Social Security Privatization

There is no question that the Social Security System serves a vital purpose in our society and that it has reduced poverty among the elderly. However, the system was fundamentally flawed from its inception because it was never properly funded. Retirement benefits are based upon a willingness by subsequent generations to transfer a portion of their earnings to retirees, rather than upon real assets being set aside to fund those benefits. It was inevitable that this system would eventually break. We are now faced with the following problems.

Problems / Reasons to Privatize

• The system is expected to run short of funds in 2037.
• Workers perceive their Social Security payroll deduction as a tax, and not as savings for retirement. It ceases to be motivation to work. It unnecessarily distorts workers' incentives. And it limits workers' willingness to be taxed through the income tax system. The current payroll tax burden is particularly demoralizing to young workers.
• Since its inception in 1935, Social Security has reduced our national savings level. By Social Security providing a retirement benefit, individuals responded by saving less. That's OK if the Social Security System did the saving for the individual. But it didn't do that, which has had the effect since day one of reducing our national saving pool, causing lower economic growth. The very system that was designed to help seniors in their retirement years undercut the nation's ability to grow economically, and to create sufficient wealth to fund the retirees' needs.
• Because the system is largely a pay-as-you-go system, it is unfair to the next generation. This becomes particularly obvious as parents have less children. The working generation should be making every effort to set aside sufficient assets to fund their own retirements.
• The system is riddled with social injustice. Because it was never actuarially funded, Social Security has certain characteristics of a welfare system. For example, it takes money from one group and gives it to another group. Yet it takes without regard to a worker's income level and distributes it without regard to a retiree's income level. The progressivity that is currently built into the system is applied based upon wages earned while working and not upon need at retirement.

Rod Grams emphasizes the impending shortfall date of 2037, and the certain dire consequences that will follow. But, let's put this in perspective. Consider that just four years ago, the Social Security System was projecting a shortfall date of 2029. In that span of four years, we have pushed back the shortfall date by 8 years. The only reason this occurred was because of economic growth during those four years that was stronger than what the Social Security System estimated. The Social Security System assumes growth rates in the 2 percent area. If we achieve growth rates in the 3 or 4 percent area, the funding problem disappears.

In other words, there is a very real possibility that we will not have a funding shortfall. Rod Grams ought not to be exaggerating the problem in order to advance his agenda.

Secondly, all of the specific techniques for pushing this date back in a privatized system are available in the current system. For example, the current system, with proper safeguards, could invest in higher-return investments.

Flawed Reasons to Not Privatize

My DFL U.S. Senate opponents talk of the excessive risk of privatization. While it's certainly true that a poorly constructed plan could be excessively risky, privatization per se does not imply excessive risk. We could if necessary restrict investments to very conservative investments. In the extreme, we could require workers to maintain all assets in U.S. government bonds.

In addition, my DFL opponents fail to acknowledge the risk in the current system. The current system relies upon a social compact between generations. But, the catch is, the younger generation didn't really agree to this social compact. If the demographics become sufficiently burdensome, the younger generation may conclude that this social compact isn't fair, and move to reduce benefits. In effect, consideration of a fix such as increasing the retirement age is a partial abdication of this social compact.

Flaws in Rod Grams Plan

The particular plan Rod Grams offers is flawed in the following respects:

• Most importantly, it is not properly funded. If all eligible workers converted to private accounts, it would result in an immediate drop in payroll taxes to the Social Security System of approximately $360 billion per year. Meanwhile, expenditures would initially be mostly unchanged ($386 billion in 1999). Rod Grams plans on transferring the on-budget surplus to the Social Security System, but that surplus, based upon realistic spending targets, is expected to total only about $1 trillion over the next decade. $1 trillion would not begin to deal with the shortfall over the decade. To make matters even more difficult, Grams supports an income tax cut of roughly that amount, thereby eliminating the on-budget surplus as a source of revenue. And the above analysis does not consider the "recognition bond" payments directly from the U.S. Treasury to individual retirement accounts. The size of these payments is difficult to determine based upon his written plan, but could easily exceed $100 billion per year.
• The plan retains some of the same social injustice of the current system. The plan levies a 2.4 percent tax against current workers' wages up to the Social Security wage cap rather than discharging this shortfall through general tax revenues. The unfunded liability in the Social Security System is a general obligation of society, and is more fairly dealt with in the general budget.
• Workers under 30 receive no value in their retirement accounts in recognition of past contributions.
• There is no particular advantage in privatizing the disability and survivor benefit parts of Social Security.
• The plan appears to open up the U.S. Government to a huge potential liability by guaranteeing a minimum benefit equal to 150 percent of the poverty level. The current Social Security System does not provide this guarantee.

The Gibson Social Security privatization plan involves:

• Establishing individual retirement accounts for anyone under 55.
• Placing a U.S. bond in each individual account which represents the present-day value of the accrued benefits associated with that individual, such that the individual retirement account is actuarially sound.
• Placing a U.S. bond in the Social Security Trust Fund which represents the unfunded liability associated with the 55 and older retirees, such that the Social Security System is actuarially sound.
• Booking this implicit debt will increase the explicit national debt from approximately $5.7 trillion to approximately $15 trillion. This effectively transfers this unfunded liability to the U.S. Government, so that it will be discharged through normal tax revenues rather than solely on the backs of current workers' wages. The additional interest on the added debt will initially push the budget into the red. If the national debt as a percentage of GDP increases year to year, it will be necessary to increase taxes. Calculations performed in the full position paper showed that this percentage would likely drop year to year, and hence a tax increase would not be necessary.
• The survivor and disability parts of the Social Security System would remain unaffected.
• That portion of the current Social Security payroll deduction (and matching employer's portion) associated with retirement (approximately 10 percent) would be transferred directly to workers' individual accounts.
• Workers control investments in their accounts within certain fiduciary standards, in order to assure that the benefit level at retirement is least as high as it would be under the current system.

A full Social Security position paper is posted on the web site at http://www.jim2000.org.

Prepared and paid for by James Gibson for U.S. Senate
PO Box 50264, Minneapolis, MN 55405-0264, 612-521-5350