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Privatize Social Security?

News: Analysis & Commentary: WASHINGTON


Soon, the question may not be whether, but how much

On Apr. 7 in Kansas City, President Clinton kicks off a series of town meetings to discuss the plight of the Social Security system, which some economists fear could be tapped out by 2030. Clinton, who called for Congress to allocate anticipated budget surpluses for a Social Security fix during his State of the Union address in February, has now found a surprising ally in House Speaker Newt Gingrich. On Mar. 5, the Speaker urged fellow Republicans to postpone income-tax cuts and make Social Security salvation their crusade this election year, too.

Although there is no consensus yet on how to solve the Social Security mess--or whether a heroic rescue is actually needed--Democrats and Republicans are both talking about some form of privatization. Indeed, the politics of the issue are coming down to a debate over how much privatization is justified, rather than whether any is appropriate at all. Wall Street interests, not surprisingly, are pushing for the maximum, since privatization would bring a new flood of money into mutual funds, bonds, and other investments.

Under one compromise scenario, about 21% of one's annual Social Security tax payment would be handed back to the individual for investment in stocks and bonds. Like a 401(k), the account would be subject to the upticks and downturns of the markets. But proponents argue that given the long-term record of rising equity markets, the potential for impressive returns would more than make up for the additional risk.

BUSINESS WEEK's Michael McNamee and Christopher Farrell take up the opposing sides of the debate. McNamee argues that a system of partial privatization would be the best solution. Farrell says the transformation of Social Security from a social safety net into a more risky investment system would violate the founding principles of the program and unnecessarily risk the monthly retirement checks that those most in need depend on.Return to top


Whom are you going to trust to watch over your retirement? The wizards of the federal government--or yourself? In the end, that question will dominate the Social Security debate. And ultimately, given the American preference for the individual over the state, the answer will likely involve privatizing.

Privatization can mean many things, from direct government ownership of stocks to wiping out Social Security. But the middle-ground fix that's likely to emerge will look like this: Workers would set up accounts funded by about 1.4% of the current 12.4% Social Security payroll tax. Another 1.5% in new payroll taxes from workers and employers would be added to the accounts. With this, workers could invest in stocks, bonds, and money markets.STOCK ANSWER. Today's retirees and 55-plus workers would stay in the old system. The 11% of payroll still flowing into it would continue to fund a safety net of a slightly reduced basic pension, plus disability insurance and survivor benefits.

When today's twentysomethings retire, that basic benefit might pay only 75% of what Social Security promises now. But those workers would more than recoup the loss from the 45-year build-up in their private accounts, which were tapping into market advances. While there is no doubt a risk, equities have for seven decades delivered around 8% real annual gains, vs. Social Security's return of 1.5%. Under limited privatization, today's 25-year-old couple with average earnings would net 10% more retirement income than today's system promises.

Higher returns are often seen as privatization's main benefit. But the real reason Social Security needs private accounts is to build up savings in the system. Since 1939, Social Security has operated on a hand-to-mouth basis, using taxes from this year's workers to pay this year's benefits. That won't work when the baby boom retires: "It's hard to see how we can go from more than three workers supporting each retiree to two workers per retiree," says Deputy Treasury Secretary Lawrence H. Summers.

The 1983 reforms were aimed at squirreling away surpluses into a trust slated to reach $3 trillion by 2019. But those overages weren't saved. Instead, the extra cash was siphoned off to cover government deficit spending. That shows that funding in advance of need can work only if the funds are safely out of politicians' reach. So Social Security, the only pension fund in the world that doesn't buy stocks, has to get into the market. And unless Americans want Washington to own a chunk of Corporate America, the only way left is private accounts.

Growth optimists say radical changes aren't needed because swelling payrolls will solve the problem. But even if productivity grows above the 1960s' boom pace for the next 75 years, Social Security actuaries estimate that as much as half of the Social Security shortfall will remain unfunded. Defenders of the government-run system point to stock-market risks. But for all but the lowest-paid workers who collect more than they put in by design, today's system returns less than Treasuries.

The focus on pitfalls ignores the biggest danger: inaction. According to Social Security trustees, even traditional fixes will cost workers and retirees the equivalent of an 18% tax hike. Voters won't pay that tab if they get nothing in return. Private accounts--blended with a healthy public safety net--offer a tangible gain. Americans won't accept anything less.By Mike McNameeReturn to top

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