids. The economy-wide average wage did not grow at all in the twenty years from to Slow wage growth will be reflected in slow growth in pensions and a lower rate of return on Social Security contributions for future generations of retirees.
In fact, because taxes will have to be hiked or benefits cut to keep Social Security solvent, workers born after will probably receive lower returns than those shown in figure 2. Many advocates of privatization believe that full or partial privatization will boost U. The low rate of capital accumulation contributes to the slow growth of national income and wages.
If saving could be increased, income growth would accelerate, making it easier for the nation to afford the extra burden of supporting a large retired population in the next century. Unlike the present Social Security system, which is largely financed on a pay-as-you-go basis, a private retirement system would involve huge accumulations of assets in individual retirement accounts. Because workers would be setting aside a percentage of their pay in private accounts for their own retirement instead of sending in contributions that are immediately spent on pension payments, the introduction of a privatized system could lead to a jump in saving.
In theory, national saving can be raised within the existing Social Security system, even if there is no move toward privatization. This could occur if Congress raised the present contribution rate or reduced benefits, increasing the annual surplus of the program. The Social Security trust funds would accumulate larger reserves than are anticipated under current law. Instead of accumulating assets in tens of millions of individual retirement accounts, as in a private system, the saving would take place in a single public fund.
Advocates of privatization doubt, however, that the funds accumulated within a public fund would actually be saved. They fear Congress would use the funds to finance growing deficits in other government accounts, such as Medicare. In the absence of larger Social Security surpluses, the Congress would be forced to deal with the deficit in other programs, either by curtailing spending or by increasing taxes.
A larger surplus in Social Security makes it easier for Congress to avoid this unpleasant choice. Privatization advocates therefore think it is safer for the accumulation to take place in tens of millions of privately owned accounts, outside the reach of a revenue-hungry Congress. Privatization also offers a politically acceptable method of managing the accumulation of huge reserves and corporate stocks.
In a system where the accumulation takes place in a single public system, legislators and public officials would be responsible for allocating the funds among investment alternatives and across individual companies. Their investment decisions might be guided by political rather than economic considerations, reducing the yield of the investments, diverting investments into unproductive uses, or intruding on the business decisions of company managers.
In a private system of individual accounts, decisionmaking authority over the accumulation would rest on the shoulders of millions of workers. Through their choices among investment alternatives and specific investment funds, workers and private fund managers rather than public officials would exercise ultimate authority over the allocation of investments.
A private retirement system, with its broad dispersion of asset ownership, also has an advantage over a public retirement fund when it comes to accumulating corporate stocks. The U. If retirement asset accumulation took place within a single public fund and if the public fund owned shares in thousands of companies, Congress or public trustees would have to decide how these shares should be voted. Voting decisions might be determined by political rather than economic criteria, possibly reducing the efficiency and profitability of American business.
Some advocates of privatization also maintain that voters would be more willing to accept an increase in their combined contribution to the retirement system if percent or more than percent of their extra contribution took the form of deposits into individually owned and managed investment accounts. While voters would reject a hike in the payroll tax, they will tolerate — and may actually welcome — compulsory saving in individually owned accounts.
This argument for privatization is essentially pragmatic. Because the work force is growing older, it is important to raise national saving. Voters and Congress are more likely to take the steps needed to increase saving if workers have direct ownership of their extra contributions to the retirement system.
This fear is exaggerated but not completely unfounded. In order to pay promised Social Security benefits, the future contribution rate must be increased. Future voters might balk at paying higher taxes, and benefits would then have to be cut.
The expected revenues of Social Security will fall short of expected benefit payouts by 14 percent over the next seventy-five years, a shortfall that is equivalent to 2. By benefit payments would need to be cut nearly one-quarter to keep the program solvent under the present payroll tax. This does not mean Social Security pensions must eventually be eliminated, as some young workers fear, but it does mean their taxes must be increased or their benefits cut if the system is to be preserved.
The two main economic arguments in favor of privatization are that it would increase real returns on pension contributions and boost national saving. Both arguments are valid, for some forms of privatization, assuming the public system to be dismantled is financed on a pay-as-you-go basis. There is no reason, however, that public retirement benefits must be supported with pay-as-you-go financing.
The important distinction is between advance funding and pay-as-you-go financing, not between public and private management of investment funds. Millions of employees of state and local governments have advance-funded pensions, and their pension funds are publicly managed. Advance funding, combined with a more aggressive investment strategy, can offer a higher return to current and future contributors. The larger accumulation in pension funds, whether they are publicly or privately managed, can boost national saving.
If the reserve were invested in the same mix of assets that would be selected by workers, it would earn an identical rate of return. The net return would actually be somewhat higher, because the expense of maintaining a single public fund is considerably smaller than the cost of administering tens of millions of private accounts, many of which would be extremely small.
For Social Security to accumulate the same kinds of assets that workers would place in private retirement accounts, a change in Social Security investment strategy is needed. By law, Trust Fund reserves are invested in U. Treasury debt where they earn the rate of return on publicly held U.
Workers seeking a high return on their retirement savings invest in other types of assets in addition to government securities. Based on the experiences of workers who invest in k pension plans, the Advisory Council estimates that 55 percent of the retirement savings of workers under age forty would be invested in equities. One of the three plans outlined by the Advisory Council proposed investing up to 40 percent of Trust Fund reserves in corporate stock, increasing the expected rate of return on reserves by about 1.
The Social Security Actuary has calculated the rate of return that workers can anticipate under the current system and under alternative systems proposed by the Advisory Council. These calculations are helpful in understanding the potential gains from privatization and how they are achieved. Figure 3 shows the expected rate of return of an average-wage worker under two alternatives.
One alternative assumes workers will continue to receive Social Security benefits under the present benefit formula but that taxes will eventually be raised starting in to ensure that the OASDI Trust Funds are never depleted.
This strategy keeps Social Security solvent, but it reduces the rate of return received by younger workers, because they must make larger contributions to obtain the same amount of benefits. Figure 3 shows that the rate of return under this policy will decline continuously for workers born in successive generations. Average-wage workers born in will typically receive a return of just 1. The second alternative assumes that 5 percent of the present payroll tax is diverted into private retirement accounts; an extra 1.
The Actuary assumes that almost half of the funds in private retirement accounts will be invested in stocks and that stocks will yield an annual real return of 9. For workers born in , the rate of return under the partially privatized system is predicted to exceed the return under a solvent OASDI system by 2 percentage points.
There are four main reasons for the difference. First, a private system will absorb some worker contributions for administration of the individual accounts.
In addition, workers will not invest all their contributions in the stock market, preferring instead to invest some funds in less risky assets, like government bonds, where yields are lower. Risk-averse workers may invest much less than half their funds in stocks, especially as they near retirement.
For middle-aged workers, returns will also be low because much of their retirement income will come from scaled-back Social Security benefits. As these benefits are reduced for example, by raising the age of entitlement for full pensions , workers will be forced to accept a lower rate of return on their past Social Security contributions.
Workers contribute 6. That limit could be raised so that workers with income well above that threshold continue to pay into the system. Because the limit on payroll taxes is adjusted every year, that gap would eventually close. Even moving it up by just a tenth of a percent or a hundredth of a percent could make a big difference with million workers paying into the system, she said. In , Congress mandated that the full retirement age would gradually rise to 67 from 65, a change that is still being phased in today.
Congress could consider raising the retirement age again. Many argue that could make sense, as people often are waiting longer to retire. Yet, implementing such a change could be tricky, particularly if that resulted in a bigger reduction for people who claim retirement benefits when they are first eligible at age 62 and who may no longer be able to work. While the extent of any future changes to the program is unknown, the key for individuals and families is to stress test their retirement plans, Elsasser said.
But that delay would cause significant anxiety for these workers, whose future benefits would be at risk. Moreover, people decide when to retire based on projections of their incomes in their initial year of retirement and in the remainder of their lives.
Congress needs to act sooner rather than later to ameliorate this problem. One possibility would be to include a fix in the stimulus legislation to cope with the economic effects of the COVID pandemic that Congress is currently considering. Two issues that are likely to arise in any discussion of fixing this problem are its cost to the Social Security trust fund and its cost to the federal budget.
With regard to the cost to the Social Security trust fund, there are three ways to look at the issue. One way is to view the cost relative to costs in a world in which no pandemic had occurred. From this perspective, the cost would be zero because the legislative change would restore the world of Social Security benefits to what it would have looked like had there been no pandemic.
A second way of looking at the issue is to view the cost of the change relative to costs in a world that reflected economic assumptions indicative of the economic recession caused by the pandemic. From this viewpoint, there would be a cost associated with fixing the problem. The year actuarial imbalance in the Social Security trust fund is estimated to be 3.
The third way of looking at this would be to construct a baseline that reflects occasional decreases in the AWI such as those experienced in and, very likely, now. From this perspective, there would also be a cost to fixing the problem. The issue is less one of cost and more one of restoring fairness to beneficiaries. This seems to be a fair outcome.
In particular, the costs of provisions related to unemployment insurance have been estimated using an updated and notably higher projection of the unemployment rate. Therefore, any estimates of an AWI adjustment would likely be made relative to an updated baseline.
The CBO has not yet made an estimate of the size of that cost. As with the cost to the Social Security trust fund, the issue is less one of costs and more one of restoring fairness to beneficiaries. This seems like a fairer and more appropriate perspective on the issue. If Congress does not act, future retirees who turn 60 in will very likely suffer a dramatic reduction in their Social Security benefits as a result of the fall in the AWI caused by the pandemic.
These retirees would also receive benefits that would be significantly less than the payments received by retirees who turned 60 last year, creating a serious Social Security benefit notch. The benefits of spouses and dependents of retirees, workers with disabilities and their dependents who are first eligible for benefits in , and some survivors and their dependents would also be lowered.
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