Creating a New Kind of Social Security

By Weaver, Carolyn L. | The American Enterprise, January-February 1997 | Go to article overview

Creating a New Kind of Social Security


Weaver, Carolyn L., The American Enterprise


Low birth rates, increasing life spans, and slower economic growth have forced politicians around the globe to search for ways to rescue their debt-ridden government retirement systems. And instead of "nip and tuck" reforms of their old statist systems, many countries are considering much more fundamental reforms--such as those adopted in Chile over a decade ago. The essence of the Chilean system is individualized retirement accounts invested in competing private financial institutions, reinforced by a government safety net. Sometimes referred to as "Social Security privatization," this highly successful (and popular) reform has boosted savings and investment in Chile, helping to rocket the economy into one of the fastest growing in South America.

Argentina, Peru, Colombia, Bolivia, and Mexico have already adopted sweeping reforms modeled after Chile's. Brazil, El Salvador, and some Asian and European countries are contemplating similar efforts.

In the United States too, proposals to replace a portion of Social Security with individualized retirement accounts are gaining support. An official Social Security Advisory Council (on which I serve), which was appointed by HHS Secretary Donna Shalala, will release a report any day now containing a proposal to convert half of the nation's giant retirement program into individually owned, privately managed accounts. Several bills introduced in the last Congress have proposed some degree of privatization. Given the dismal alternatives--like raising Social Security taxes and cutting benefits again--these proposals are generating real enthusiasm, especially among younger people.

Privatization's Many Benefits

Many good results would flow from phasing out our existing Social Security arrangement--which taxes workers to pay benefits to retirees--and creating a new one which helps each worker save for his or her own retirement. By permitting workers to deposit part of their payroll taxes in privately managed, personal accounts, every worker, rich and poor alike, would become a shareholder, building retirement protection while securing the higher returns of private capital investment. Workers would own these accounts, and any investment earnings, and thus would be shielded from political uncertainty about future benefits. Payroll taxes would become true contributions. At "retirement," workers could withdraw their funds whether or not they continued working, and any balances remaining at death could be inherited by family members. Thousands of money-management firms, competing for new customers, would offer a wide range of investments with different risks and rates of return, as well as More saving and more capital investment would result, boosting the wages of American workers and increasing national income in future decades.

Privatization would also alleviate Social Security's recurring funding problems. With a system of fully funded individual accounts, Social Security would run on automatic pilot, no longer hostage to demographic uncertainties and political manipulations. We'd still have to dig out from under the debt accumulated under the existing system, but individual accounts would provide an appealing "light at the end of the tunnel" for the people being asked to bear the brunt of needed changes.

There are many ways to convert Social Security to a system of true pension saving, three of which are summarized below. The Chilean system provides a proven example of full-scale privatization replacing an old-style tax-and-transfer system. The United Kingdom provides an example of a government-run system that is being gradually reduced in importance as private pensions are actively encouraged. Lastly, a U.S. proposal, one of the three contained in the report our Social Security Advisory Council is about to release, is a hybrid of the Chilean and U.K. approaches. It retains a scaled-back government program for the purpose of providing a base benefit and also creates a system of mandatory personal accounts.

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