Privatization Offers Option for Social Security

Opinion polls show that American workers are less and less confident that the Social Security system will be there for them when they retire. This skepticism about the viability of the most popular of all government programs rests on gloomy and credible projections. In less than 15 years the Social Security surplus--the cumulative excess of revenues over benefits paid to retirees--will start to disappear. By 2030 it will be gone and payroll taxes will cover only about 75% of promised benefits. Everyone in Washington knows what’s coming. What’s lacking is a consensus about how best to head off insolvency.

There is little public or political appeal in proposed patchwork fixes like gradually extending the retirement age (perhaps, as Federal Reserve Board Chairman Alan Greenspan suggests, to 70), raising payroll taxes and cutting payments to the better-off, which in some scenarios is any retiree with an income above $30,000. And such proposals fail to really address the basic demographic issue of an aging population and a work force that is getting smaller proportionate to the retirees it supports. Right now there are about 130 million workers and 43 million Social Security beneficiaries, a ratio of 3 to 1. By 2030, the ratio is expected to be only 2 to 1.

The problem isn’t too few workers but too many retirees. When Social Security was created in 1935 the average life expectancy was 61 years. Today it’s 76, and by 2030 it will be very close to 80. By then more than 20% of Americans will be 65 or older. This remarkable extension in life expectancy comes at a cost; for Social Security, it’s a ticking bomb.

The most effective way to assure the system’s solvency may well be through a radical reform that would phase in full or partial privatization. A functioning model exists in Chile, the first hemispheric nation to adopt a government-sponsored social security program (in 1924) and the first in the world (in 1981) to replace its public system with a privately funded and administered plan.

Under that plan, workers make mandatory contributions of 10% of their earnings to individual accounts. The money is invested in any of a number of closely regulated pension plans. These are essentially mutual funds with portfolios divided between domestic private-sector securities and government bonds. The funds offer choices in terms of the risks they assume, but in every case Chile limits common stocks to no more than 30% of portfolios. The great benefit of privatization is that over the long term retirees can expect to enjoy larger pensions than a public system would provide.

The Chilean system, which of course is far more complex than can be described here, may be no more than a direction indicator for where the U.S. system could be going. It would take a lot of effort and debate to devise such a system, and a prolonged educational campaign to inform the public of its strengths. But increasingly this appears to be the approach the United States should be taking, and the time to begin considering it is now.