What is Social Security Privatization?

With critical financial trouble on the horizon privatization is one suggested method to save the Social Security assistance program.

Author Attorney Greg Reed:

The Social Security system has been a highly successful program to help financially support those who are past a normal working age and those with disabilities who cannot work. Individuals earn the right to participate in the program if they work for a specific period of time incrementally contributing to the collective fund. This fund is rapidly running into financial trouble due to declining worker-to-beneficiary ratios and privatization is one method some believe will save the program.

While there are several variations on the theme, the basic premise of privatization is that retirement funds would move from a pooled trust fund to individual accounts.

It’s no secret that the Social Security program is in trouble.

The 2015 annual Trustees’ report states that Social Security’s Old-Age and Survivors Insurance program (OASI, the largest program) lost $39 billion in 2014. The report also states the OASI has lost money every year since 2010 and is projected to continue running at a deficit until 2035, at which point the program will no longer have the funds to make the projected payments. Social Security’s other major program, Disability Insurance, is in even worse shape. The Disability Insurance trust fund was slated to run out at the end of 2016, but the program was kept afloat by transferring funds from the retirement program.

There have been many proposed solutions to the Social Security deficit.

Some have suggested that the retirement age be raised so people will spend more time paying in to the system and less time drawing benefits. Others have suggested only paying benefits to low-income individuals and cutting benefits for those who have enough to live comfortably without them. 47,000 millionaires collect retirement benefits, and while the wealthiest Americans could probably get along fine without them, cutting the benefits of a few thousand will not be enough to save the system. One of the more controversial solutions is privatization.

Currently, younger workers pay in taxes which benefit older workers.

When the younger workers age, there will theoretically be a new set of younger workers paying taxes to fund their benefits. This is called a “Pay as you go” system (PAYG). In contrast, Privatization would take a percentage of a worker’s income and invest it in a private account. The private account would be tied to individual rather than younger taxpayers.

There is some debate over the best way to transition to this system.

There is the voluntary “carve-out” plan or partial privatization, which has been implemented in the United Kingdom, where some money is invested in a private fund and some is used to pay for the benefits of retired workers. This is similar to the policy being promoted by current presidential candidate John Kasich. On the more extreme end, some countries, such as Chile, have Social Security systems that are entirely privatized.

There are also several viewpoints on what should happen to the money once it is in a private account.

Some have suggested that the government invest in mutual funds, while others believe the taxpayers should choose how to invest the funds individually. Letting individuals invest their own funds allows the greatest freedom and flexibility, but also may lead to people making foolish investments. Presidential candidate Donald Trump has said his privatization plan would include guidelines to “make sure that your money is diversified, that it is invested in sound mutual funds or bond funds, and not in emu ranches.”

While there are several variations on the theme, the basic premise of privatization is that retirement funds would move from a pooled trust fund to individual accounts.

Over thirty different countries have implemented some sort of privatization, and the results have been varied. Chile provides an excellent case study as it has had privatized Social Security since 1981.

Other countries have tried privatizing their assistance programs, how has it worked out for them?

There are many good ideological arguments both for and against the privatization of Social Security. However, before looking at those, let’s see how privatization has worked out on a practical basis in the other countries that have tried it. Currently, there are over 30 countries around the world that have a privatized or partially privatized system. This list includes Australia, Chile, Denmark, Italy, Mongolia, Sweden, and the United Kingdom. Much of South America is also on the list.

Currently, there are over 30 countries around the world that have a privatized or partially privatized system.

Chile was the first country to transition from a “pay-as-you-go” system like ours to a privatized system in 1981.

Privatization has generally worked well there. In the US, the rate of return for individual (taxes paid in vs benefits paid out) is generally well under 5%. In Chile, the average rate of return is 11%. However, privatization in Chile has not been without its problems. One of the most serious issues with privatization is an increase in income inequality. Social Security is ostensibly designed as a benefit to the poor, but, under privatization, workers who earn more are able to invest more. A 1995 study demonstrated that a woman earning 75% of a man’s salary would only receive 35-45% of his pension.

A second major issue with privatization that has arisen in Chile is noncompliance.

Roughly half of workers choose to not contribute anything to their private accounts. Those who do not contribute are still entitled to a minimum benefit, but the minimum benefit is not enough to provide even a basic standard of living. This essentially leaves half of Chilean workers without a retirement plan. It should be noted that those who do not contribute to retirement funds are generally the poorest workers who need to spend the money on immediate needs rather than save for the future.

In the other countries that have tried it, privatization has had mixed results.

It increases the rate of return on investment, and, on its surface, appears to be a more solvent system. Some claim privatization in the UK turned their pension system from a £3 billion expense to a £2 billion source of income. There is also a negative side to entrusting citizens with greater personal responsibility over their money. In the United Kingdom, many workers made poor investments and ended up losing a lot of money in what was known as “the pension mis-selling scandal”. In Chile, high administrative costs outweigh the increased return on investment. By some estimates, the 11% average rate of return claimed by the Chilean government is really only around 5% once administrative costs are factored about- roughly the same as the rate of return in the United States.

While Chile and the UK are good examples of the benefits and costs of privatization, they are both very different from America demographically and culturally.
America’s values of personal liberty, individualism, responsibility play a large role in politics and public policy.
In our next segment, we will discuss the benefits and costs of implementing such a program in the United States.

There are good arguments both for and against the privatization of Social Security. What are the benefits and costs?

Entitlement programs have always had a controversial history in the United States. Americans believe in empathy, compassion, and helping your fellow man. In contrast, America is also a country of rugged individualism, self-sufficiency and personal accountability. Social Security is the biggest entitlement program, so it’s no surprise there is a lot of debate over how to fix it. Privatization- taking the pooled fund and dividing it into individual accounts- has been one the most controversial solutions proposed.

There is a legitimate fear that the population will age and the decreasing number of younger workers will not be able to support the increasing number of retirees.

Those in favor of privatization believe it will fix the Social Security deficit, increase the rate of return on investment, and allow individuals to take control of their retirement. Those on the other side do not believe privatization will fix anything, and it will only contribute to higher costs. Below is a detailed look at the arguments from each side:

Increased Solvency

The main argument for privatization is that it will end the pay as you go system. Older workers will not be dependent on younger workers for their benefits. There is a legitimate fear that the population will age and the decreasing number of younger workers will not be able to support the increasing number of retirees. Privatization makes each individual responsible for their own fund and prevents the fund from being “raided” by the government.

Increased ROI

Estimates vary greatly, but the current rate of return on investment (ROI) on Social Security is between 1-5%. The stock market has an average ROI of 11.53%.

Individual Control

Personal responsibility is valued highly in America. Privatization will give more choice to individual. Depending on how it is implemented, privatization might allow individuals to decide how their funds are invested, pass them on to their children, or otherwise be able to control the fund in a way they can’t under the current system.

Lower Taxes

Theoretically, the increased rate of return means you don’t have to pay as much into the system in order to take the same amount out. This means payroll taxes for Social Security may eventually be lowered under privatization.

Ends Life Expectancy/ Inequality Issue

Wealthy people live longer than those in poverty. Because of this, the poor essentially subsidize benefits for the rich. If benefits are tied to a personal account rather than a pool, it will end this issue.

Arguments against Social Security Privatization

From the perspective of these arguments, privatization looks like a panacea for the Social Security Administration’s current funding problems. However, there are also many arguments against privatization.

Doesn’t solve the problem

It is possible privatization will do nothing to help the current situation and may even exacerbate it. A 1997 study showed that if 1% of payroll taxes had gone to private accounts (half of Presidential candidate John Kasich’s proposal) the trust fund would have been insolvent in 2015.

The wealthy tend to have multiple retirement savings accounts and the poor generally rely solely on Social Security. Under privatization, market fluctuations would then impact the poor much more than the rich.

Instability

If Social Security accounts are tied to the stock market, then a stock market crash could hurt retirees. The current system provides a fixed amount at regular intervals, which is beneficial to those without income from a regular job. Tying benefits to the stock market could make it significantly more difficult to plan for retirement.

People Can’t Handle Personal Responsibility

Perhaps the most cynical argument against privatization, this is also a very valid point. In looking at other countries that have attempted privatization, it seems this is the biggest issue. In the UK, citizens were simply not educated about investing and when they had the opportunity to invest they ended up losing a lot of money. In Chile, workers would rather have their money upfront than invest it for the future.

Greater Administrative Costs

Currently, the Social Security Administration only spends 1% of its revenue on administration. If each individual American has a private account, all these accounts would have to be created, tracked and maintained. Proponents of privatization say the opposite is true- private companies are more efficient and will be able to spend less on administration.

Inequality

Income inequality has become a big issue in American politics. In Chile, privatization has hurt the poor while benefitting the rich- the poor essentially opt out because they can’t afford to save, while the rich invest as much as they can and receive a high rate of return on that investment. Something similar could happen here. The wealthy tend to have multiple retirement savings accounts and the poor generally rely solely on Social Security. Under privatization, market fluctuations would then impact the poor much more than the rich.
There are several strong arguments on each side. Given how privatization has performed in other countries, it is clearly not a magical solution. On the other hand, Social Security is losing money and changes will need to be made in order to keep it afloat. Privatization could be a viable solution which allows individuals to receive a greater benefit and have more control of their money. On the other hand, privatization could become just another way to push the most vulnerable Americans deeper into poverty.