Backgrounder- Heritage Backgrounders give researchers the in-depth information they need on a wide variety of key issues.
April 23, 1997
By Daniel J. Mitchell, Ph.D.
America's Social Security system is in serious trouble. Payroll
tax rates have been increased 17 times in the past 40 years, yet
promised benefits exceed projected revenues by trillions of
dollars. Moreover, Social Security has become an increasingly bad
deal for American workers who must pay record high taxes to a
system that provides only meager levels of income for their
retirement years. Even worse, there is no way to fix the current
system to remedy these problems. Additional payroll taxes or
benefit reductions would address the massive long-term deficit, but
only by making the system an even poorer investment for working
Americans; and raising benefits or cutting taxes, both of which
could improve the rate of return for workers, would catapult Social
Security into bankruptcy even sooner.
The only answer to these seemingly intractable problems is to
privatize the Social Security system. Countries around the world,
including Chile, Australia, Mexico, Singapore, and Great Britain,
have allowed workers to opt out of unsound government schemes in
favor of private savings plans. The results have been spectacular,
with higher levels of retirement income and more security for
senior citizens. Less well known is the success of private
retirement savings in the United States. More than 1 million state
and local government employees in the United States have been
exempted from Social Security and are now enjoying higher levels of
retirement income through private pension plans.
Privatization would not require any reductions in benefits for
those who already are retired or nearing retirement. It would
enable America's future elderly to retire with dignity, in addition
to bringing enormous benefits to the economy overall. Replacing the
payroll tax with a system of private savings accounts would boost
the anemic level of savings in the United States. It also would
boost the creation of jobs by sharply reducing the tax penalty
imposed on employment. The resulting increase in economic growth
would add thousands of dollars to the average family's income.
Despite these benefits, lawmakers may delay implementing
necessary changes simply because of the political risk they
associate with trying to reform Social Security. Doing nothing,
however, only guarantees that the United States will face a crisis
of alarming proportions when the baby-boom generation finally
Despite mounting national and international evidence to support
privatization as a remedy for Social Security's looming crisis,
policymakers are proceeding with great caution. Many of them
consider Social Security a "third-rail" issue, and the dishonest
"mediscare" campaign of the last election cycle likely has made the
subject even more difficult to address. But the political and human
costs of doing nothing far exceed the risk of reform:
1. Social Security is going broke.
2. Social Security taxes are too
3. Social Security is a bad deal for
4. Privatization is the way to
guarantee a safe and secure retirement.
5. Thousands of Americans already have
private retirement systems.
6. Privatization could jump-start the
7. Privatization is sweeping the
If Social Security were a private pension system, it would be
forced to declare bankruptcy. The gap between what Social Security
has promised to pay and what it expects to collect is
staggering-and this huge unfunded liability is just part of the
problem. Equally grave is the inadequate income Social Security
provides upon retirement when compared with the record amount of
taxes workers are forced to pay into the system.
In addition, this troubled system threatens the economy as a
whole. Left on autopilot, entitlement programs like Social Security
could push the overall budget deficit to record levels. Even
reasonably optimistic estimates conclude that federal borrowing
will grow at least sixfold, consuming 15 percent of economic
output.33 According to the Bipartisan
Commission on Entitlement and Tax Reform, entitlement spending
alone by 2030 will exceed total tax revenue collections, meaning
government would have to borrow just to fund all defense spending,
all non-entitlement domestic spending, and net interest.34
Opposing parties in Washington battle regularly over how best to
deal with the $4 trillion national debt. It turns out, however,
that they may be focusing on the molehill and ignoring the
mountain. According to long-term projections by the Social Security
Administration (SSA), future benefit payments exceed payroll tax
revenues by an astonishing $160 trillion over the next 80 years.35 Annual deficits alone begin to exceed
$1 trillion in less than 40 years, and the yearly shortfall will
reach $9.8 trillion by 2075.
The "good" news is that the outlook is not quite as bad as these
figures suggest. Once they are adjusted for inflation and interest
rates ("present value"), the figure for these future deficits,
although still huge, is smaller. According to Boston University's
Laurence Kotlikoff, the present value of the unfunded liability
totals $10 trillion.36 Harvard
Professor Martin Feldstein's estimate is slightly less optimistic:
$11 trillion.37 Some have concluded
that the unfunded liability is "only" $9 trillion,38 while others put it at $12 trillion.39 The point, however, is the same:
Social Security's unfunded liability is still more than twice the
official national debt.
There is no guarantee that this massive unfunded liability will
not become even worse. The Social Security Trust Fund's Board of
Trustees acknowledges that the long-range balance has deteriorated
significantly since 1983, with the unfunded liability increasing in
12 of those 13 years (the improvement in 1988 was due solely to a
change in accounting methodology, not to any actual improvement in
the system's finances).40
The unreliability of the government's estimates can be seen by
reviewing Social Security policy over the past 25 years. A 1972
benefit increase was accompanied by promises that the system would
be solvent for another 75 years. Five years later, President Jimmy
Carter signed a record payroll tax increase that was supposed to
guarantee the Social Security system would be solvent for 50 years.
After only five more years, the system was in crisis again. The
result: further payroll tax hikes, increases in the retirement age,
and some trimming in the growth of benefits, all accompanied by
still more promises that the system would be financially secure for
another 75 years.41
Even though they acknowledge this deterioration, supporters of
the status quo claim that Social Security's problems have been
overstated. They note that the system will run a surplus for
another 15 years and believe that even after the surplus
disappears, there will be enough money in the Trust Fund to pay
benefits until 2029.42 It is true that
Social Security taxes currently exceed outlays, but these modest
short-term surpluses are dwarfed by the deficits that will begin
when the baby-boom generation decides to start retiring in about a
dozen years. The SSA's own figures show that the system will begin
to experience deficits in 2012 (2009 if the federal government's
"share" of federal employee payroll taxes is not counted). At that
point, deficits begin to grow exponentially and will top the $1
trillion mark by 2036.
The argument that Social Security can rely on the Trust Fund is
even more ill-founded. Simply stated, the Trust Fund is a hoax.43 It contains nothing more than
IOUs-money the government owes itself. The annual surpluses that
many thought were being used to build up a reserve for baby boomers
have been spent on other government programs, leaving the Trust
Fund holding a bag of government bonds.
People cannot write IOUs to themselves and have that piece of
paper represent real assets; neither can the government. As the
Congressional Budget Office (CBO) has noted, "The government's
ability to finance a given schedule of Social Security benefits is
not inherently related to the solvency of the Social Security Trust
Funds...because the assets of the Social Security Trust Funds do
not represent any real stock of resources set aside to pay for
benefits in the future."44 Thus, when
Social Security begins to run a deficit, either in or by 2012, the
only way these bonds can be redeemed is by cutting benefits,
raising taxes, or issuing more debt. Yet these are precisely the
circumstances the Trust Fund was created to avoid.
Even those who believe the Social Security Trust Fund is real
have reason to worry. As recently as 1984, there supposedly were
enough IOUs to cover the Trust Fund until after 2060.45 It is now estimated (the date has been
moved forward in eight of the past ten years alone) that it will go
broke in 2029.46
Years ago, liberal economist Paul Samuelson noted with approval
that Social Security was a Ponzi scheme.47 In addition to the fact that they are
illegal in all 50 states,48 Ponzi
schemes have another serious problem: They work only if more and
more people are suckered into the game.49 The problem for Social Security is
that population trends are heading in the wrong direction. In 1950,
there were 16 workers for each retiree. Today, there are only 3.2
workers per retiree.50 By 2030, only 2
workers will be available to support each beneficiary.51
This aging of America will cause Social Security to
self-destruct. Senior citizens (those over age 65) now comprise 12
percent of the population.52 When the
baby boomers retire, the share of the population over 65 will jump
to 20 percent. One of the reasons for this problem is something
that otherwise would be considered good news: rising life
expectancy. When Social Security was created in 1935, the average
person did not live to be 65.53 Now
men live well into their 70s and women live almost to 80.54
More important for purposes of Social Security, however, is the
life expectancy of those who do reach age 65. In 1935, the average
65-year-old was expected to live about 12.6 more years. Today,
people who reach age 65 are expected to live more than 17
additional years. And by 2040, they will be expected to live at
least another 19 more years.55
Longer life spans, however, are just one piece of the puzzle.
Another is the trend toward early retirement. As recently as 1960,
77 percent of people in their early 60s remained in the workforce.
Today, that number has dropped to 55 percent.56 Needless to say, instead of continuing
to pay into the system, early retirees become a burden on those who
Adding to the demographic squeeze of increasing life expectancy
and early retirement is the falling U.S. fertility rate. Women in
the 1940s, 1950s, and 1960s averaged at least two and one-half
children each, and sometimes more than three. Fertility rates are
considerably lower today; women barely average two children each,
and that rate is expected to fall even more after the turn of the
Payroll taxes have been one of the fastest-growing burdens on
families over the past three decades. As Charts 5, 6, and 7
illustrate, the rate has climbed steadily. The payroll tax,
however, is only part of the burden. As recently as 1971, Social
Security taxes were applied only to the first $7,800 of income;
today, they are applied to the first $65,400 in wages. By taxing
more of a worker's income and at a higher rate, the payroll tax has
become a bigger burden than the income tax for about 75 percent of
Because of this crippling burden, the consequences of trying to
finance Social Security's deficit with higher taxes would be
catastrophic. Just bringing the system into balance would require
an increase of about 6 percentage points in payroll tax rates.59 Moreover, this estimate is based on a
set of economic assumptions that may not be warranted. Based on
SSA's less optimistic assumptions, payroll tax rates would have to
rise to 28 percent (40 percent or more including Medicare) for
promised benefits to be paid.60
Although such tax increases might be sufficient to pay promised
future benefits, the economy would suffer severe consequences.
Total job losses could reach as high as 3.5 million even under the
more favorable assumptions,61 and
fewer jobs would mean lower Social Security payroll tax
collections, causing the actual tax burden to climb even
The numbers are even more depressing when Medicare is added to
the equation. As Chart 8 illustrates, the Medicare payroll tax has
jumped from 0.7 percent to 2.9 percent in just 30 years (and,
unlike Social Security, with no limit on the amount of income
subject to the tax).62 Because of the
system's poor design, even this quadrupling of the tax rate leaves
Medicare teetering on the edge of bankruptcy.63 The tax increase needed to keep
Medicare solvent eventually could add 14 points to the tax rate,
double or triple the total number of jobs lost,64 and cause overall economic output to
drop by nearly 10 percent.65
These economic losses would add to the damage already caused by
high payroll taxes. According to academic research, economic output
already is 1 percent lower on an annual basis because the payroll
tax discourages both the quantity and quality of employment.66 One percent may not sound like much,
but it amounts to about $70 billion, or an average loss of more
than $1,000 in output for a family of four.
Paying record high taxes into Social Security might not be so
bad if workers eventually could get their money back, but there is
little doubt that Social Security is a poor investment for American
workers.67 Charts 9 and 10 illustrate
that many age groups, including some of those who already are
retired, would have been much better off if they had been able to
participate in private savings plans. Even workers making low wages
would have been better off with private savings.
The Heritage Foundation figures are replicated by other experts.
William G. Shipman of State Street Global Advisors in Boston, for
example, compares the amount of retirement income provided by
Social Security with the amount private markets would provide.
These figures show that stocks would provide the highest level of
retirement income, but that even a very cautious investment in
bonds would give people of all age groups and all income levels
more retirement income than Social Security can provide (Charts 11,
12, and 13).
Social Security's poor performance record has been confirmed in
study after study. Arthur P. Hall of the Tax Foundation, for
example, has concluded that dual-income couples in their 30s and
40s are among the biggest losers in today's system with real rates
of return ranging only between -1 and -1.5 percent. This analysis
assumes workers will get what they are promised even if Social
Security runs a deficit. If payroll taxes are increased to keep the
system solvent, the rates of return for younger baby boomers drop
below -1.5 percent.68 The Tax
Foundation's analysis also shows that the post_baby boom generation
will get little from Social Security. If payroll taxes are raised
so that benefits can be paid, the rates of return for today's
average-wage working couples in their 20s will be less than -1.8
percent.69 The news is even worse for
children: Real rates of return for today's teenagers will fall
below -2 percent, and those born today will see a return on their
Social Security investment of somewhere between -2.5 and -3
A slightly more optimistic outlook is provided by Dean R. Leimer
of the SSA's Division of Research. Even after including the
increase in payroll taxes needed to pay future benefits, he
concludes that the average rate of return for those born in 1950
will be 2.2 percent, which will fall to 1.8 percent for those born
in 1975 and 1.5 percent for those born in 2000.71 As Chart 14 illustrates, the only
"winners" were those born before 1926.
Low-income workers are supposed to be one of the few groups that
benefit from the current system. More specifically, it is argued
that couples with low incomes and one working spouse are big
winners. A detailed study of this group, however, found that more
than 50 percent received a negative rate of return from the
program.72 Another study concluded
that minimum-wage workers who retired in 1994 would have been
better off if they had invested in private savings accounts.
Investing in stocks, for example, would have brought in $100,000
more than Social Security.73
Another way to examine the numbers is to compare how much
taxpayers receive with how much they have invested. Unfortunately,
the results are no better. A dual-income couple retiring in 2010
will have paid $73,000 more than they will receive in benefits. A
similar couple retiring in 2030 will have lost $173,000 when taxes
paid are compared with benefits received.74 It should be borne in mind, moreover,
that this result may well be overly optimistic because it assumes
that Social Security will have the money to pay benefits currently
Defenders of the status quo are beginning to attack
privatization as a solution. Their primary argument is that Social
Security is much stronger than people think and that its unfunded
liability can be eliminated by a "modest combination" of payroll
tax increases and benefit reductions.75 Some opponents of privatization even
warn of a Wall Street plot.76 In
general, these defenders of the existing system would "fix" it by
taking some or all of the following actions:77
On paper, these reforms could be shown to reduce some of Social
Security's unfunded liability, but this would come only at a high
price: Each one also would make the program's grossly inadequate
rates of return even worse. The current government-run system
forces workers to pay record amounts into Social Security but
promises only meager levels of retirement income in exchange. Any
policy change that raised taxes or reduced benefits would simply
make this unbalanced equation even worse for taxpayers.
When confronted with this evidence, some defenders of Social
Security respond that the entitlement program was never designed to
be a pension system78 and, although it
is unfortunate if workers who are forced to participate happen to
lose money, it is part of the system. Others admit that Social
Security cannot be fixed without making the rate of return worse,
but then nitpick about the transitional problems that might occur
in moving to a private system.79
Not only is privatization necessary, but the sooner it occurs,
the easier it will be to solve these problems.80 This can be explained by examining the
growing scope of the changes that would be needed just to keep the
current system solvent. Carolyn Weaver, a member of the Social
Security Advisory Council, estimates that if lawmakers were to act
immediately, benefits would have to be reduced by 15 percent to
close the long-range funding gap. If they wait until the Trust Fund
runs out of "money," the benefit reduction could exceed 25
There is no way to fix the current Social Security system, but
there is a way to guarantee workers a safe and secure retirement.
The answer lies in privatization, which has the added virtue of
being relatively simple to implement. Younger workers would be
allowed to pay the major portion of their current payroll tax
burden into private retirement accounts, the money from which would
be invested in stocks, bonds, and other income-producing assets (a
portion of the tax could be retained to help finance benefits for
current retirees and those nearing retirement). Upon retirement,
these accounts would be exchanged for annuities that would pay
workers a stream of income well in excess of the amount Social
Security now promises to provide.
There is some truth to the old saying that it takes money to
make money. Those with financial resources can save and invest
their money and take advantage of compounded returns to increase
their wealth. One of the strongest arguments for Social Security
privatization is that it will allow low-income and middle-income
workers to improve their financial stability in the same way.
Instead of sending 12.4 percent of their income to the government,
where it is spent immediately, low- and middle-income workers could
elect to set aside some or all of that income in private retirement
These private retirement accounts would be completely different
from Social Security. First, they would be private property; unlike
promised Social Security benefits, income from private savings
would not depend on the twists and turns of politics. Second,
because their money would be invested in stocks, bonds, and other
financial assets, workers would benefit from the real rates of
return on capital, which have averaged more than 7 percent over the
past 70 years (even including the Great Depression).82 Perhaps even more compelling, in any
single 30-year period within those 70 years, the average rate of
return did not fall below 6 percent.83
This obviously is far more favorable than the mediocre-or even
negative-rates of return provided by Social Security.
Laurence Kotlikoff estimates that if payroll taxes were invested
privately, workers' retirement income could be three times the
amount promised by Social Security.84
The Institute for Research on the Economics of Taxation (IRET) has
found that private investment would allow a worker to retire with
five times as much as Social Security can provide (and more than
seven times as much as it can afford).85 Put another way, the retirement income
a worker can generate by privately saving only 2 percent of current
income is greater than the amount the same worker can receive in
exchange for taxes now sent to Social Security.
Similarly, Martin Feldstein has concluded that contributing 2.5
percent of income to a private savings account would provide the
same benefits as one receives in exchange for the full 12.4 percent
payroll tax sent to Social Security.86
According to a National Chamber Foundation study, the couple with
average income who started working in the mid-1980s would retire
with more than $1 million if they had been free to save privately
what they now pay to Social Security-even if financial markets
performed only half as well as the historical average.87 Economists at Texas A&M University
have concluded that privatization would enable workers to generate
retirement income that is between 1.5 and 5.5 times greater than
the Social Security benefits now promised.88
Almost all analysts agree that younger workers would be better
off with a private system, but some are concerned that older
workers, because they are trapped in Social Security, would not be
able to profit from privatization. This view is mistaken. Private
savings accounts could be set up for workers at any stage of their
careers, with benefits dependent on the number of years remaining
until retirement. The only real issue is how to account for all the
payroll taxes workers have been sending to the government all these
Depending on their circumstances, some workers would be so much
better off under a private system that they could quit Social
Security today and still come out ahead. As Charts 15 and 16
illustrate, exactly when workers could leave Social Security
profitably without receiving anything in exchange for their taxes
depends on three factors: sex,
marital status, and income.
Even though many workers would do better by walking away from
Social Security and writing off the taxes they have paid into it
(and even though they might be happy with such an opportunity),
such an approach might appear to be unfair. If workers have been
forced to pay into the system for years, they should receive
something in return. Moreover, many would be too old for a "cold
turkey" approach. There should be a way to allow workers to enjoy
the benefits of privatization without losing the value of the
payroll taxes they have paid into the system.
Fortunately, there are two reasonably simple ways to do this.
The first would be to create a dual system. Workers could leave
Social Security and, upon retirement, receive a monthly benefit
check from the government based on their earnings and the amount of
taxes they paid into the system before privatization. The bulk of
their retirement income, of course, would come from private savings
accounts set up after privatization.
The second option also would allow older workers to set up
private savings accounts. Instead of maintaining a dual system,
however, the government would give workers a rebate reflecting the
value of what already had been paid into the system. This rebate,
probably in the form of a bond that would mature upon retirement
(as is done in Chile), would become part of the private savings
account. A vast majority of workers would
benefit under this approach.
Finally, workers should have the option of remaining in the
current Social Security system. Although such a decision would not
make financial sense, allowing them to choose this option would
alleviate the concerns of extremely risk-averse workers while
demonstrating that it is impossible for anyone to be worse off
under privatization. When this option was used in Chile, more than
90 percent of workers still chose to join the private system.
All privatization proposals explicitly guarantee that benefits
for those who are retired or near retirement will not be touched.
The most obvious reason for this is political. Social Security
reform looks like an uphill battle as it is, and it is almost
certain that antagonizing existing beneficiaries would make reform
There is also a moral argument that favors preserving the status
quo for senior citizens. Simply stated, the government made a
contract with them to provide a certain level of benefits in
exchange for taxes paid, and it would be wrong to break that
contract. Some critics note that older retirees are getting much
more from Social Security than they paid in, but that argument
would have been worth making when the system was first created. To
renege on the deal now would disrupt the lives of millions of
recipients who have assumed that the government would honor its
Although privatization generally is a win-win proposition, some
groups will receive disproportionately better benefits. Among the
biggest winners would be the poor.89
More than any other group, lower-income Americans rely on Social
Security for their retirement income. For the poorest 20 percent of
the elderly, it represents more than 80 percent of their income.90 A private system that allows the poor
to build a nest egg of savings for retirement also will give them
greater and more secure income when they retire. The benefits for
the poor are even clearer when one considers that, according to the
SSA's own figures, future tax collections will be sufficient to pay
only 70 percent of future benefits.91
Defenders of the current system argue that Social Security is
still a reasonably good deal for lower-income workers because
calculations of monthly retirement checks are skewed to help the
poor replace a greater share of pre-retirement income. The fact
that rates of return for middle- and upper-income workers are worse
than the rate of return for lower-income workers (Chart 18),
however, does not mean that the poor would not be better off in a
system based on private savings, especially when one considers that
life expectancies vary with income. The poor generally do not live
as long as those with higher incomes, and therefore also do not
live long enough to collect as much in Social Security benefits.
Moreover, because benefits depend on only 35 years of wages, those
who work for longer periods get absolutely nothing in exchange for
the additional payroll taxes they have paid. Needless to say, the
biggest victims are the poor, who work longer than those with
higher incomes, largely because they spend fewer years in school.92
The poor also stand to reap additional benefits from
privatization. Specifically, they are the most likely to benefit
from the increased economic growth and job creation that would
follow a shift from a tax-based entitlement program to a
savings-based private savings plan.
One of the big benefits of privatization is the positive impact
it would have on the rate of savings in the United States. A global
study conducted by the World Bank found that government systems
undermine savings,93 and this
conclusion is confirmed by the U.S. experience. Analysis of
household behavior in the United States indicates that every dollar
of perceived Social Security benefit reduces private savings by 60
cents.94 Even a study co-written by a
researcher at the SSA confirms that "a dollar of Social Security
wealth substitutes for about three-fifths of a dollar of fungible
assets."95 Privatization would reverse
this corrosive effect, replacing a system that drastically reduces
savings with an approach based on real savings.
As Chart 19 shows, the rate of personal savings in the United
States is among the lowest in the world. Not only does the U.S.
government punish the frugal by double taxing (and sometimes triple
taxing and quadruple taxing) savings and investment income, but
politicians have eliminated most of the reasons to save. The
subliminal messages being sent out are (1) that saving for
retirement and health care expenses is unnecessary because the
government will tax someone else to give you money when you get old
in addition to providing you with Medicare and Medicaid benefits;
(2) setting aside money for education is not necessary because the
government is picking up more and more of the tab; and (3) buying a
house will not be difficult because the government has numerous
ways to subsidize the purchase.
Privatization of Social Security might not address all of the
government's anti-savings policies, but creating private retirement
accounts based on real savings would be a step in the right
direction. Countries that have privatized their Social
Security_type systems have seen their savings rates skyrocket. In
Chile, for example, the savings rate increased by at least 150
percent during the 1980s.96 Total
savings in the newly privatized Australian system, meanwhile,
jumped from AUS$155 billion to AUS$224 billion (an Australian
dollar is worth about 75 cents) in three short years.97 Singapore, which never made the
mistake of creating a government system in the first place, has the
highest savings rate in the world.98
There is every reason to think the same thing could happen here;
one recent study, for example, estimates that privatization would
boost the U.S. savings rate by 2.6 percent of gross domestic
product (GDP) by 2010.99
There is growing agreement that a system of private retirement
accounts would be better for workers and the economy than Social
Security. Because of the current system's $10 trillion unfunded
liability, however, many people wonder whether privatization is
feasible. More specifically, because lawmakers almost surely will
have to fulfill the promises made to those currently receiving
benefits and those nearing retirement, they wonder how the
government will finance those benefits if younger and middle-aged
workers withdraw from the system to take advantage of better
opportunities in the private sector.
There is no single answer to this question, but policymakers
undoubtedly will consider mixing and matching from among several
Critics of privatization argue that replacing Social Security
with a system of private retirement accounts is a gamble. However,
tens of millions of Americans already participate in various
private retirement savings arrangements, including pensions,
individual retirement accounts (IRAs) and 401(k) and 403(b)
employee savings plans. The number undoubtedly would be even higher
were it not for government restrictions and the harsh tax bias
against savings (see box, "The Tax Code's Bias Against
Opponents will argue there is a difference between wholesale
privatization and private plans that simply augment Social
Security. Perhaps the most compelling evidence for totally private
savings comes from the experience of three Texas counties:
Galveston, Brazoria, and Matagorda. In the early 1980s, all three
governments exercised their option to withdraw from Social Security
and rely instead on a private retirement savings plan. (Perhaps
fearing that other municipal governments might take the same step,
Congress revoked this option in 1983.)105 Galveston County's workers voted to
privatize their retirement pension by an astounding margin of 78
percent to 22 percent.106
The results have been spectacular. For about the same amount of
money that it would cost to participate in Social Security,
employees of these three counties now receive greater benefits than
they could derive from Social Security:
The fire department in Houston, Texas, has been operating a
private retirement system since 1937. The system has more than $1
billion in real assets (unlike the IOUs in the Social Security
Trust Fund), and retired firefighters enjoy more than three times
the income they would receive from Social Security.111
More than 1 million state and local government workers across
the country also are exempt from Social Security taxes and
participate instead in private pension plans. Analysis of these
plans-which cover state workers in Maine, Nevada, Ohio, and
Colorado; teachers in California and Ohio; and city employees in
Los Angeles-confirms that senior citizens can enjoy a more
prosperous retirement if their savings can be invested in
private-sector assets. In particular:
These experiences demonstrate that privatization is neither
risky nor untested. Not only does it work in the United States, but
countries around the globe have been replacing government-run
schemes with retirement systems based on private savings.116 Some have embraced full
privatization, while others have privatized only a portion of their
systems; in each case, however, private retirement accounts
invested in private-sector assets have been great financial deals
for individual workers and a boost to the national economy.117
In 1924, Chile became the first country in the Western
Hemisphere to create a government-run pension system.118 Over time, however, this system
developed many of the symptoms afflicting Social Security programs
throughout the world.119 Costs
exploded, unfunded liabilities expanded, and high taxes stunted job
creation. By 1981, the Chilean government had decided that the only
way to solve the problem was to phase out its Social Security
system and replace it with mandatory private savings.120
Under Chile's private system, new workers are required to
deposit 10 percent of their income in pension funds of their
choice;121 currently, there are more
than 20 options. More than 90 percent of Chile's older workers, who
were given the choice of staying with the government-run Social
Security scheme, chose the private options.122 The overwhelming support for private
savings options should come as no surprise; those who participate
over their working years will be able to retire with an average of
70 percent of pre-retirement income-more than three times the
amount promised under the old system.123 After just 14 years of operation,
benefits already are 40 to 50 percent higher than under the
This private system has been good for the Chilean economy as
well. Over the past ten years, economic growth has averaged nearly
7 percent annually, placing Chile among the world's fastest-growing
economies.125 Unemployment is down
around 5 percent, and the government is in the enviable position of
having to decide how to dispose of a budget surplus.126 Little wonder, then, that Chile has
the highest credit rating of any country in Latin America.127
The private retirement plan also has turned Chile's workers into
capitalists, with savings equal to four times their annual income
(quadruple the average in the United States).128 Indeed, the pension fund is the
biggest asset owned by the average Chilean.129 Finally, for that small handful of
workers with meager earnings or checkered employment histories, the
Chilean government provides a guaranteed safety net. The minimum
pension for an average-wage worker is 40 percent of pre-retirement
In 1992, the Australian government created a system of mandatory
private pensions for all workers. Under this system, which will be
phased in completely by 2002, workers will contribute 12 percent of
their income to private retirement accounts (9 percent will be
"paid" by employers). The Australian government estimates that
these accounts, known as Superannuation Guarantees, will provide
workers with pensions equal to between 79 and 106 percent of
The equity in the average account already totals about
US$30,000. Workers have
considerable freedom to invest their own savings or, if they
prefer, to choose from more than 1,000 professionally managed
pension funds.132 In addition, the
Australian government, like the government of Chile, will continue
to provide a safety-net pension for those whose earnings are too
low to fund an adequate private pension.
The United Kingdom has a two-tiered retirement system.133 All workers must participate in a
traditional government Social Security program that provides a
minimum income upon retirement. The second tier, however, allows
workers to choose a private system as long as it is guaranteed that
benefits will match what would have been provided if they had
chosen to remain completely in the government system. Because the
private pension funds will provide more retirement income for lower
costs, more than 70 percent of British workers have exercised this
option.134 To help finance these
private savings (and because they agree to forego the second tier
of government pension payments), workers who choose the private
option receive a tax reduction of 4.8 percentage points.135 Moreover, because of the reduction
in future benefit payments, as well as an exit tax levied on those
who choose the private option, the fiscal benefits to the
government have been enormous: There no longer is any significant
unfunded liability for future taxpayers.136
The British private savings alternative has been so popular
that, in March 1997, the
Conservative government proposed to privatize the remaining
government-run part of the system. In addition to yielding major
long-term budget savings, this proposal would boost savings and
give British workers more retirement income.137 As with other privatization efforts,
the actual mechanics are easy and straightforward. Taxpayers in
Britain would receive a tax cut amounting to about nine pounds a
week, which they would be required to invest in a private
Singapore, which has never had a government-run pension scheme,
in 1955 created a private system that is widely viewed as the most
extensive program of forced private savings in the world.139 Workers are required to set aside 40
percent of their income each year (on income of up to approximately
$50,000) in personal accounts.140 As
a result, Singapore now has the world's highest savings rate. It is
especially noteworthy that even though the population is aging
rapidly (those over age 60 will total 30 percent of the population
in less than 40 years), private savings under this plan will allow
Singapore to avoid the fiscal crisis faced by most other economies
with aging populations.141
This private savings account is used not only to fund
retirement, but also for health care, home purchases, insurance,
and higher education.142 The
retirement portion of the plan operates in a manner similar to
Chile's. Upon retirement, the worker purchases an annuity that will
pay a guaranteed income for the rest of his or her life. The
savings plan also seems to be good for housing: 85 percent of the
population-the highest rate in the world-lives in owner-occupied
A shortcoming of the Singapore system, however, is that the
government has a role in directing the investments. As a result of
this needless intervention, funds do not earn nearly as high a rate
of return as they otherwise could.144
This is why a large majority of residents take advantage of a
provision that allows them to withdraw their funds at age 55 and
place them in more lucrative privately directed investments.145
Considering the stunning success of Chile's private system, it
should come as no surprise that other countries throughout Latin
America also are adopting this approach. Peru, Argentina, Uruguay,
Colombia, Bolivia, Mexico, and El Salvador either have privatized
or are engaged in privatizing their retirement systems.147 Although not all of these plans are
identical in their details, they share a common feature: using the
superior performance of private investment to give senior citizens
a more safe and secure retirement.
Numerous other countries are moving in the same direction.148 Workers in Sweden, for example, set
aside 2 percent of their income in private retirement accounts.149 This may be small in comparison to
the government portion, but it is noteworthy in a nation known for
its cradle-to-grave welfare state. Both Denmark150 and Italy151 also recently added private elements
to their retirement systems. Privatization is only partial at this
stage, but if the Australian experience is any indication, the
evidence soon will become so convincing that these countries
probably will scrap their expensive government-run systems. Other
European countries with modest amounts of mandatory private savings
include Switzerland and Finland.152
Other countries with mandatory private savings include Ghana,
Kenya, Nigeria, Tanzania, Uganda, India, Indonesia, Nepal, and Sri
Lanka,153 although the results in
these countries have not been very satisfactory, largely because
their governments manage the investments. Moreover, politicians in
most countries misuse this authority and direct the money in ways
that enhance their political standing rather than maximize income
for workers. (Singapore and Malaysia are rare exceptions, and even
they underperform the privately managed funds.)
The existing Social Security system's negative impact on the
U.S. economy is twofold. First, by its very nature, it
significantly reduces incentives to save because many people
mistakenly believe the government will take care of them after they
retire.154 Second, this negative
impact on savings is compounded by the way the payroll tax
discourages employment. In effect, Social Security imposes a 12.4
percent penalty on jobs, thereby simultaneously penalizing
businesses which create jobs and discouraging the unemployed from
Perhaps the best way to understand the economic harm imposed by
the current system is to review how the economy would benefit under
privatization. Martin Feldstein estimates that privatization would
provide a $10 trillion to $20 trillion boost to the economy over
time. Put another way, the economy would become 3 percent larger
every year into the future.156 As
time passed, this additional growth would mean thousands of dollars
in additional income for American families. One study concludes
that wages would increase from 13 percent to 26 percent under a
Laurence Kotlikoff's estimates of the economic benefits of a
private retirement system are similarly encouraging. According to
his research, the future boost to the economy could be as much as
4.5 percent.158 A comprehensive study
by two other economists found that potential benefits could equal 3
percent to 5 percent of GDP.159 Even
though translating this higher growth into new jobs would be
somewhat speculative, the increase in employment would be
significant, judging by previous research on what has happened when
tax rates have increased. The 1988 and 1990 payroll tax rate
increases, for example, cost the economy 500,000 jobs.160
Q: Should lawmakers start by
privatizing the surplus?
A: Because of the interest in privatization and concern
that Social Security Trust Fund money is being exchanged for IOUs
and spent on other government programs, there is considerable
interest in rebating surplus Social Security revenues to workers
and requiring that this money be placed in IRAs. This is a good
idea, but the effect would be very limited. Because Social
Security's financial status has declined very rapidly since the
last big bailout in 1983, annual surpluses between now and 2012
will average only about $30 billion.161 This amounts to about $250 per
worker per year before the system would begin to run a deficit.162
Q: Should government be in charge of
A: Only if taxpayers want to lose money or enjoy rates of
return that are about as poor as those now provided by Social
Security. As Chart 20 illustrates, government-managed pension funds
(even in systems based on private savings) do very poorly.163 The reasons are easy to understand:
Private pension fund managers have a legal responsibility to
maximize the well-being of their clients. Even if this legal
obligation did not exist, there would be tremendous competitive
pressure to provide adequate returns in order to attract new
customers and retain current ones. In government-managed systems,
by contrast, political considerations often dominate. Some might
argue that the United States would be immune to this kind of
manipulation, but many politicians, including former Labor
Secretary Robert Reich, have been quite candid about their desire
to expropriate private pensions for political purposes.164
Government management of investment also could have serious
consequences for taxpayers generally. Under a proposal advanced by
a minority of the members of the Social Security Advisory Council,
for example, the government would guarantee a minimum return on
funds that politicians invested in the stock market.165 This would be an open-ended
invitation to abuse fiduciary responsibility and invest on the
basis of politics: After all, the taxpayer guarantee would
"protect" workers' pension earnings.
Q: Won't a private system lead to
higher administrative costs?
A: Some critics argue that a private system would have
much higher administrative costs than Social Security does.166 They note that the SSA spends almost
all of its money on benefits and less than 1 percent of its budget
on bureaucracy.167 This comparison
presents three major problems. First, assuming the figures are
accurate, workers still would be better off with a private system
because the rate of return is so much higher than Social
Security's.168 In effect, workers are
willing to let their pension fund have a small slice as long as
they get a good deal.
Second, during the early years, administrative costs chewed up
more than 10 percent of Social Security's budget. Even as recently
as 1969, overhead accounted for 2 percent of outlays.169 Social Security has an
advantage over private firms in that the government forces everyone
to participate, thus allowing administrative costs to be spread
widely. Private pension companies in a system of mandatory savings
almost certainly would realize significant reductions in overhead
costs-which is exactly what happened in Chile, Singapore, and
Malaysia, where competition and experience led eventually to
dramatic savings despite relatively high initial overhead costs.170
Finally, the overhead figures for Social Security do not include
compliance costs that are imposed on the private sector. Private
employers file 29 million employment tax returns with the federal
government each year.171 The most common-Form 941
for employer's quarterly payments-requires more than 14 hours of
recordkeeping, preparation, copying, and assembling, according to
estimates by the Internal Revenue Service.172 With the cost of
professional tax assistance averaging about $50 per hour,173 the burden
imposed on the private sector is significant. Another indication of
the impact of these compliance costs is the 6.7 million hours that
callers to Social Security have wasted while waiting for a real
person to answer the phone. Assuming these wasted hours are worth
the economy-wide average hourly wage of $15.09, this represents a
compliance cost of $100 million.174
Q: Can changing the consumer price
index solve Social Security's problems?
A: Many economists believe the government's consumer
price index (CPI) overstates inflation. One commission concluded
recently, for example, that the CPI may overshoot the actual
inflation rate by more than one percentage point.175 If true, this has a
profound impact on Social Security because of the annual cost of
living adjustments (COLAs) received by beneficiaries. If COLAs were
reduced to correct for this alleged inaccuracy in the CPI, the
reduction in future benefit payments would be so immense that the
unfunded liability would be reduced dramatically.176
Before rushing to make any changes, however, policymakers should
realize that adjusting the CPI would reduce the long-term deficit
problem by making the rate-of-return problem worse. Social Security
is a wretched deal for future retirees. If the level of benefits is
reduced further by changing the CPI, the cost to workers of
remaining in the government system-compared with what they could
get under privatization-will skyrocket.
Q: Is economic growth the answer?
A: It would be difficult to imagine a single problem in
society that could not be helped by faster economic growth. Social
Security is no exception. According to the Trustees' report,
increasing the average rate of economic growth by one percentage
point each year would wipe out 50 percent of the system's
question is how to achieve that growth. One way is to privatize the
system, thereby rendering the whole issue of Social Security's
deficit moot. Another would be to enact the flat tax.178 It should be noted,
however, that even though faster growth would reduce the unfunded
liability, it would do little to make Social Security a good deal
Q: What happens if the stock market
A: There is always a risk that financial markets will
perform poorly. An investor placing funds in the market in 1987
just before the market fell 500 points would have had a negative
return if the funds were withdrawn at the end of the year. Private
retirement accounts avoid this short-term risk because the money is
invested for the long term. For those patient investors who placed
their money in the market in 1987 (and investors would have to be
patient in a privatized system), their original investment would
have more than tripled by now.179 Thus, although markets
involve some risk, long-term investors almost certainly will
realize the historical average rate of return of more than 10
percent (7 percent after adjusting for inflation).180 This rate of return,
incidentally, includes both the Great Depression of the 1930s and
the 500-point decline of 1987. Simply maintaining the status quo,
on the other hand, means betting that politicians will not cut
Social Security benefits or take other steps that could reduce
retirement living standards in the future.181
To the extent that policymakers feel that financial markets are
too risky, they could structure a privatized system that offered
guaranteed returns. In effect, the individual would contract with a
financial services company that ensured a certain rate of return.
Knowing that markets offer a historical real return of 7 percent,
companies presumably would be willing to guarantee workers a return
slightly below that. The company would profit when the market was
particularly strong, but also would bear the downside risk when the
market was weak. The individual worker would earn slightly lower
returns over the long term, but also would have the comfort of
knowing that returns were guaranteed. This is a key feature of the
private retirement system used by the county workers in Texas.182
Q: Can workers be trusted to invest
their own money wisely?
A: Government clearly has a bad track record when it
comes to investing, but many in government believe that workers
themselves would not do much better. If policymakers considered
this a problem, they could impose restrictions on pension fund
investments. The economic evidence, however, suggests that this
concern is misplaced. A study by Watson Wyatt Worldwide, a benefits
consulting firm, found that younger workers invested more heavily
in stocks, apparently understanding that equity investments are the
smartest strategy for those who take advantage of long-term average
rates of return. Older workers are much more likely to shift to
fixed-income assets such as bonds, demonstrating that they know
they should minimize risk as retirement approaches.183 Workers in countries that
have privatized some or all of their retirement systems receive
large amounts of information from pension fund managers detailing
the benefits and risks of various investment strategies.
Q: What about means-testing Social
A: Some policymakers have proposed reducing the massive
Social Security deficit by reducing benefits for senior citizens
with higher incomes.184 But even though this would
shrink the unfunded liability, it also would make Social Security
an even worse deal for those senior citizens who are affected.
Perhaps more important, means-testing has the same economic impact
as an increase in tax rates. With means-testing, those who earn
more than a certain amount of money would have their Social
Security benefits reduced. Simply stated, productive economic
behavior would result in less income.185 The message this sends to
workers and seniors is pernicious: "Don't work, don't save, don't
be responsible and build up your own nest egg," because such
behavior will result in a special penalty.186
Q: What would happen under
privatization to other features of Social Security such as
disability and survivors' benefits?
A: Private markets already provide identical products in
the form of life insurance and disability insurance. Chile is a
good example of how these additional features of Social Security
can be moved to the private sector. Even an article published by
the American Association of Retired Persons concedes that Chile's
private retirement system has increased the level of disability and
This question highlights another benefit of privatization: the
ability to pass a nest egg on to one's children. Under the current
system, workers who die early get very little out of Social
Security. Surviving spouses and children will receive some benefits
from the government, but a private system could provide equivalent
benefits while also allowing the assets in the deceased worker's
account to go directly to the family.188
Q: Why not just raise the retirement
A: Restricting benefits by raising the retirement age
would improve Social Security's long-term balance; but by forcing
people to work longer and leaving them with fewer years in which to
collect benefits, a higher retirement age also would make the
system an even worse deal for workers. A private system would give
workers wide latitude in deciding whether to keep working or to
retire, based on what is in each worker's best interests.
Q: What exactly did the Social
Security Advisory Council propose?
A: There were three separate proposals advanced by the 13
members of the Council.189 The conventional wisdom is
that the Council endorsed a limited degree of privatization,
especially because a common feature of the three plans was the
diversion of some payroll taxes into private investments. There are
significant differences in detail, however.190 Only the plan (advanced by
five of the Council's members) to allow taxpayers to invest five
percentage points of their existing payroll taxes privately could
fairly be called a real step toward privatization.191
Q: Should workers be forced to
A: Some have argued that shifting from today's Social
Security system to one based on private savings does not go far
enough. More specifically, they question whether the government
should force people to save a certain amount of their income.192 Social Security
reform certainly could be structured so that citizens were free to
choose the level and timing of their participation. Because many in
Washington do not believe individuals are smart enough to make the
right choices, however, it is highly likely that any privatization
would be accompanied by mandatory participation. This type of
system also would avoid the "moral hazard" problem that would occur
if some individuals, acting on the assumption that the government
would take care of them in their retirement years, deliberately
chose not to save.
Politicians understandably do not want to address Social
Security's two major problems: (1) promised benefits that exceed
projected revenues and (2) record-high taxes paid now in return for
meager levels of retirement income paid in the future. Many
policymakers realize the unfunded liability problem cannot be
solved without ever-worsening rates of return for workers, but they
also know that rates of return cannot be improved without adding to
the system's debt.
The only option that would solve both problems is privatization.
This option admittedly is accompanied by political risk, and the
natural instinct among lawmakers will be to delay reform; but doing
nothing guarantees the United States will face a crisis of
incredible proportions once members of the baby-boom generation
reach retirement age. Privatization would avoid this tragedy by
dealing with the current system's huge unfunded liability while
allowing workers to escape a government-run program that forces
them to accept miserable returns on their payroll tax dollars. If
lawmakers really want to improve living standards for tomorrow's
workers and retirees, the choice is clear: It is time to privatize
Glossary of Social Security Terms
Rate of return
The percentage increase, usually on an annual basis, in the
value of an asset, plus any net income the asset produces. Money
invested in the stock market, for example, has increased in value
an average of more than 10 percent annually since 1926.
Rate-of-return calculations frequently are expressed in real terms
(adjusted for inflation). For example, the real rate of return for
stock investments over the past 70 years has averaged 7 percent.
Returns on investments vary with risk.* Rates of
return are important in the Social Security reform debate because
workers would receive much higher returns if they had the freedom
to take the money now consumed by Social Security payroll taxes and
put it into private savings.
A technique used to calculate the worth today of a given amount
of future income or liabilities. Part of the calculation is an
adjustment in the figures to reflect inflation. Also part of the
calculation is what professionals call the "time value" of money.
Simply stated, money has value because it can be used for
consumption or invested to yield an inflation-adjusted return.
Thus, even if adjusted for inflation, money is more valuable today
than it will be in the future. Present value is important in the
Social Security reform debate because these calculations expose why
the system is deeply in debt (even though currently running a
surplus) and why workers are getting a bad deal.
A description applied when projected future income will not be
sufficient to pay future obligations. Another way of stating the
concept is to say the system is not actuarially balanced. This
calculation is important in the Social Security reform debate
because promised benefits exceed estimated tax revenues by $160
trillion (even though, when adjusted to present value, this falls
to a "mere" $9 trillion to $12 trillion).
An agreement by one entity (usually a financial services
company) to provide someone with a certain level of income, either
for a fixed number of years or for the rest of the recipient's
life. In discussing Social Security reform, annuities are important
because it is widely assumed that upon retirement, individual
workers would use some or all of their private savings to purchase
annuities. The actual income provided by the annuity (plus
inflation adjustments) would depend on the amount of savings in the
worker's account and on the worker's remaining life expectancy.
A reference to systems, such as Social Security, in which
retirement benefits are financed by current workers.
A reference to retirement systems in which the worker builds up
private savings that then are used to finance retirement
*Equities (shares or ownership of an income-producing
asset) produce higher returns on average; the returns, which can
comprise both dividends and capital gains, will vary with economic
conditions. Private bonds, which are commitments to pay a fixed
stream of income in exchange for a loan, generally pay lower
returns, but also have less risk (that is, there is less
fluctuation in either the market value of the bond or the stream of
income it generates). Finally, certain investments, like government
bonds or bank accounts, have relatively little risk and pay
commensurably low returns.
America's Social Security system may be actuarially bankrupt,
but government retirement systems in several other countries around
the world are in far worse shape.* As Chart 3
illustrates, the World Bank calculated several years ago that the
unfunded liabilities of the U.S. system are considerably lower than
those of other major industrialized
democracies.** The situation is even worse
in former Soviet-bloc countries: As they try to boost growth and
escape the legacy of socialism, their economies are stifled by the
payroll taxes-often exceeding 30 percent-needed to support
government-run retirement programs.
* Martin Wolf, "Mind
the pensions gap," Financial Times, January 28, 1997.
** World Bank, "Averting the
Old Age Crisis: Policies to Protect the Old and Promote Growth,"
Policy Research Report (New York, NY: Oxford University Press,
Some argue that the real Social Security tax burden is only 6.2
percent because the employer pays 50 percent of the 12.4 percent
levied. Just because the employer sends money to the government,
however, does not change the fact that the worker pays the bill, as
one SSA researcher has noted: "workers actually pay the tax, even
though it is collected from the employer."* A perfect
analogy is the personal income tax. Because of withholding,
businesses technically pay 100 percent of the tax on their
employees' wages and salaries (more than 100 percent once income
tax refunds are considered). But most, if not all, taxpayers
recognize that they are the ones who bear the burden. Even the
Clinton Administration agrees, testifying that the "true incidence
of both the employer and the employee portions of social insurance
taxes ultimately falls on the worker."**
* Dean R. Leimer, "A Guide to Social Security Money's
Worth Issues," Social Security Bulletin, Vol. 58, No. 2
** J. Mark Iwry, Statement of Benefits Tax
Counsel, Department of the Treasury, before Subcommittee on Tax and
Finance, Committee on Small Business, U.S. House of
Representatives, June 28, 1995.
As the country moves toward privatization, one issue that will
require attention is the treatment of savings in the tax law. A
neutral, fair tax system should not impose a higher burden on
income that is saved and invested than on income that is consumed,
yet that is exactly what happens under the current law.
The most obvious bias is the double tax on savings. A taxpayer
who spends his after-tax income incurs little or no federal tax
liability. The taxpayer who saves and invests the money is not
nearly so lucky. Even though the income was taxed when first
earned, any interest or other earnings generated by that income are
subject to an additional layer of tax. To make matters worse,
because of capital gains taxes, double taxation of dividend income,
and death (estate) taxes, some income is taxed three or four
Even if Social Security is not privatized, this bias against
savings and investment should be eliminated.* This
can be accomplished in one of two ways. The first would be the
traditional IRA approach, which allows the taxpayer to defer
taxation on income that is saved, with the tax later applied to
both the original income and any returns when the money is
withdrawn. The second approach, known as "municipal bond
treatment," would tax income that is saved, but all subsequent
withdrawals, including any interest or other earnings, would be
spared the second layer of tax.
The double taxation of savings would be eliminated in tax
reforms like the flat tax that treat all taxpayers and all income
equally. These broad-based reforms would repeal other provisions of
the tax code-including the capital gains tax, the death tax, and
the double tax on dividends-that tax income
* Daniel J. Mitchell, "Taxes, Deficits, and Economic
Growth," Heritage Foundation Lecture No. 565, June 17,
** Daniel J. Mitchell, "Jobs, Growth, Freedom, and
Fairness: Why America Needs a Flat Tax," Heritage Foundation
Backgrounder No. 1035, May 25, 1995.
1 Social Security
Administration, The 1996 Annual Report of the Board of Trustees
of the Federal Old-Age and Survivors Insurance and Disability
Insurance Trust Funds, communication from the Board of Trustees
of the Federal Old-Age and Survivors Insurance and Disability
Insurance Trust Funds, House Doc. 104_228 (Washington, D.C.: U.S.
Government Printing Office, 1996).
2 Social Security
Administration, Life Tables for the United States Social
Security Area, Actuarial Study No. 107, August 1992.
3 Office of the Actuary,
Social Security Administration, unpublished data, 1996.
4 Martin Feldstein, "The
Missing Piece in Policy Analysis: Social Security Reform,"
American Economic Review, Vol. 86, No. 2 (May 1996).
5 SSA, 1996 Annual
6 Dan Goodgame, "Many Happy
Returns," Time, January 20, 1997.
7 Feldstein, "The Missing
8 Stephen J. Entin, "Private
Savings vs. Social Security: Many Happier Returns," Institute for
Research on the Economics of Taxation Congressional Advisory
No. 55, September 4, 1996.
9 SSA, 1996 Annual
10 Social Security
Administration information at
12 Arthur P. Hall, "Forcing
a Bad Investment on Retiring Americans," Tax Foundation Special
Report No. 55, November 1995.
13 Arthur P. Hall, "Social
Security: A Bleak Outlook for Baby Boomers," Tax Foundation
Special Report No. 56, January 1996.
14 William G. Shipman,
"Retiring with Dignity: Social Security vs. Private Markets," Cato
Institute SSP No. 2, August 14, 1995.
15 Michael Tanner, testimony
before Subcommittee on Social Security and Family Policy, Committee
on Finance, U.S. Senate, August 2, 1995.
16 Peter J. Ferrara, "Power
to the People: A Private Option for Social Security," Americans for
Tax Reform Policy Brief, 1996.
17 Bruce Bartlett, "Social
Security Privatization," National Center for Policy Analysis
Brief Analysis No. 209, August 20, 1996.
18 Shipman, "Retiring with
19 Arthur P. Hall, "A Primer
on Social Security Reform," Tax Foundation Special Report
No. 66, November 1996.
20 E. J. Myers, "Social
Security Privatization Is Here," The Wall Street Journal,
January 16, 1997.
21 Merrill Matthews, Jr.,
"Some Americans Already Have Privatized Social Security," National
Center for Policy Analysis Brief Analysis No. 215, November
22 Stephen Glass, "Mrs.
Colehill Thanks God for Private Social Security," Policy
Review, No. 83 (May/June 1997).
23 Feldstein, "The Missing
27 Peter J. Ferrara, John
Goodman, and Merrill Matthews, Jr., "Private Alternatives to Social
Security in Other Countries," National Center for Policy Analysis.
Policy Report No. 200, October 1995.
28 Robert J. Myers, "Chile's
Social Security Reform, After Ten Years," Benefits
Quarterly, Third Quarter 1992.
29 Sylvester J. Schieber and
John B. Shoven, "Social Security Reform: Around the World in 80
Ways," American Economic Review, Vol. 86, No. 2 (May
30 Mukul G. Asher,
"Compulsory Savings in Singapore: An Alternative to the Welfare
State," National Center for Policy Analysis Policy Report
No. 198, September 1995.
31 "Tomorrow's Pensioners,"
The Economist, March 8, 1997.
32 World Bank, "Averting the
Old Age Crisis: Policies to Protect the Old and Promote Growth,"
Policy Research Report (New York, NY: Oxford University
33 William Modahl, "Social
Security Imbalances Could Wreck the U.S. Economy," The American
34 Bipartisan Commission on
Entitlement and Tax Reform, Interim Report to the President,
35 Office of the Actuary,
Social Security Administration, unpublished data, 1996.
36 Laurence J. Kotlikoff,
"The U.S. Fiscal and Savings Crises-The Role of Entitlements,"
unpublished manuscript, December 1994.
37 Feldstein, "The Missing
38 Pete du Pont, "A New
Beginning for Social Security," IntellectualCapital.com, January 9,
1997; available on the
Internet at http://www.intellectualcapital.com/iced.htm.
39 Karl Borden, "Dismantling
the Pyramid: The Why and How of Social Security Privatization,"
from Cato Institute SSP No. 1, August 14, 1995.
40 SSA, 1996 Annual
Report . See also The 1988 Annual Report of the Board of
Trustees of the Federal Old-Age and Survivors Insurance and
Disability Insurance Trust Funds, communication from the Board
of Trustees of the Federal Old-Age and Survivors Insurance and
Disability Insurance Trust Funds (Washington, D.C.: U.S. Government
Printing Office, 1988).
41 Carolyn Weaver, "Social
Security Myths in the Making," On the Issues, American
Enterprise Institute, January 27, 1995.
42 Henry Aaron, "The Myths
of the Social Security Crisis: Behind the Privatization Push,"
The Washington Post, July 21, 1996.
43 Goodgame, "Many Happy
44 Congressional Budget
Office, The Economic Effects of Uncompensated Changes in the
Funding of Social Security, 1991.
45 David Koitz and Gary
Sidor, "The Long-Range Social Security Projections," CRS Report
for Congress, Congressional Research Service, January 7,
46 Michael Tanner, "Public
Opinion and Social Security Privatization," Cato Institute
SSP No. 5, August 6, 1996.
47 Michael Tanner, "Sixty
Years of Tinkering," The World & I, November 1995.
48 Michael Tanner, "The
Other Trust Fund Report," Cato Institute, available on the Internet
49 Thomas Sowell, "A legal
con game," Forbes, March 27, 1995.
50 SSA, 1996 Annual
51 Tim Penny, "Social
Security Reform: The Progressive Case," Policy Report, Cato
Institute, Vol. XVIII, No. 5 (September/October 1996).
52 Stephen J. Entin, "Social
Security Retirement and Disability Programs Need Help Now,"
Institute for Research on the Economics of Taxation
Congressional Advisory No. 54, May 14, 1996.
53 SSA, Life
54 Mark Weinberger, "Social
Security: Facing the Facts," Cato Institute SSP No. 3, April
55 Peter G. Peterson,
Will America Grow Up Before It Grows Old (New York, N.Y.:
Random House, 1996).
56 Wilfried Prewo, From
Welfare State to Social State (Zellik, Belgium: Centre for the
New Europe, October 1996).
57 SSA, 1996 Annual
58 Shipman, "Retiring with
59 Feldstein, "The Missing
60 Borden, "Dismantling the
61 Entin, "Private Savings
vs. Social Security."
62 SSA, 1996 Annual
63 Stuart M. Butler,
testimony before Subcommittee on Medicaid and Health Care for
Low-Income Families, Committee on Finance, U.S. Senate, March 6,
64 Entin, "Private Savings
vs. Social Security."
65 Gary Robbins and Aldona
Robbins, "Salvaging Social Security: The Incredible Shrinking Trust
Fund and What We Can Do About It," Institute for Policy Innovation
Policy Report No. 130, April 1995.
66 Feldstein, "The Missing
67 Workers who retired
before the mid-1980s generally are receiving a good rate of return
when the amount of tax paid is compared with the benefits received.
For more details, see Geoffrey Kollmann, "How Long Does It Take for
New Retirees to Recover the Value of Their Social Security Taxes,"
CRS Report for Congress No. 90_67 EPW, updated
January 30, 1990.
68 Hall, "Social Security: A
69 Hall, "Forcing a Bad
71 Leimer, "Guide to Social
Security Money's Worth Issues."
72 Daniel Garrett, "The
Effects of Differential Mortality Rates on the Progressivity of
Social Security," Economic Inquiry, No. 33 (July 1995), pp.
73 David R. Henderson, "It's
Not Just the Kids Who Lose," Fortune, September 30,
74 "Social Security's End,"
Investor's Business Daily, March 4, 1996.
75 Richard C. Leone, "What
Crisis?" The New York Times, January 15, 1997.
76 Robert Dreyfuss, "The End
of Social Security as We Know It?" Mother Jones,
77 Thomas W. Jones, "A
Strategy to Maintain Social Security Benefits: The Social Security
Debate," Challenge, Vol. 39, No. 5 (November 21, 1996).
78 Joe White, "Is Social
Security Bankrupt?" Slate, January 27, 1997; available on
the Internet at
79 Michael Kinsley, "Social
Security: From Ponzi Scheme to Shell Game," Slate, December
13, 1996; available on the Internet at http://www.slate.com/Features/SocSec/SocSec.asp.
80 David Altig and Jagadeesh
Golchak, "Social Security Privatization: A Simple Proposal,"
unpublished manuscript, January 1997.
81 Weaver, "Social Security
Myths in the Making."
82 Bartlett, "Social
Security Privatization"; "Spending for a Rainy Day," Investor's
Business Daily, April 11, 1996.
83 David R. Henderson,
"Personal Savings Accounts Would Be Good for Everyday Americans,"
The American Enterprise, January/February 1997.
84 Kotlikoff, "The U.S.
Fiscal and Savings Crises."
85 Entin, "Private Savings
vs. Social Security."
86 Feldstein, "The Missing
87 Peter Ferrara, "The
Social Security Mess: A Way Out," Reader's Digest, December
88 Thomas R. Savings, "How
to Put Security Back in the Social Security System,"
Perspectives on Policy, Private Enterprise Research Center,
Texas A&M University, October 1995.
89 This analysis also
explains why black Americans, who generally have lower incomes and
lower life expectancies, would benefit greatly from a privatized
Social Security system.
90 Michael Tanner,
"Privatizing Social Security: A Big Boost for the Poor," Cato
Institute SSP No. 4, July 26, 1996.
91 Stephen J. Entin,
Social Security: Problems and Opportunity, Institute for
Research on the Economics of Taxation, June 19, 1995.
92 C. Eugene Steuerle and
Jon Bakija, Retooling Social Security for the 21st Century:
Right and Wrong Approaches to Reform (Washington, D.C.: Urban
93 World Bank, "Averting the
Old Age Crisis."
94 Feldstein, "The Missing
95 Dean R. Leimer and David
H. Richardson, "Social Security, Uncertainty Adjustments, and the
Consumption Decision," Economica, No. 59 (August 1992).
96 Mario Marcel and Alberto
Arenas, "Social Security Reform in Chile," Inter-American
Development Bank Occasional Paper No. 5, 1992.
97 Australian Insurance and
Superannuation Commission bulletin, September 1995.
98 Ferrara, Goodman, and
Matthews, "Private Alternatives to Social Security."
99 Neil Howe and Richard
Jackson, Natural Thrift Plan Project, National Taxpayers
Union Foundation and Center for Public Policy and Contemporary
Issues, November 15, 1996.
100 Telephone conversation
with Steve Entin, March 25, 1997.
101 Privatization 1996:
A Comprehensive Report on Privatization of Government Assets,
Enterprises, and Public Services (Los Angeles, CA: Reason
102 Congressional Budget
Office, The Economic and Budget Outlook: Fiscal Years
1998_2007, January 1997.
103 Congressional Budget
Office, The Economic and Budget Outlook: An Update, August
Piñera, "Empowering Workers: The Privatization of Social
Security in Chile," Cato's Letters, Cato Institute, No. 10
105 Matthews, "Some
Americans Already Have Privatized Social Security."
106 E. J. Myers, "Social
Security Privatization Is Here,"
107 Pete du Pont, "How to
Retire on $2,740 a Month," IntellectualCapital.com, December
12, 1996; available on the Internet at
108 Matthews, "Some
Americans Already Have Privatized Social Security."
109 Glass, "Mrs. Colehill
Thanks God for Private Social Security."
110 Matthews, "Some
Americans Already Have Privatized Social Security."
111 E. J. Myers, "Social
Security Privatization Is Here."
112 William E. Even and
David A. MacPherson, Freed from FICA: How Seven States and
Localities Exempt a Million Employees from Social Security and
Provide Higher Pension Benefits to Retirees (New York, N.Y.:
Third Millennium, March 1997).
114 This is particularly
noteworthy because the pensions being reviewed are defined benefit
plans rather than defined contribution plans (as in the Texas
counties). In a defined benefit plan, a worker's initial retirement
benefit is determined by formulas that depend on income levels and
number of years worked, with administrators responsible for setting
contribution levels that will allow these benefits to be funded. In
defined contribution plans, retirement benefits, instead of being
predetermined, depend on the amount of money that is saved and the
rate of return earned by those funds.
115 There are, to be sure,
actuarially unbalanced defined benefit pension plans, but it is not
clear whether their soundness is the result of (or in spite of) the
fact that the workers are not also forced to participate in Social
Security. Because defined benefit plans have a checkered history,
advocates of Social Security privatization recommend using defined
116 The government
retirement programs in many of these countries had experienced
greater financial problems than the U.S. Social Security system-a
fact that demonstrates there is a way out for U.S. policymakers.
See Paul Craig
Roberts, "It's Time to Privatize Social Security," Business
Week, February 27, 1995.
117 For a discussion of
private pension coverage in major industrialized countries, see E.
P. Davis, "The Structure, Regulation, and Performance of Pension
Funds in Nine Industrial Countries," World Bank Policy Research
Working Paper No. 1229, December 1993.
118 Barbara E. Kritzer,
"Privatizing Social Security: The Chilean Experience," Social
Security Bulletin, Vol. 59, No. 3 (Fall 1996).
119 Peter Russell, "How
Chile Farms Out Nest Eggs: Can Its Private Pension Plan Offer
Lessons to the U.S.?" The New York Times, March 21,
120 Geoffrey Kollmann,
"Social Security: The Chilean Example," CRS Report for
Congress No. 95_839 EPW, October 21, 1996.
121 Workers also
contribute 3 percent for disability and survivors' benefits.
123 Sara E. Rix, "Chile's
Experience with the Privatization of Social Security," AARP Public
Policy Institute Issue Brief No. 23, August 1995.
127 Comments by Jose
Pinera at conference on "The Other Side of the Pyramid: A New
Social Security System for the Next Century," Cato Institute,
Washington, D.C., February 14, 1997.
128 Suneel Ratan, "How
Chile Got It Right," Time, March 20, 1995; "Social
Security's Shaky Outlook," Investor's Business Daily,
October 10, 1995.
130 R. J. Myers, "Chile's
Social Security Reform."
131 Australian Department
of Social Services, Superannuation Guarantee, November 9,
132 Australian Insurance
and Superannuation Commission bulletin, op. cit.
133 For a thorough
discussion of the British retirement system, see forthcoming
Heritage Foundation paper by Robert E. Moffit on Social Security in
134 "Social Insecurity,"
Investor's Business Daily, November 16, 1995.
135 John Goodman, "Social
Security Reform: Other Countries Are Leading the Way," National
Center for Policy Analysis Brief Analysis No. 212, August
136 Carolyn L. Weaver,
"Creating a New Kind of Social Security," The American
Enterprise, January/February 1997.
137 Jill Sherman, "Major
says reforms offer new security in old age," The Times of
London, Internet version,
March 6, 1997.
Pensioners," op. cit.
139 Goodman, "Social
Security Reform: Other Countries Are Leading the Way."
140 Pete du Pont, "Chile,
Singapore, and Seniors," The Washington Times, March 17,
141 Prewo, From Welfare
State to Social State.
142 "Social Insecurity,"
143 Goodman, "Social
Security Reform: Other Countries Are Leading the Way."
144 World Bank, "Averting
the Old Age Crisis."
145 Mukul G. Asher,
"Compulsory Savings in Singapore."
146 Office of Research and
Statistics, Social Security Administration, "Social Security
Programs Throughout the World, 1995," Research Report No.
64, July 1995.
147 G. Ricardo Campbell,
"Argentina Approves a Privatization Option for Social Security,"
Social Security Bulletin, Vol. 56, No. 4 (Winter 1993), and
"Colombia Moves Closer to the Privatization of Social Security,"
Social Security Bulletin, Vol. 56, No. 2 (Summer 1993).
148 Geoffrey Kollmann,
"Social Security: Worldwide Trends," CRS Report for Congress
No. 96_32 EPW, November 14, 1996.
149 Schieber and Shoven,
"Social Security Reform: Around the World."
150 World Bank,
"Averting the Old Age Crisis."
151 G. Ricardo Campbell,
"Italy Creates Private Pension Funds," Social Security
Bulletin, Vol. 56, No. 2 (Summer 1993).
152 Ferrara, Goodman, and
Matthews, "Private Alternatives to Social Security."
153 World Bank,
"Averting the Old Age Crisis."
154 Jagadeesh Gokhale,
Laurence J. Kotlikoff, and John Sabelhaus, "Understanding the
Postwar Decline in United States Savings: A Cohort Analysis,"
unpublished manuscript, November 1994; Lawrence H. Summers and
Chris Carroll, "Why Is United States National Savings So Low?"
Brookings Papers on Economic Activity, Vol. 2 (1987), pp.
607_635; Feldstein, "The Missing Piece"; World Bank, "Averting the
Old Age Crisis"; Kotlikoff, "The U.S. Fiscal and Savings
155 Job losses caused by
government Social Security schemes are a worldwide phenomenon. See
World Bank, "Averting the Old Age Crisis."
156 Feldstein, "The
157 Howe and Jackson,
National Thrift Plan Project.
158 Laurence Kotlikoff,
"Privatization of Social Security: How It Works and Why It
Matters," Institute for Economic Development Discussion Paper
Series No. 66, October 1995.
159 Patricio Arrau and
Klaus Schmidt-Hebbel, "Macroeconomic and Intergenerational Welfare
Effects of a Transition from Pay-As-You-Go to Fully-Funded Pension
Systems," paper presented to Econometric Society conference, August
160 Aldona Robbins and
Gary Robbins, "Effects of the 1988 and 1990 Social Security Tax
Increases," Institute for Research on the Economics of Taxation
Economic Report No. 39, February 1988.
161 Robbins and Robbins,
"Salvaging Social Security."
163 World Bank,
"Averting the Old Age Crisis."
164 Kryzysztof M.
Ostaszewski, "Privatizing the Social Security Trust Fund? Don't Let
the Government Invest," Cato
Institute SSP No. 6, January 14, 1997.
165 "Social Security's
Savings," The Wall Street Journal, January 6, 1997.
166 Robert J. Myers,
"Privatization of Social Security: A Good Idea?" Journal of the
American Society of CLU & ChFC, July 1996.
167 Peter Diamond,
"Privatization of Social Security: Lessons from Chile," prepared
for Seventh Annual Conference of the National Academy of Social
Insurance, Washington, D.C., January 26, 1995.
168 Private money managers
have fees as low as four-tenths of 1 percent for assets they
manage, and the average returns they generate for investors are
well in excess of the income provided by Social Security.
169 Social Security
Administration, Annual Statistical Supplement (Washington,
D.C.: U.S. Government Printing Office, 1996).
170 World Bank,
"Averting the Old Age Crisis."
171 Internal Revenue
Service, Publication 55B, Annual Data Book, Table 7-Number
of Returns Filed (1995).
172 Department of the
Treasury, Internal Revenue Service, Instructions for Form
941 (Revised January 1996).
173 Telephone conversation
with Arthur Hall of the Tax Foundation, March 18, 1997.
174 James L. Payne, "How
Much Does Social Security Really Cost?" The American
Enterprise, January/February 1997.
175 "Toward a More
Accurate Measure of the Cost of Living," Final Report to the Senate
Finance Committee from the Advisory Commission to Study the
Consumer Price Index, December 4, 1996.
176 Max R. Lyons, "Fix the
CPI and Keep Social Security From Going Broke," fact &
fallacy, Employment Policy Foundation, Vol. III, No. 2
177 Robbins and Robbins,
"Salvaging Social Security."
178 Mitchell, "Jobs,
Growth, Freedom, and Fairness: Why America Needs a Flat Tax."
179 Total Return
Analysis 9-30-87 to 12-31-96, Bloomberg Financial Markets
On-Line Service, Bloomberg L.P., March 24, 1997.
180 Shipman, "Retiring
181 Albert B. Crenshaw,
"Is There a Stock Answer to Social Security Worries?" The
Washington Post, June 2, 1996.
182 Glass, "Mrs. Colehill
Thanks God for Private Social Security."
183 Anne Willette, "Wall
Street, workers key to solvency," USA Today, December 30,
184 Peterson, Will
America Grow Up Before It Grows Old.
185 World Bank,
"Averting the Old Age Crisis."
186 David R. Henderson,
"The Sneak Attack on Seniors," Fortune, March 4, 1996.
187 Rix, "Chile's
Experience with the Privatization of Social Security."
188 Ferrara, "Power to the
People: A Private Option."
189 For a complete
explanation of the Council's actions, see Robert E. Moffit,
"Reforming Social Security: Understanding the Council's Proposals,"
Heritage Foundation F.Y.I. No. 128, January 24, 1997.
190 J. D. Foster,
"Rebuilding Social Security...," The Washington Times,
January 21, 1997.
191 Sylvester J. Schieber,
"Your Retirement, Your Social Security," The Wall Street
Journal, January 8, 1997.
192 Dale Steinreich,
"Social Security Reform: True and False," The Free Market,
Ludwig Von Mises Institute, Vol. 14, No. 10 (October 1996).
Creating a Better Social Security System for America
Daniel J. Mitchell, Ph.D.
McKenna Senior Fellow in Political Economy
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