peer reviews

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Social Security Debate Group 2:

Restructuring vs. Privatization of Social Security

Chad Clark, Derek Stubbs, James Burkhart, John Risco, Kevin Arsenault, Michelle Loyfman

Florida State University

MAN 5716: Business Conditions Analysis

Dr. William A. Christiansen

March 28, 2021

CASE FOR RESTRUCTURING OF SOCIAL SECURITY

Introduction:

Social Security is an 85 year old program first signed into law by President Roosevelt in August of 1935. The program itself is a 75-year old social insurance plan to ensure retired workers over the age of 65 have a continuous income. In the beginning part of this paper, we will argue that the Government is well suited to continue to oversee the plan and for the program to not be privatized. Changes will have to be applied to the current plan, changes that will ensure that each Trust is well prepared to meet the requirements of each participant.

Current laws allow for the U.S. Government to apply changes to the Trust to guarantee that each participant is prepared for life after retirement. The current program has been amended a number of times in the past, one major change being the Amendment of 1972. This amendment first introduced “indexing to the program” (Kollman, 2000). Starting in the year 1975, plans would be “indexed” or adjusted for the rise of the cost of living. Since 1972, all major changes to the program were for expanding, Social Security was made nearly universal as time went on, with more and more being eligible for benefits.

What’s the Problem:

According to the Congressional Budget Office, current trust funds will be exhausted by the year 2031, with the payments required in the year 2032 to be reduced by 26% (Congressional). With that number slowly creeping up on participants of Social Security, changes must be made in the next few years to ensure trust funds do not deplete completely by the year 2031. Some proposed changes that could be made by the U.S. Government would be to increase the current tax rate, 12.4%, by two percentage points to bring the overall tax to 14.4%. This is an increase of one percentage point for the employee and one percentage point for the employer. Another possible change would be an increase on the maximum amount of earnings to be somewhere around $150,000. The government amended the ceiling to $137,000 however, in this argument, the group will argue for that number to be increased even more.

This group strongly believes that restructuring the current program would be best, other countries that have privatized the program have proven unsuccessful. The World Bank reported on Chile, who has privatized their program, that “more than half of all workers [are excluded] from even a semblance of a safety net during their old age” (Anriq, 2004). This shows that the predicted benefits were not enough for most participants to continue to live after retiring, with 41% continuing to work after they “retired.” Another reason why Social Security should not be privatized and continue to be a government run program is that normal people cannot be trusted to make successful investment decisions. Because of poor investment choices by the citizens of Chile, the government was required to provide subsidies for those not able to cover a minimum pension payment for themselves (Anriq, 2009).

Argument:

The Government is better suited to manage and safeguard the Trust funds related to Social Security benefits of the American citizens. There are laws in place that allow the government to adjust the administration of the Social Security trusts to meet current and future obligations related to the payment of benefits. The risk of changing to privatization has too many risks and uncertainties both in security of the trust and maintaining the investment of the trust funds.

The Social Security system is designed as a pay as you go methodology and operates on a 75-year plan, which is updated with projections annually. Each year the completed year is dropped, and a new year is added. The latest update, as of this debate, was completed in 2020, for the year ended 2019. The Social Security administration has already adopted the policy of Solvency for ensuring benefit obligations required will be paid. The U.S. Chief Actuary just updated the Commissioner of Social Security on the effects of the pandemic on the costs of the programs in a memorandum dated November 24, 2020. Based on this memorandum, the impact of the pandemic to Social Security is shows an increase in the cost rate from 17.06% to 17.13%, Actuarial balance increased to from a negative 3.21% to a negative 3.28% and no change to the income rate of 13.85%. The major impact of the pandemic was losing another three years of funding reserve, which is estimated to be depleted by 2034.

Based on United States census data the elderly population is growing and living longer. It also has a decline in number of individuals able to contribute to the social security program because of a smaller birth rate. “The Social Security Board of Trustees project that changes equivalent to an immediate reduction in benefits of about 13 percent, or an immediate increase in the combined payroll tax rate from 12.4 percent to 14.4 percent, or some combination of these changes, would be sufficient to allow full payment of the scheduled benefits for the next 75 years”. (Gross, 2010) The American workers and businesses that employ people in this country would argue they cannot afford an additional 2% increase to the already high tax. Those individuals who have reached the age where they are able to collect their earned benefits would argue they cannot afford a cut to those benefits.

Over time, the tenets of governmental assistance have only become more prominent in the last century or so. On August 14, 1935, President Roosevelt signed the “Social Security Act” into law, which created a social insurance program and payment system for retired workers in the United States who were 65 years of age or older. The focus and goal in enacting the respective act and program are to provide supplemental income to the workers that retired and cannot work due to a multitude of specific issues that came to fruition in their lives. However, as the social security program is currently public, there is the direct and beneficial need for social security as a whole to become restructured in its current setting (Nishiyama & Smetters, 2007). With that in mind, this discussion will focus on the benefits of social security restructuring, while providing important pieces of information relating to how this change is needed to be done now. As time goes on, without any direct and implementational changes, the economic flaws and detriments from a public social security program will surely outweigh any of its supposed and purported benefits (Scheil-Adlung, 2001).

To reiterate above, the “Social Security Act” was signed by President Roosevelt in 1935, over 85 years ago. With any enacted legislation and program, there are reports directly indicating the potential insolvency of the current social security program, which requires another program to be implemented, eventually taking its place. There are those who supported a limited government which directly becomes interchangeable with the restructuring of social security giving private corporations and other organizations the ability to take the reins sort of speak. As expressed by Ramirez & Lewis (2018), “These results highlight the potential for beliefs about private companies to serve as a group heuristic in political reasoning and the ability of citizens to make reasoned choices on complex public policy issues.” This quote would generally argue and present a point of view as to the benefits and reasonings behind the increased responsibilities given to organizations who can gauge and guide the restructuring efforts of the current social security program. Without understanding the general representation offered by researchers and economic theorists, then the focus of beliefs behind the restructuring of social security will become only further confusing and moot in time. There should also be the discussion that having this act of restructuring generally can avoid any unnecessary spending on behalf of the government and also monetize the process by streamlining the process as a whole without consequence (Frost, Trapassi, & Heinz, 2019). The United States’ government should be supporting any course or action that will lower its workload and also commit itself to the benefit of the population in the country (Diamond, 1996).

Economically, one benefit that can arise from the restructuring of social security would relate to investing methods, which if done properly can allow and ensure better returns over the long-term. This can become beneficial if an individual was allowed to invest his or her income payments, in turn allowing them to pursue more risk and volatility within the respective market. One can then ascertain that a higher risk can equal a more significant reward and that is a step some social security collectors may be willing to move forward with (Frost, Trapassi, & Heinz, 2019). In addition, another economic benefit would be that the restructuring of social security can in turn boost the economy because people are given the ability to use their income for distinctive investments. In other words, individuals will put their supplemental social security income into investment vehicles, which will, in fact, churn and give more money back to companies and organizations for whom they are putting their money with. By being able to invest more, this can create jobs in return, which will help create jobs and also benefit workers as they grow older in helping them save for their own respective retirements (Ramirez & Lewis, 2018).

CASE FOR PRIVATIZATION OF SOCIAL SECURITY:

Introduction:

For over three quarters of a century, Social Security has been a critical lifeline to the elderly population of America. Since its creation in 1935 as a part of the New Deal, Social Security has continued to significantly expand, covering a broader share of the population; examples include the introduction of disability insurance in 1956 and the early retirement benefit in 1956 and 1961 for women and men, respectively; further, Americans are living longer. At inception, the program’s purpose was to provide social insurance for the elderly, meaning a safety net for persons who were no longer able to work due to age-related issues; the purpose was not to serve as a replacement for traditional savings or employer-provided pensions (Rosenblum, 1997). The vast expansion has necessitated changes to the program through the years, but the changes have not been sufficient to ensure the long-term solvency of the program.

What’s the Problem:

As of 2012 (the most recent data found), Social Security’s Old-Age and Survivors Insurance (“OASI”) showed an unfunded obligation of $7.4 trillion (Gokhale, 2012); essentially, the present value of future outflows minus the present value of future inflows – projected under current law – concluded this deficit. Moreover, since 2009, OASI Trust Fund has run at a deficit, requiring net outflows in order to meet current obligations. The reason for the deficit is simple: Social Security is structured as a “pay-as-you-go” program, meaning current recipients’ benefits are being funded by the current workforce. This system is being stressed as Baby Boomers transition into retirement at a faster pace than that of general workforce growth, leading to the program’s shortfalls, and woes. For example, in 1945, there were approximately 42 workers for every beneficiary of the program; in 2010 that number had fallen to approximately 3 workers for every beneficiary of OASI (Rosenblum, 1997). By 2070, that number is expected to fall below 2 workers for every beneficiary (Rosenblum, 1997).

In addition to its current insolvency, OASI is believed to be a contributor to negative economic behavior by Americans (Rosenblum, 1997). For example, some economists believe that the program is a large driver of the poor savings right in America (Rosenblum, 1997). According to the Dallas Federal Reserve report on privatization of Social Security in 1997, Americans have been saving less than 4% of GDP in recent years; this compares to 8% in Germany and over 20% in Japan. In 1995, median net worth of households aged 65-74 was just over $100,000; this net worth was principally driven by home equity (Federal Reserve Survey of Consumer Finances). What’s more, only 35% of households in that same age range had any savings in retirement accounts. According to Harvard economist Martin Feldstein, the existence of Social Security benefits reduces private savings by incentivizing an older part of the population, who are able-bodied, and well-trained, to leave the workforce; consequently, this weighs on the economy as productivity declines given that members of the labor force with the greatest experience level are the ones exiting the labor force.

There is a clear outcome here: if there are no changes to the existing OASI program by 2035, the trust fund will only be capable of supporting 75% of currently contractual payments. (Gokhale, 2012). Reforms currently being discussed, including raising the retirement age, raising the social security tax, and others, remain politically unpopular. Consequently, there is a case to be made about “privatizing” OASI as a solid alternative to the existing program – with some significant benefits to doing so.

Argument for Privatization:

The effort of reforming Social Security is admittedly political suicide in today’s environment; however, if you could remove the political narrative and evaluate the merits of privatizing the program, many Americans would likely shift their opinion. To understand what “privatization” means, it is worth sufficiently explaining the process. In theory, instead of paying a 12.4% tax (6.2% paid by employee and 6.2% paid by employer) to fund the current OASI beneficiaries, people’s contributions would be deposited in mandatory individual retirement accounts, which the individuals own – not the government. The biggest hurdle to this process is how to transition from the existing program to the new way, given the OASI is pay-as-you go. The transition – lasting approximately three decades – would likely require additional deficit spending to ensure existing OASI beneficiaries continue to receive benefits once funds are diverted to the individual retirement accounts (Gokhale, 2012). The process won’t be easy or pain-free, but it is an effort that will better position the United States and its people for long-term economic security.

With the process explained, it is worth discussing in detail some of the benefits that would result from privatizing Social Security. First, one of the key benefits would be that the individuals would actually own the money being deposited in their retirement account; therefore, when that person dies, its estate would inherit any remaining funds. With OASI, benefits end upon an individual’s death, regardless of how long the beneficiary has received them. For example, if a person dies at the age of 60 – therefore not eligible for OASI – his/her estate would receive absolutely nothing from the government; this is despite that person hypothetically paying into the program for maybe 40 years. If that same person had instead been contributing the same monies into an individual retirement account, his/her estate would hold all of those assets. This is a crucial benefit to privatizing Social security.

The second key benefit to privatizing Social Security is the opportunity to earn significantly higher returns than that of what is generated in the Social Security Trust Fund. Individual account owners would have a range of investment options, including mixes between equity and fixed income. With OASI, the Trust Fund is solely composed of specific Treasury Bonds that are created for Social Security, effectively earning a risk-free rate that averaged 2.9% in recent years. (Williams, 2018). For comparison purposes, the stock market has returned 7% annually, inclusive of dividend reinvestment, adjusted for inflation. (Motley Fool) The power of compounding that 4% incremental return would be astounding. To be fair, the argument against this is often that there is significant volatility in the markets, leading to discomfort for retirees; while this is true, the S&P 500 has never returned a negative return on a 20-year rolling basis. (Williams, 2018). Candidly, the shift from the government managing a Trust Fund invested in T-Bills to individuals owning their own retirement accounts would better position individuals for retirement.

The last main benefit that is worth mentioning is the expectation that savings rates would jump considering the aforementioned ownership component of the retirement accounts as well as the higher returns. From a macro perspective, a rise in the savings rate would increase the amount of capital for investment both domestically and overseas. (Bosworth & Burtless, 1997). The current low rate of savings in the U.S. (i.e. weak accumulation of resources) is a factor in the slow growth of national income and wages over the last fifty years. (Bosworth & Burtless, 1997) With the current Ponzi Scheme model, there is no accumulation of assets; privatizing social security would reverse that, and individuals would start to see their assets grow in an account that is owned by them, and generating a higher return than what was previously experienced. What’s more, human behavior would likely drive savings higher as Americans would watch their account balances grow, leading to a more personal investment in the outcome of their retirement planning. As it stands today, a majority of Americans consider Social Security as their main source of retirement benefits and have done very little to save more than the mandatory tax paid out of their wages. If the U.S. did achieve the higher savings rate as a result of the privatization, the country would be positioned to experience stronger investment throughout the world, which should improve productivity and wages.

Conclusion:

Social Security remains one of the most contentious issues in politics today; as a consequence, our leaders are failing to address a looming failure in the program. The fact is that by 2035 there will need to be legal changes to Social Security, as the program will no longer be positioned to meet 100% of its obligations. The time for change is now, and it needs to bold in order to ensure a sustainable and fiscally responsible retirement system for the aging population in America.

While the politics around this issue remain difficult and complicated, the actual process to privatize Social Security would be just as difficult and complicated. For one, the government would have to create deficit spending in order to continue to service the obligations of existing OASI recipients. The government would also need to provide grants, via additional debt, to be able to compensate existing contributors to the Trust Fund for their years of payments. This transition would be a phase out approach and take over three decades to complete. Some objections to privatization are simply predicated on the difficulty of doing it – which is not a sufficient excuse to neglect the looming crisis.

Americans stand to significantly benefit from privatization due to a few key factors. For one, the shift of ownership of assets would go from the government to the individual; these assets would be passed down from generation to generation. Additionally, the returns for the individual retirement accounts should be significantly higher than that which is earned on the existing trust fund. Investment choice would empower the individual to make decisions that best suited their retirement goals, removing that decision from the U.S. government. Lastly, with Americans making the contributions to their own respective accounts, the savings rate would climb, leading to more investment power in the future. It is time to take action to address Social Security’s looming crisis, and privatization is that action.

Bibliography

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Diamond, P. A. (1996). Proposals to restructure social security. Journal of Economic Perspectives, 10.3, 67-88.

Frost, N. A., Trapassi, J., & Heinz, S. (2019). Public opinion and correctional privatization. Criminology & Public Policy, 18.2, 457-476.

Gokhale, J. (2012, February 16). Social Security Reform: Does Privatization Still Make Sense? Harvard Journal on Legislation, 50, 169-207.

Goss, S. C. (2010, November 3). The Future Financial Status of the Social Security Program. Retrieved March 2021, from Social Security: Office of Retirement and Disability Policy: https://www.ssa.gov/policy/docs/ssb/v70n3/v70n3p111.html

Investopedia. (2020, January 2). What Would Privatized Social Security Mean for Americans? Retrieved March 2021, from Investopedia: https://www.investopedia.com/ask/answers/040715/what-would-privatized-social-security-mean-americans.asp

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Ramirez, M. D., & Lewis, P. G. (2018). Beliefs about corporate America and the structure of opinions toward privatization. Political Behavior, 40.4, 1011-1034.

Rosenblum, H. (1997). Why Social Security Should Be Privatized, Southwest Economy. Retrieved March 2021, from Federal Reserve Bank of Dallas: https://www.dallasfed.org/~/media/documents/research/swe/1997/swe9703b.pdf

Scheil-Adlung, X. (2001). Building Social Security: The Challenge of Privatization. (1st Edition ed., Vol. Volume 6). New York: Routledge.

Williams, S. (2018, July 16). The Pros and Cons of Privatizing Social Security. Retrieved March 2021, from The Motley Fool: https://www.fool.com/retirement/2018/07/16/the-pros-and-cons-of-privatizing-social-security.aspx