Privatization: Not the Answer for Social Security Reform

Abstract

Introduction As Social Security faces financial difficulties, few would argue that the program is not in need of change.1 However, there is much less consensus about the manner and degree of change required.2 Most proposals that have emerged in the Social Security reform debate involve three basic concepts: pre-funding, investment diversification, and privatization.3 Although these concepts are frequently considered interdependent, they are actually separate and distinct. Pre-funding refers to the requirement that there be sufficient assets accumulated in the trust fiend in advance to pay for future retirement costs.4 Diversification describes an investment strategy that allocates Social Security reserve funds among different investment alternatives.5 Privatization pertains to the creation of individual accounts owned and managed by workers, very much like the accounts of 401 (k) defined contribution plans.6 Privatization proposals generally are based on either a "carve out" or "add on" approach.7 The add on approach funds the individual accounts with new Social Security contributions, whereas the carve out approach diverts portions of current contributions to fund the individual accounts.8 Pre-funding and diversification could be implemented under the existing structure of Social Security; however, privatization radically changes boththe structure and character of the existing program. Furthermore, the carve out model of privatization presents a questionable trade-off.9 On the one hand, workers will have greater investment freedom in a privatized system; on the other, they will be exposed to significantly greater risks. Thus, Social Security privatization has potentially serious implications for retirement income security to the extent that it relies on current contributions.10 For this reason, privatization is the focus of much of the Social Security reform debate and is the subject of this Article. Specifically, this Article analyzes the impact of privatization on the existing Social Security program. Part I describes the structure and status of the current Social Security program. Part 11 describes the principal elements of Social Security reform proposals. Part III critiques the private retirement system and its reliance on individual accounts as primary retirement savings vehicles, and demonstrates why this model is inappropriate as a replacement for the existing Social Security program. Part IV explores the impact of privatization on the public welfare function of Social Security and examines some of the weaknesses in many of the privatization proposals. The Article concludes that privatization is a questionable solution for the Social Security debate. Therefore, as policymakers take steps toward implementing a privatized system, they should be mindful of the primary objectives of the existing Social Security program and the relationship of these goals to present societal conditions. …