| James N. Markels | ||||
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by
James N. Markels While
libertarians might not be pleased with President Bush’s performance in
his first term, things may be looking up for Round Two as Bush has made
Social Security privatization of some form a top priority for his
administration. Anti-privatizers
have been quick to publish op-eds arguing either that Social Security
isn’t in “crisis,” or that privatization just can’t work. One
of the more public salvos came from Los Angeles Times columnist
Michael Kinsley, who posted
his argument for how privatization “is mathematically certain to
fail,” and challenged readers to prove him wrong. He argues that, “[t]o ‘work,’ privatization must generate more
money for retirees than current arrangements.
This bonus is supposed to be extra money in retirees’ pockets
and/or it is supposed to make up for a reduction in promised benefits,
thus helping to close the looming revenue gap.”
This money must come from “greater economic growth or from
other people,” Kinsley says, requiring “either more capital to
invest or smarter investment of the same amount of capital.”
He argues that privatization will lead to neither because
“every dollar deflected from the federal treasury into private Social
Security accounts must be replaced by a dollar that the government
raises in private markets.” This, he says, would result in no
additional capital, and the hordes of new investors are highly unlikely
to be smarter than current investors.
So, Kinsley reasons, the extra money “must come from other investors,
in the form of a lower return.” This
lower return, Kinsley argues, must logically kill the whole system,
since it is the high rate of return that privatizers promise will be the
force to save Social Security. It is a pretty persuasive argument until you realize that he gets the
issue wrong from the very beginning.
The problem with Social Security is not that there isn’t
enough money, it is that the program has distributed money over time in
a way that is doomed to result in gigantic future shortfalls. In other words, the problem is one of allocation, not
aggregation. The reason why we don’t need more money to fix Social Security is
because the average worker, over the course of his or her lifetime,
makes enough money to fund his or her own retirement through private
investment. With the
average historical market rate of return, it
doesn’t take much to reap large rewards.
In Chile’s private pension system, for example, workers have
been so successful with their accounts that more
retire early (see Table 6) rather than wait until the usual
retirement age. So the
problem isn’t lack of money, it’s how the money is spent. Social Security takes money from current workers to pay for today’s
retirement benefits, much like a classic Ponzi scheme where early
investors are paid handsome profits from the contributions of later
investors. The problem with
Ponzi schemes is that eventually there aren’t enough new investors to
keep the profits coming, and the whole thing collapses.
Social Security faces the same problem. When Social Security first began in 1935, there were plenty of workers
to pay for the few retirees. As
a result, Social Security’s first beneficiary, Ida M. Fuller of
Vermont, paid in a mere $44 over three years in payroll taxes before
receiving $20,933.52 in benefits over the next 35 years after she
retired. Obviously, Ms. Fuller did quite well for herself.
However, the workers who paid for her retirement did not get any
of that money to fund their own pensions.
They had to hope that there would be enough future workers to do
that. Unfortunately, since Ms. Fuller’s days, the number of workers per
retiree has been dropping because people are living longer and having
fewer children. In 1950
there were 16 workers per every retiree. Today there are about three,
and by 2025 there will be only two.
With the amount of retirement benefits rising faster than payroll
tax receipts, Social Security will start running a deficit in 2019
according to the latest Congressional Budget Office figures.
It is this deficit that Kinsley thinks private accounts must overcome by
increasing the amount of cash available.
But that is an argument against government investment of payroll
taxes to pay Social Security benefits, not against an actual privatized
system. If the workers
paying for Ms. Fuller had been able to put their money into private
accounts, the money she received would have been invested rather than
transferred through the government, resulting in a net increase in
investment capital. And, as
a Cato Institute study showed (see Figure 3), those workers would
have done much better than what Social Security offered with that
investment. On the
downside, of course, Ms. Fuller would have been on her own. The place where more money is needed is in transitions costs. The
question is how do we pay current government obligations while allowing
workers to divert some of their earnings into private accounts.
Someone is going to take a hit because Ms. Fuller’s $20,889.52
profit came at the expense of future generations.
But at least paying off current obligations is finite; keeping
the current system only prolongs the bubble that our changing
demographics are sure to burst. We can see where that bubble is taking us by looking at countries
already dealing with the worker-retiree ratios that are on the horizon
for us. France and Germany
have only 2.5 and 2.3 workers per retiree respectively, and they are
saddled with payroll taxes of 49.3 and 40.9 percent.
That’s the future of Social Security in America, and it’s no
wonder that several countries have opted to privatize their pensions
rather than face such daunting tax rates. The ultimate truth about Social Security is that it is easier for one person to provide their own pension with the help of market returns than for multiple workers to pay directly to current retirees, especially when the number of retirees keeps rising far faster than the number of workers. Kinsley is right; privatization won’t bring more money into the system. But we need to stop Social Security’s history of paying today’s retirees at the cost of tomorrow’s. |
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