The Privatization of Social Security

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Brian Wallen and Hee Chang Lee

Social Security

What is Social Security?

• In the United States, social security refers to the program for qualified people called the Federal, Old Aged, Survivors, and Disability Insurance(OASDI).
• This program is funded by money from the Federal Insurance Contributions Act, which is a taxt taken from paychecks, and put into the National Treasury. Additionally, the Treasury issues T-Bills to the Social Security administration in order to cover all payments that must be made.
• To receive partial benefits a person must have worked for at least 10 years and be age 62 or older. Full retirment benefits can not be received until a person is 66.
• Survivors may receive parents' benefits if under 18, or handicapped.
• Non-workers can also receive benefits based on disabilities faced.
• The benefits received are then based on the amount of income earned in their last year of working.
• If benefits begin before 66, then they decrease as person ages, being reduced each year by a certain percentage

The History of Social Security

• The Social Security Act of 1935 was the precursor to the program now in place in the United States.
• At the time, the program paid benefits only to the retired worker.
• Many types of workers were excluded from these benefits including farmers, the self-employed, and some small businesses.
• The payments to the benefactors were funded by a variation of FICA tax now in place.
• As the system progressed through the years, more and more people began to gain eligibility through new laws enacted(see timeline).
• As the United States reached the twenty-first century, policy makers began to notice the impending problem that the baby-boomer generation would cause as they grew older.

Timeline of Social Security

• 1935 - Social Security Act passed by Roosevelt administration
• 1936 - Applications for social security numbers first distributed by post office
• 1937 - Payroll taxes paid for the first time in order to fund Social security
• 1939 - Social Security Amendments of 1939 broaden who can be included as beneficiaries
• 1946 - Social Security Administration established
• 1956 - Social security acts again broaden who is eligible, this time it is disabled workers, and beneficiaries up to age of 18
• 1961 - Workers allowed to accept reduced retirement at age 62 due to new legislation
• 1995 - Social Security became an independent agency
• 2006 - Social Security privatization becomes highly politicized issue

The Future of Social Security

• Because of the rising amount of baby boomers, there is expected to be a rapid depletion of the Social Security fund that was set up in order to finance the program.
• Figure 1 shows the expected increase in percentage of GDP for social security. Also, from the figure, it is believed that revenue will meet costs until 2016.
• By the time, the baby boomers are causing this explosion the amount of workers per beneficiaries will go down greatly as seen in figure 2.
• The number of workers per beneficiary will be reduced by fifty percent, greatly reducing the amount of payroll taxes collected as revenue.
• This is leading many policy makers to search for alternatives to a "pay-as-you-go" pension system.

Figure 1 - http://www.socialsecurity.gov/OACT/TR/TR06/II_project.html#wp106217 http://www.socialsecurity.gov/OACT/TR/TR06/images/II_project_IID5.gif

Figure 2 - http://www.socialsecurity.gov/OACT/TR/TR06/II_project.html#wp106217 http://www.socialsecurity.gov/OACT/TR/TR06/images/II_project_IID3.gif

http://www.retiresecure.org/images/051305-1.gif

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Privatization

What is Privatization?

• Privatization can be classified into many ideas thus being a hard concept to define.
• Term began to pick up widespread circulation in the late 1970's and early 1980's as the economic slowdown from the Carter and Ford years took place
• In modern sense it is any shift of activities or functions from the state to the private sector i.e. the government transferring payment of pension funds from the Treasury to private investment companies.
• Used also as a tool in reducing pressure from Government overload.
• Advocates of privatization hope to divert claims from Treasury and direct them at private industry in order to relieve stress on the amount of money demanded from government sources.
• Programs will cause people to blame private industry instead of government when benefits are not as high as in past.
• Also a privatization of wealth which increases proportion of population that holds shares of stock.

How does Privatization work?

• Privatizing Social Security involves 3 elements

1. Forcing workers to contribute to personal savings accounts
2. Honoring Accrued Benefits
3. Choosing a method to finance accrued benefits while social security transitions from a government program into a quasi-government program.

• There are multiple methods of Privatization.

1. The first method is gradually phasing out government contributions to OASI accounts and then allowing workers to invest money.
2. The scond method is Privatization with a Flat minimum annual benefit based on a wage index.
3. The third method is a Progressive matching scheme in which the government matches peoples' contributions to a personal account. The match is a function of labor income and the percentage match falls steadily as income increases.

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The International Model

Chile

• In 1980, Chilean government began a privately administered national system of Pension Savings accounts.
• Pension level in Chile is based on money accumulated during working years.
• While working, 10% of earnings is put into personal account each month by a person's employer and only applies to the first $22,000 of income. Above this amount, saving is no longer necessary.
• If worker wants to retire early or have higher pension, they can save more than the mandatory amount.
• Money in the account is managed by a company that makes low risk decisions, ensuring there is a diversified portfolio.
• Competition between various companies mean that the companies will attempt to provide as high a rate of return as possible.
• If pension is not at required minimum after 20 years of working, government will then pay the pension.
• Legal retirement age for men-65, women-60, but they can keep working after retirment age while collecting a pension.
• System solves the problem in a pay-as-you go system because the number of workers per retiree decreases as the population ages preventing one demographic from shouldering the weight of the tax burden.

Results

• The long-term investment capital has helped fund economic growth and the development of better financial markets and institutions.
• Average real rate of return on investment rises and falls with the economy, so it started spectacularly, then fell.
• High commissions, and adminstrative costs have cause some depletion of funds.
• Resources administered to the national pension system have accounted for a large portion of the nation's economy.

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Social Security Privatization in the United States

Economic Affects

• If full privatization used, it will produce a long-run steady state.
• Initially aggregate labor supply will be reduced because of increase in taxes to pay for transition.
• Benefits would be paid to people at a certain generational cutoff age, then the private accounts would be used.
• Returns are not fixed, but tied to claims on private capital.
• Allows for people to work as long as they want reducing the number of workers per beneficiaries, and returning the system to solvency.

Pros of Privatization

• Lessen the hindrances of work and saving, and potentially increase economic growth.
• Lessen the chance that the government will use social security surpluses to cover other deficits.
• Restore confidence in social security since right now many young workers do not believe the system will be solvent when they retire.

Cons of Privatization

• The disability and death insurance that protects today's workers would be threatened.
• The rates of return that private systems offer are misleading, and do not offer the same protections as the current insurance system.
• The transition from one type of social security to the next could bring about insolvency even faster.
• Benefits would become based upon peoples' investment skills as opposed to how long they had been working.

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Sources

Economic Report of the Presidentpp.129-47 United States Government Printing office. Washington:2004.

Empowering Workers: The privatization of Social Security in Chile Pinera, Jose. The Cato Journal Online Vol. 15 issues 2 -3. pp.1-9.

Social Security Administration. SSA.gov. History sections, retirement benefit sections.

Center for Economic Research and Policy. Baker, Dean and Rosnick, David. Basic Facts on Social Security. March 2005.

Retire Secure website. retiresecure.org/images/051305-1.gif.

Pension Reform and Financial Investment in the United States and Canada.Beland, Daniel,McMaster University, Social and Economic Dimensions of an Aging Population Research Papers.

Securing Social Security for the Future.Stiglitz, Joseph Economists' Voice v2, n1 (2005): 1-6