News Column

The Privatization Question

October 2002, HISPANIC BUSINESS Magazine


While the potential upside is intriguing, privatizing Social Security is ultimately too risky.

By Loretta Sánchez

The subject of privatization, or shifting government projects to the private sector to achieve a more efficient outcome, has been a topic of great interest in the past decade. In many cases this approach has been successful in cutting costs. In other cases, there is far more to consider than the bottom line. Social Security is an example of the latter.

Today, the Social Security system provides cash benefits to 46 million retired and disabled workers, their dependents, and their survivors. Medicare provides an additional 40 million people with health insurance. Because any changes to these programs would have an extraordinary impact on the lives of all Americans, it is critical that we carefully examine proposed reforms.

On its face, privatization of Social Security seems to offer enormous potential benefits. Proponents argue there would be more individual control over investments and contributions, along with the opportunity for increased financial return. Privatization would have the added benefit of boosting the financial industry as workers increasingly turn to individual retirement accounts and brokerages.

Unfortunately, there are three important variables missing from the privatization equation: Some Americans’ lack of the necessary fiscal sophistication for understanding the financial markets; the possibility of an unstable investment market; and a biased rate of return.

Financial sophistication is something many business professionals take for granted. But with nearly 30 percent of Americans having only a high school diploma or less and 44 million Americans reading at first-grade level or below, who will ensure that the public is making sound investments?

Would the government be responsible for subsidizing investment programs devastated by sudden market downturns, such as those recently seen in the science and technology markets? Not only would the flood of disparate investment decisions have the potential to throw off the market, transitions to personal retirement funds run the risk of creating large-scale problems that could disproportionately affect today’s younger workers. That does not even take into account the potential for victimization through fraudulent investor schemes.

As many of us learned over the last few years, the financial markets can be rocky and unstable. Even the most skilled investors have been unable to avoid recent financial losses. If all of the nation’s retirement funds are tied up in investments in a market that becomes unstable for any number of reasons, there is absolutely no guarantee that retirees will really get the best returns on those investments. Worse, they could end up impoverished. Given the current war and global uncertainty, market instability is increasingly likely.

Since current proposals for Social Security privatization are based on a percentage of earned income, those at the bottom rungs of the salary chain would have less to invest and would earn disproportionately low returns. That would create an economic void for our least financially stable citizens.

If the market were to crash or even slip dramatically in certain sectors, we, as a nation, would be left to pick up the tab for healthcare costs and assistance for the aged – a population that is projected to grow 74 percent by 2025. All this at a time when the government would least be able to afford it. We cannot gamble on the future. Now is the time to prepare for financial security.

Last year, the U.S. House of Representatives passed H.R. 2, the “Social Security and Medicare Lock-Box Act of 2001.” This bill prohibits the use of Social Security surpluses for anything other than reforming the Social Security and Medicare programs. Although September 11 has shifted some of our budget priorities, it should not compromise our promise to protect seniors.

As a member of the Blue Dog Coalition, I pride myself on making prudent fiscal decisions and minimizing bureaucracy. I am in favor of making federal agencies as streamlined and efficient as possible so they work smarter, not harder. Reform of the Social Security system is imperative, but privatization is not the answer. It contains an X factor – an unknown variable – that could potentially contradict a universal rule of fiscal responsibility: You should only risk funds you can afford to lose.

In this time of war and fiscal uncertainty, it is my opinion that the United States can’t afford to take the risk of Social Security privatization.

Loretta Sánchez (D-CA) is serving her third term in the U.S. House of Representatives. She serves on the House Committee on Education and the Workforce and the House Armed Services Committee.

Handled properly, private retirement accounts could provide a measure of control – and an adequate ‘safety net.’

By L. Jacobo Rodríguez

Most American workers are required to participate in a retirement plan over which they have no control, in which administrators engage in questionable – if not downright fraudulent – accounting practices, and in which all contributions are invested in a single “asset”: government securities. I’m talking about the government-run, pay-as-you-go system known as Social Security.

It is perhaps for the aforementioned reasons that many American workers support moving to a retirement system that would enable them to invest a portion of their Social Security taxes in private retirement accounts. In a recent Zogby International/Cato Institute poll conducted amid the downturn in the stock market and corporate accounting scandals, 68 percent of Americans expressed support for private retirement accounts. Among Hispanic workers, the percentage was almost 72 percent. Most respondents cited personal control as the reason for supporting such accounts.

That workers want more control over their retirement plans should come as no surprise. Under the current Social Security system, workers have no property rights concerning the 12.4 percent payroll tax they pay for Social Security, nor do they have the right to receive a retirement pension from the government once they retire. Whether they receive anything and how much they receive is up to the 535 politicians in Congress and their political interests of the day.

These same politicians use excess Social Security money to fund other government programs, disguising the true extent of government spending in the process. In exchange for that money, the government issues debt to itself, an accounting practice that would be deemed fraudulent in the private sector.

This practice has left the Social Security system in a precarious state. The unfunded liability of the Social Security system is estimated to be in the trillions of dollars. Payroll taxes will have to rise to more than 18 percent of wages for the system to remain solvent, or promised benefits will have to be reduced by as much as 25 percent.

Opponents of giving workers more control claim that the current system is fundamentally sound and that privatization could leave workers, especially those who are not financially savvy, high and dry should the stock market crash. But that need not be the case, even in times of high market volatility. I know of no person in favor of private accounts who would make investing in the stock market mandatory. What we are proposing is giving workers property rights so that they actually own the accounts and the money deposited therein.

Because investing in a well-diversified portfolio of stocks and bonds will generate greater returns over a long period of time than investing in government bonds, it is safe to assume that the majority of workers would invest their retirement savings in the stock market, even if they were not required to do so. It is also safe to assume that most American workers would reduce the risk profile of their retirement portfolio as they approached retirement. The important issue here is ownership and the control that comes with it, not rates of return per se.

It is not true that transitioning to a retirement system based on private accounts would involve eliminating the “safety net,” as opponents of choice claim. Those workers who are already retired would continue to receive the benefits promised them; those who do not have enough for a minimum pension would receive a supplementary pension from the government funded from general revenues, provided they met certain conditions. The rest would live in their old age with the satisfaction of having provided for their own retirement.

For Hispanics, the importance of having private accounts should not be underestimated. Hispanics as a group are substantially younger than other Americans. By the time these Hispanics retire, it is likely that the current Social Security system will be running annual deficits in the billions of dollars. As a result, Hispanics are likely to pay more into the currently constituted system than they get out of it.
If Hispanics – and all American workers – were allowed to invest part or all of their payroll tax in private accounts, they would be able to accumulate real financial assets, pass those assets on to their descendants, and live their old age in financial security. In short, personal retirement accounts would give workers a better chance of realizing the American Dream.

L. Jacobo Rodríguez is a financial services analyst at the Cato Institute, a nonprofit public policy research foundation headquartered in Washington, D.C.


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