U.S. Retirees Face a Private-Savings Crisis: Clive Crook

Here’s some good news about America’s public-pension system. Contrary to many reports, the country can afford it.

Social Security faces much less fiscal pressure over the coming decades than pension systems in other advanced economies. It will need patching, but the repairs aren’t that difficult.

But there’s bad news as well. When it comes to incomes in retirement, fixing Social Security is the smaller part of what needs to be done. The real challenge is to increase saving.

The narrow fiscal problem is manageable because the U.S. will have plenty of taxpayers. Americans retire later than most Europeans, and they have more children, too, so the aging of the U.S. population is less pronounced. Between now and 2050, the U.S. working age population will expand, whereas Europe’s will shrink. The fundamental variable is the ratio of U.S. pensioners to workers: This will rise as the baby boomers retire, but more slowly than elsewhere.

America’s public-pension problem is easier in another way. Again by advanced-economy standards, the U.S. commitment to government spending on pensions is middling rather than high. True, if you fold government spending on health care for senior citizens into the mix, things look a lot worse, thanks to rising health costs. There, the U.S. is a global outlier. But if you look just at incomes in retirement, the projected cost of Social Security is moderate.

Old and Broke

America’s real pension problem is not that Social Security is going bust, but that the retirement incomes it will provide are too small. Too many people will rely exclusively on Social Security. Private pension saving -- increasingly through 401(k)s and other defined-contribution vehicles rather than traditional defined-benefit plans -- is inadequate, and fees eat up too much of the return for small savers. For many families, saving through home equity has turned out to be a catastrophic mistake. When they retire, many baby boomers will see a far bigger drop in their standard of living than they had expected. Many will have to work longer, whether they want to or not.

To mend the system, the U.S. must do two things. First, the easy part, get Social Security back in fiscal balance. Second, supplement it with a new retirement saving plan.

In cold fiscal terms, Social Security is a pay-as-you-go transfer system (current taxes pay for current benefits) masquerading as a funded savings plan (in which benefits are paid out of the return on investments). Benefits already exceed payroll tax receipts, and this gap will grow. Forget the “trust fund” and its holdings of government debt. That’s money the government owes to itself: It nets out to zero. What counts is that the system is now adding to the budget deficit, and will add more with time. Some combination of spending cuts and tax increases -- either within the Social Security budget or outside it -- will be needed to balance the books.

This calls for nothing too drastic. A gradual increase in the retirement age to reflect rising life expectancy is most of what’s required to pay for benefits at roughly the existing rate. But managing Social Security’s burden on the budget doesn’t raise incomes in retirement. For that, people need to save more -- and those without the means to do so will need help.

Why not simply acknowledge that Social Security is not a savings plan but a transfer system, make it more generous, means-test it to limit the cost and then raise other taxes to pay the bill? That approach has the advantage of fiscal simplicity, but the politics doesn’t work.

Making Privatization Work

The fact is, the masquerade serves a purpose. Support for Social Security is strong precisely because people see it as a savings plan. They have paid into the system -- or so the letters from the Social Security Administration tell them every year -- and they feel entitled to what the system owes them. Recasting Social Security as just another welfare program would be the first step toward dismantling it altogether.

The opposite approach is partial privatization, as tried by George W. Bush. The idea was to let people divert some of their payroll taxes to a private pension. All being well, they could expect a higher return on that money, so adding their private pension and their diminished entitlement to Social Security together, they would come out ahead. One problem is that savers would have to bear more financial risk -- not something you should ask people of limited means to do. Another is that the shortfall in payroll tax receipts would drive Social Security deeper into deficit, which subtracts from national saving when one of the goals in all this is to increase it.

Even so, it’s a pity that Bush’s plan was trashed so viciously. Greater private saving should be part of the solution -- as an addition to Social Security, rather than a replacement in whole or in part. Building the “ownership society” Bush talked about is surely a worthy goal. Democrats shouldn’t renounce that idea because of its provenance. The idea that retirees “own” their Social Security benefits -- as illusory in fiscal terms as that notion might be -- accounts for the country’s devotion to the system, and this devotion is telling. People want and should be granted ownership of the assets they will need to support them in retirement.

How, specifically, might this be done? I’d recommend, as a start, that an additional 5 percent be deducted from wages and invested in a choice of pooled accounts holding a mixture of domestic and foreign assets. Pooling and central administration would keep fees very low. Balances would accumulate tax-free until retirement; distributions would then be taxed. I’d also advocate that taxpayers provide a subsidy to those on low incomes, sufficient to cover the whole deduction for those earning the minimum wage, so that everybody could afford to save through their retirement account. To help meet the cost of this taxpayer subsidy, narrow the existing tax preferences for saving, which flow to those on higher incomes who least need the help.

The aim would be to make the subsidy and the plan as a whole both revenue-neutral and progressive. Revenue neutrality means that public saving would not decline. Moving the subsidy from rich to poor improves equity, and will probably increase private saving overall. That’s because the existing subsidy for saving by high-income households diverts saving to tax-preferred vehicles more than it increases saving overall. Directing the subsidy to people who can afford to save little or nothing now would therefore raise saving in the aggregate.

Social Security can be easily mended -- but the U.S. needs to be more ambitious than that. The “ownership society” is part of the answer. Rather than scorning that idea, Democrats should make it their own.

(Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.)

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    To contact the writer of this article: Clive Crook at clive.crook@gmail.com.

    To contact the editor responsible for this article: James Gibney at jgibney5@bloomberg.net.

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