Academic journal article Financial Services Review

Partial Privatization of Social Security: A Simulation of Possible Outcomes and Risks to Workers

Academic journal article Financial Services Review

Partial Privatization of Social Security: A Simulation of Possible Outcomes and Risks to Workers

Article excerpt

Abstract

Social Security reform as put forward by the President's Commission on Strengthening Social Security (2001) includes three model proposals each of which contain voluntary privatized accounts. Opting for private savings incurs the penalty of losing benefits that accrue in a set-aside account. Three simulations were run using Monte Carlo simulation based on historical distributions of stock and bond returns. These simulations projected end-of-period savings under different market conditions for Model 2, the only model projecting elimination of Social Security deficits. In all cases the average privatized account accumulations were greater than the set-aside benchmark account; however, the probability of falling below the set-aside account's lost benefits range from a low of 13% to a high of 30%. The considerable probability of failing to exceed a lost-benefits account will be an important consideration for workers in determining whether or not to exercise the option to participate.

© 2003 Academy of Financial Services. All rights reserved.

1. Introduction

The report of the President's Commission (2001) on Strengthening Social Security proposes three models for reform, each of which includes a personal savings account that could be invested in a variety of securities, including corporate and treasury bonds as well as equities. Personal savings accounts build on the earlier proposals of the Federal Advisory Social Security Council (1997), which included two proposals with personal accounts (PAs). The President's Commission's version of PAs offers an option to participate, unlike the required participation of the previous proposed plans. The present value cost of underfunded Social Security (SS) obligations are approximately $3 trillion (Shrieber & Shoven, 1999). Partial or even full privatization will not make up that shortfall, but it could help. The size of the deficit depends on assumptions made. For example, if immigration is higher than anticipated or economic growth exceeds the assumptions made, then the deficit could be a surplus.

The choice of investment vehicles for a PA would vary and could range from index funds to a much wider selection of investments. Alternatively, a portion of payroll taxes could simply be allocated to private security accounts by the government without individualized accounts, under the assumption that returns would be greater than those afforded by the current Social security Trust (SST) fund. Currently the SST earns an imputed 5.9% rate of return on surplus funds (Niggle, 2000), subject to change with government borrowing conditions. The government, by spending surpluses, is essentially borrowing from itself at the imputed SST rate of interest and in effect creating obligations to the SST. A SS deficit is compiled that will need to be repaid out of general revenues, and/or increased payroll taxes, and/or cuts in benefits. To avoid further buildup of these obligations, some type of privatization scheme that assumes greater returns to workers than implied under the current system could make it economically and politically feasible to reduce benefits.

Under the Social Security Administration's (SSA) most-likely-scenario assumptions put forward in the President's Commission's report, SS benefit payments are projected to exceed payroll taxes by 2016 with an anticipated deficit of $318 billion by 2035 (President's Commission, 2001). Without a major increase in taxes, cuts in benefits, or a complete overhaul of the benefit programs, actual benefit payments would have to fall to just 74% of promised benefits by 2038 to accommodate the discrepancy between SS tax collections and payments.

If taxes alone were to be increased to eliminate the shortfall instead of implementation of privatized savings reforms, then rates would need to be increased from the current 12.4% of payroll to 17.8% immediately and further increased to as high as 19. …

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