Privatization

Privatization is the creation of individual accounts which accumulate some portion of the employee's contribution, that may be invested in a variety of investment vehicles and are used, at least in part, to fund the individual's benefit when that individual retires.

Privatization is promoted as a major way to cut the projected Social Security shortfall, but the truth is privatization,itself, has little effect on that shortfall. (In fact, as proposed, it actually incurs several trillion in additional costs, which the advocates claim will eventually be recovered. But the recovery isn't in the privatization itself, it's in moving from a pay-as-you-go program to one that relies on earning a return in a massive increase in funds held awaiting to cover future benefits.

This is critical, so we'll repeat it. The claimed benefits of privatizing social security have nothing to do with individual savings accounts. They come from two actions that could be accomplished without privatization:

1. The additional investment income on an increase in the amount held for future benefits, and
2. The assumption (not unreasonable) that investing these funds in non-government investments will provide a higher rate or return than investing them in government securities, albeit with some greater risk.

Simply, if the government borrowed $2 trillion dollars (the amount it will have to borrow to fund the transition the administration is proposing) and took that money, along with the current trust fund money, and invested them in a mix of high-grade stocks, investment quality corporate bonds and even government debt, there would be no problem to discuss. (Well, there's the matter of repaying the $2 trillion -- plus interest -- the government would have to borrow, but that is no different than discussing the problem of borrowing the same amount to fund the transition to private accounts.)

Effects of Privatization

The effects of privatizing Social Security involve the following, to some degree (depending on the actual plan implements)

1. Shift from common pool of funds to individual accounts.
2. Transfer of risk of inadequate retirement funds from government pool to individual, accompanied by the chance for greater rewards, as well.
3. Lessening of the shift in benefits to lower wage earners
4. Increased cost and complexity in administering program.
5. Risk of unsophisticated investors making inappropriate selections.
6. Ongoing lobbying pressure to change rules at a later date to benefit special interests (fund managers and/or possible investment media).

Why Privatize?

If privatization offers no solution to the Social Security shortfall, why privatize? Actually, there are two answers, one financial and one strictly political (in the nonpartisan sense of the term).

Financial Justification

Simply, privatization has the consequence of transferring at least some portion of a pay-as-you-go system into an an actual savings system and, when such a system need not worry about changes in the ratios of workers to retirees, because workers are, in effect, funding their own retirements and that is an unchanging ratio of 1:1. Insofar as this change can be accomplished, we are moving towards a truly permanent guarantee of the overall system's solvency (rather than 75 years). If nothing else, we are funding the future liabilities (benefit obligations) as the obligation is incurred, rather than as the actual payment is due -- the same guidelines that were established for private sector defined benefit programs.

It has been noted than comparisons of returns between the current system and what one could earn by investing one's money are not legitimate, because Social Security is not a savings/investment program. But even the most cautious and secure saving program (one invested the same way as the trust fund surplus) in individual accounts will provide a better return.

Done honestly, we have to recognize there is a cost in transferring to a savings system and that cost must be paid. In large part, the greater returns earned later are nothing but the return on paying the costs now. There is no actual financial gain. But neither is there any financial loss (although there is a transfer in timing of the additional costs-- from the future to the present.)

It should also be noted that much of the opposition to privatization has to do with the nature of the investments available and the risks of the stock market. But the above mentioned benefits exist even if the individual privatized accounts are invested in the exact same ways as the Social Security trust funds, themselves -- government debt.

Political Justification

Privatization also restores faith in individuals that there will be funds available when they retire. It is a reaction to a firmly entrenched perception, rather than a necessary reality, but it restores confidence in the system and public confidence has value. (It may also help avert some draconian changes in future benefits that will seriously damage the most important underlying purpose of the system - providing retirement funds to those who are least able to build their own.)

Additionally (under our plans) the costs will be born by those who perceive a benefit in converting an inter-generational tax to a savings program. (There are no magic "other government funds" to pay for the transition.)