Freeman

ARTICLE

If Rates of Return Matter, Social Security Is a Goner

Privatization Ought to Be a No-Brainer

SEPTEMBER 01, 1998 by LAWRENCE W. REED

When President Clinton called for “a national conversation” on Social Security a few months ago, he probably didn’t expect that privatizing the whole thing would quickly become the talk of the country. But that’s exactly what has happened. The new national willingness to explore options that previously were politically untouchable now seems so promising that privatization of the federal government’s biggest welfare program may actually happen before the turn of the millennium. For Americans to embrace the most sweeping reform since Social Security was enacted in 1935, however, advocates of privatization will have to convince them that they’ll be better off financially trusting their retirement savings to private investment.

On the face of it, that shouldn’t be a difficult task. In just 15 years, Social Security will start running deficits as baby boomers retire in large numbers and benefits begin to outstrip revenues. Lest anyone think that there are billions of dollars waiting in a trust fund for the system to tap, forget it. The Social Security Trust Fund consists of four brown file folders in Parkersburg, West Virginia, containing receipts for $650 billion in U.S. Treasury bonds. The trust fund has been spent. It is nothing more than an accounting gimmick, and redeeming the bonds to pay benefits after 2012 will require a huge tax increase on young workers.

When Social Security started, 30 Americans supported each beneficiary. Today, that ratio is just three to one, and in barely another generation, there will be just two payers for every recipient. This intergenerational Ponzi scheme will collapse before then in an actuarial nightmare, harming all Americans, unless Congress acts soon to return control of retirement decisions to citizens instead of politicians.

Social Security has probably reached the end of the line as far as the public’s tolerance of further payroll tax hikes is concerned. An Associated Press poll taken in March found nearly 76 percent of all Americans opposed to raising taxes to fund the system. And nearly 90 percent of younger workers—those “Generation X” citizens between ages 18 and 34—want to shift at least some of their Social Security tax payments into private investment accounts. President Clinton himself has ruled out any further tax increases to solve the problem. Thus, the risk of depending on Social Security would seem to be very high, indeed. Those who still say we’re safer if we put our eggs in the government’s basket had better start coming up with better arguments.

No wonder 90 percent of Generation X’ers oppose any more tax hikes for Social Security. According to economists Laurence Kotlikoff and Willi Leibfritz in a recent paper for the National Bureau of Economic Research, a 25-year-old worker can expect to pay $175,000 more in Social Security taxes over his lifetime than he can expect to receive in Social Security benefits. Even today’s 55-year-olds will end up, on average, paying in $4,000 more than they’ll ever get back. Only people in their late 50s and older can hope for a positive return—if they don’t die before reaching average life expectancy.

William W. Beach and Gareth G. Davis, in a January 1998 document from the Heritage Foundation called “Social Security’s Rate of Return,” argue that it isn’t enough to contrast what workers will pay in with what they’ll take out. Beach and Davis say the most meaningful analysis would compare what workers will get from Social Security with what that same amount of money could earn in private investment. When younger workers examine those numbers, they will be horrified by the raw deal that this New Deal government program really is:

A single male earning what the Social Security Trustees call “an average income” (or $25,723 in 1996) is particularly hard-hit by Social Security’s low returns. A 21-year-old single male making an average income throughout his lifetime can expect to lose $309,400 in potential retirement income by staying in Social Security when compared with what he would earn if he invested his payroll taxes in a safe, conservative private retirement fund made up of 50 percent equities and 50 percent government bonds.

Beach and Davis show convincingly that for almost every type of worker and family, retirement under the current Social Security system means “receiving fewer dollars in old age and passing on less wealth to the next generation than they could if allowed to place their current Social Security tax dollars in private retirement investments.”

Partial or total privatization of retirement systems is a trend that is sweeping the world for the same reason it’s now being seriously considered here: government programs with their low rates of return for younger workers were inherently too expensive and headed for insolvency. Chile was the first country in this hemisphere to adopt a national, government-sponsored social security program (in 1924) and the first in the world (in 1981) to end it by substituting a privately funded and administered plan. Chilean workers have earned an astounding average annual rate of return, after inflation, of 12 percent during the past 15 years. Great Britain and Australia have joined the privatization bandwagon, as have Argentina, Peru, Hungary, Romania, Croatia, and even Russia and several other nations. If they can do it, why can’t America?

How risky would it be for American citizens to invest their own retirement savings in the stock market? An analysis of the historical performance of stocks from the prestigious Wharton School in Pennsylvania shows that while there certainly have been single-year periods and even five-year periods in which the stock market averaged a negative return, the longer stocks are held, the less the risk. Never in American history did stocks produce a loss—in real terms—over a 20-year period. The very best return on stocks in any 20-year period was 12.6 percent; the very worst—1 percent—was still much better than today’s younger workers can expect from the Social Security system!

As it is, six million Americans already do not participate in Social Security. More than a dozen states exempt from 20 percent to all of their public workers from it. And nearly three-quarters of the nation’s police and firemen are not in the system.

Paul Farago, a senior adviser to the Oregon-based Cascade Policy Institute, notes that the original Social Security act allowed municipal governments to go on their own. As recently as 1981, employees of Galveston County, Texas, voted by a margin of 78 percent to 22 percent to leave the federal program for a private alternative. Two other nearby counties soon followed. Congress eliminated the opt-out provision in 1983. But today, Farago points out, the thousands of Texas county workers who opted for the private plan, and who paid about the same in contributions as they would have with Social Security, are getting several times the return.

Social Security advocates have long buttressed their case for continuation of the program with phony claims that workers could count on safety and a decent return on their money. Now that the truth is known, privatization ought to be a no-brainer.

ASSOCIATED ISSUE

September 1998

ABOUT

LAWRENCE W. REED

Lawrence W. (“Larry”) Reed became president of FEE in 2008 after serving as chairman of its board of trustees in the 1990s and both writing and speaking for FEE since the late 1970s. Prior to becoming FEE’s president, he served for 20 years as president of the Mackinac Center for Public Policy in Midland, Michigan. He also taught economics full-time from 1977 to 1984 at Northwood University in Michigan and chaired its department of economics from 1982 to 1984.

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