July 18, 2000

July 18, 2000 | Commentary on Social Security

Social Security: As the World Turns

Whatever you think of Texas Gov. George W. Bush's Social Security reform plan, give him credit for challenging the notion that you can't discuss Social Security during an election campaign.

While Bush seems to be doing fine politically, critics have nevertheless denounced his relatively modest proposal as impractical and untried. This will come as a surprise to the workers in more than 20 countries that have switched from government-run pension systems to retirement plans based on long-term savings and investment.

So let's ask the obvious: If personal retirement plans work in places as diverse as Australia, Chile, Great Britain, Mexico, Poland and Sweden, why won't they work here?

While provocative, the arguments against privatization - the transition will cost too much, administrative fees will be too high, the safety net will be pulled out from under the poor, Americans are too unsophisticated to make smart investments - just don't wash. Because of well-developed capital markets and widespread stock ownership, privatization would probably be even more successful in the United States than it has been elsewhere. And it's been very successful elsewhere.

Critics worry there won't be enough money to pay retirees their promised benefits if we let workers shift some of their payroll taxes to personal accounts. It's true that we will need to find several trillion dollars over the next 20 years to fund promised benefits if we allow workers to invest some of their taxes. But this transition cost pales when compared to current costs. The Social Security Administration itself predicts that under the current system $21.6 trillion will be needed, above and beyond expected taxes, to pay promised benefits between 2015, when Social Security first dips into the red, and 2075. Seen in this light, switching to a system of personal accounts will save taxpayers money.

Countries with far fewer resources than the United States have made the transition to private accounts, so clearly it can be done. Lawmakers in these countries realized that the relatively short-term transition costs are far cheaper than the long-term unfunded liabilities associated with pay-as-you-go pension systems. By making this investment up front, Great Britain could be debt free by the year 2030, according to Organization for Economic Cooperation and Development (OECD) estimates. Sweden also has used pension reform to wipe out a huge long-term deficit.

What about administrative costs? If lawmakers create a system with unlimited individual choice and no participation standards, administrative costs could easily total 2 percent to 3 percent of assets under management. But this is unrealistic. Any private investment plan approved by Congress would probably limit choices to broad-based "index" funds, passively managed, where administrative costs would be a fraction of 1 percent. Australia's "Industry Funds" cost workers about $50 per year per person. In Sweden, funds can't even participate unless administrative charges are less than 0.5 percent of assets under management. Could U.S. workers expect costs this low? In many cases, they're getting costs even lower than this with their employer-based retirement plans.

How would the poor fare under a private system? Many critics assume a system of private accounts would mean less retirement income for low-income workers. But they are forgetting that Social Security is already a bad deal for the working poor. Many low-income workers - because of poor health and other socioeconomic factors - don't live long enough to recoup the taxes they paid. The rate of return for younger workers ranges from an average high of 2.39 percent for those living in North Dakota to a negative 0.01 percent in one suburb of Detroit. It's hard to see how any system of private accounts could do worse.

Nobody really has to come out a loser. The privatized Australian pension system, for example, has a safety net that guarantees all retirees at least as much retirement income as they would have received under the old government-run system. The two-tiered British pension system provides a similar guarantee. In Sweden, the new "safety net" benefit is larger than the minimum benefit under the government system.

Another common complaint is that ordinary workers will lose money because they don't know how financial markets work and will be vulnerable to slick sales people. This might be a valid concern if workers were asked to select individual stocks and make trading decisions. But any private Social Security system will require professional fund management. In Chile, workers pick from a list of approved pension funds; in Australia, joint management/labor committees select the funds.

This doesn't mean all fund managers will get high returns or that malfeasance is impossible. It does mean that a properly designed system can provide workers a safe and comfortable retirement without requiring them to understand so much as the difference between a stock and a bond.

It's too early to tell how Gov. Bush's Social Security plan will affect the presidential race. But if the current debate ultimately leads to a system of private investment accounts, the real winners will be U.S. workers.

Daniel J. Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation (www.heritage.org).

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy

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