Why Privatizing Social Security Can’t Work

About a month or so ago, I wrote a column in which I just briefly mentioned that any plans to privatize Social Security would never work, and I said I had covered that topic in prior columns. Well, several readers told me they didn’t remember those older columns (the latest was about 4 years ago) and they asked me to address the topic again. So, here goes.

The idea of privatizing Social Security used to be all the rage back in the 1980s and 1990s. But ever since the almost catastrophic financial crash in the late 2000s, saying you want to turn Social Security over to Wall Street brokers (i.e., to “privatize” Social Security in the traditional sense of the term) is like saying you want some monkeys with a dart board to make financial decisions about our nation’s primary means of supporting older folks, people with disabilities, and surviving widows, widowers and children. 

Still others claim that Social Security should be managed more like other public pension funds. Most of those funds have a diversified portfolio, with a variety of investments. But every nickel of Social Security assets is invested, by law, in U.S. treasury notes, considered by everyone the safest of all places to stash your cash. What most folks who advocate putting Social Security funds into private markets can’t comprehend is the immense size of the Social Security trust funds. Compared to a large public pension fund (like many teachers’ retirement funds or police and firefighter funds) Social Security is like Fort Knox and these public funds are just big piggy banks. Those funds may have billions of dollars in assets. But Social Security has trillions. You simply can’t compare them. 

Or put it another way. Social Security makes up about one-fourth of the entire federal budget of the United States. You just don’t take a quarter of our country’s budget and put it on Wall Street. After all, would you want the federal government, via the Social Security trust fund, to be the major owner of Chevron stock or the primary investor in Phillip Morris?

A more reasonable approach to “privatizing” Social Security would allow individual taxpayers to use private or managed accounts to supplement future Social Security benefits. And when you hear talk of such proposals, please remember to ask this question: Is it a “carve-out” plan or an “add-on” plan? There is a huge difference.

Both plans involve requiring younger workers to contribute money to an IRA-type account that would offer several investment options. The worker could choose a safe but generally low-yielding account or a riskier but potentially more rewarding one. The investments from this account would then be used to augment Social Security retirement benefits.

But the difference lies in the funding details. In a carve-out plan (these are usually the plans touted by Republicans), the worker’s IRA investment would be funded with a portion of his or her Social Security payroll tax. For example, currently 6.2% of a worker’s salary is deducted for Social Security taxes. A carve-out plan might specify that 4.2% continue to be used to fund Social Security while 2% would be funneled into the private account. In other words, this plan gets its funding by carving it out of the current Social Security system.

On the other hand, an “add-on” plan (the plans usually touted by Democrats) would require a worker to contribute an extra amount to fund the private account investments. So, 6.2% of his or her salary would still be deducted to finance Social Security benefits. But in addition, that worker would be required to chip in an extra percentage point or two of salary to fund the Social Security supplement. So, this plan gets its funding by adding to the current Social Security system. 

Each plan has its pros and cons. The downside to an add-on plan is that more out-of-paycheck spending would be required from workers to fund their retirement portfolio. But the advantage to the plan is its greater rewards. Most “add-on” proposals are modeled after the highly successful “Thrift Savings Plan,” an add-on IRA that has been available to federal government workers for years and has given many of them the kind of financial security in retirement not usually associated with middle-class civil servants. 

The upside to “carve-out” proposals is that no extra financial burden would be placed on young workers to finance the supplemental benefits. But the often-unexplained downside is that huge reductions would be necessary in future Social Security benefits. It’s just simple math. If you are going to carve out about one-third of the Social Security payroll tax to fund a worker’s private supplement, then obviously future Social Security benefits for that same worker are going to have to be cut by at least one-third. Apparently, the hope is that a well-managed private account will more than make up the difference. Also, carve-out plans come with huge transitional costs. Remember: Social Security is a “pay-as-you-go” program, meaning the money deducted from today’s worker’s paychecks is used to fund benefits to current retirees. So, if you cut the amount of money going into the system, you must get funding from other sources to pay promised benefits to current retirees. 

But here is the most important point I need to make about proposals for private accounts — whether carve-out or add-on. Although they are often mentioned in the same breath as other proposals to “save Social Security,” they do nothing of the sort. Social Security’s long-range financing problems are the result of baby boomers quickly turning into senior boomers. For years, Social Security has been working extremely well with a ratio of three workers supporting one retiree. But by the time all the boomers retire (and that will be happening at a quickening pace over the next 15 years), there will be only two workers supporting each retiree. The system simply cannot work AS IT’S CURRENTLY STRUCTURED at a two-to-one ratio. 

As I’ve pointed out many times to my readers, there are many relatively modest proposals for reform that will keep the system running for many more generations. All of those possible solutions involve either slight tax increases or moderate cuts in benefits. None of them involve the creation of private accounts for Social Security beneficiaries. I am not saying the private accounts are a bad idea. I am saying that they have nothing to do with the future financial health of the program.

If you have a Social Security question, Tom Margenau has a book with all the answers. It’s called “Social Security: Simple and Smart.” You can find the book at www.creators.com/books, or look for it on Amazon or other book outlets.  


Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.