Social Security: Who Wants Private Accounts?

By Finke, Michael PhD, Cfp; Chatterjee, Swarnankur PhD | Financial Services Review, Winter 2008 | Go to article overview

Social Security: Who Wants Private Accounts?


Finke, Michael PhD, Cfp, Chatterjee, Swarnankur PhD, Financial Services Review


Abstract

Preference for partial privatization of social security is explored using a 2004 sample of 7,565 young baby boomers. Two-thirds of the sample would choose partial privatization. Although a greater proportion of higher-income, wealthier, and more educated respondents preferred private accounts, multivariate analysis reveals that intelligence has a stronger effect than socio-economic variables. An average of 43% would be invested in equities, but a surprising 35% would be invested in government bonds. Men and those with higher intelligence are more likely to prefer equities, whereas women prefer corporate bonds and the less educated, Blacks, and respondents with children preferred government bonds. © 2008 Academy of Financial Services. All rights reserved.

JEL classifications: H55 (social security and public pensions)

Keywords: Social security; Portfolio choice; Private accounts; Privatization

1. Introduction

Interest in the diversion of social security taxes into private accounts has increased in recent years because of demographic shifts that threaten the solvency of a pay-as-you-go system, concern over government spending of social security surplus taxes, and increased household personal responsibility for retirement and participation in financial markets (Social Security Administration, 2001). The impact of partial privatization of social security on the financial services industry is potentially enormous. Goolsbee (2004) estimates that if 2/3 of recipients divert 20% of social security taxes into private accounts, these accounts would grow to over $2 trillion by 2030 and result in fees to the financial services industry whose net present value equals $960 billion.1 Extant literature on social security privatization is rich in analysis of the relative merits of privatization; however, few stuthes have explored household demand for private accounts.

This study uses a data set rich in demographic characteristics to provide a thorough analysis of demand for social security privatization among a large sample of households nearing the peak earning years of their life cycle. This study also analyzes portfolio composition preferences within these accounts, providing the first estimate of possible shifts in demand for financial instruments that may occur after privatization. We also explore theory related to demand for control of financial assets and provide insight into the previously established relation between cognitive ability and investment choice.

2. Literature review

2.1. A Brief history of social security privatization

In December of 1995, a subcommittee of the 1994 through 1996 Advisory Council on Social Security considered the merits of various proposals to divert a portion of FICA tax to personal savings accounts, similar to systems in Sweden, Chile, and the United Kingdom in which government directed private accounts are used to buy retirement annuities (Social Security Administration, 1996).2 A number of bills proposing the establishment of some form of private Social Security accounts were introduced by legislators in the U.S. Congress in 1998 and 1999 following analyses of the feasibility of privatization by the Clinton administration and me Department of the Treasury. In 2001, the Bush administration established the Commission to Strengthen Social Security, a 16-member bipartisan group charged with creating "specific recommendations to preserve Social Security for seniors while building wealth for younger Americans" (www.csss.gov). In December 2001 the Commission concluded that Americans would be better off if given the choice to save a portion of their Social Security taxes in private accounts that could be invested in financial instruments with a higher expected investment return (Social Security Administration, 2001). In his 2005 State of the Union address, President Bush proposed that individuals be able to invest up to 20% of their Social Security taxes into private accounts where they would be given some autonomy over investment choice. …

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