Privatization by Baby Steps--Without the Risk

The recent stock market plunge has been seized on by opponents of Social Security reform as evidence that President Bush’s plan for using private IRA-type accounts is too risky, despite consistent evidence that the market over time greatly outperforms Social Security’s return.

But there’s still a compelling economic case for private investment accounts, even without a penny of these funds being invested in the stock market. Simply allow taxpayers to divert 2% of their Social Security taxes to a privately held fund with two caveats: All funds must be invested in Treasury securities, and future benefits will be reduced proportionally to the initial funds diverted.

Because this proposal restricts investment to federally insured securities, it eliminates the risk of financial loss so feared by critics. Not only will retiree benefits be more secure than the current program--there is no safer security in the world then U.S. savings bonds--they also will earn a higher rate of return.

In fact, if “security” is really the goal of reform opponents, then this proposal actually is less risky than the current program. The U.S. Supreme Court long ago determined that Social Security payments exist at the whim of legislative fiat. Congress may increase or lower benefits or even cancel benefits at any time, and taxpayers have no legal recourse. Given previous congressional propensity to tinker with benefits and the multitrillion-dollar unfunded liability of the program, it is no wonder that polls consistently show that millions of young Americans fear the benefits will not be there for them. Wouldn’t workers feel more secure with a private stash of Treasury securities?

To the extent that Social Security taxes are diverted to private accounts, the “apparent” federal deficit will be increased, but the effect is illusory. From an accounting perspective, the increase in the deficit is directly offset by a reduction in long-term Social Security obligations. From a cash flow or actual borrowing perspective, there is also no substantial effect. Currently, Social Security surpluses are invested in Treasury securities. This plan will eliminate much of this surplus, but since the same money would have to be invested by individuals in Treasury securities, there would be no increase in government bonds or interest rates as a result.

Privatization would restore some integrity and security to Social Security. To the extent that individuals hold private Treasury portfolios instead of relying on unfunded government promises, they are more secure and earn a higher return. The system itself is improved because long-term obligations are reduced. Perhaps most important, we can begin to break the arbitrary “pay-as-you-go” nature of a program dependent on the shrinking and capricious relationship between working taxpayers and earning beneficiaries.

The key is to get payroll tax dollars into the accounts of workers and out of the hands of politicians in Washington, because letting politicians control your money is the greatest financial risk of all.