The United States Social Security Administration serves as an independent agency of the federal government. It is a program that provides social insurance to those who are in retirement at a qualifying age, manage a disability, or are eligible for survivors’ benefits. Most workers must pay taxes that go into this program to qualify for benefits in the future, then the eventual distribution is based on the total level of contributions of the claimant. Supplemental Security Income, or SSI, is a need-based system that falls outside of the work-based requirements.
The law that created the Social Security program was passed in 1935, and then the system assumed its present name after World War II. The headquarters of the program are in Woodlawn, MD – which is just west of Baltimore. There are also ten regional offices, eight processing centers, and more than 1,000 field offices. About 60,000 people have employment through the Social Security Administration.
Social Security is the largest social welfare program in the United States, with a 2014 net cost of over $900 billion. The amount represents about one-fifth of total federal expenditures each year. That is why the idea of privatizing the system comes up at least once in each election cycle. The pros and cons suggest that it might be possible to raise profits while lowering costs. This guide will take you through each side of the debate.
List of the Pros of Privatizing Social Security
1. It would help to balance out the financial losses seen in the current structure.
During the 2016 investment season, the Social Security program earned a return of 3.15%. If that value had been invested in the S&P 500 index, then the return would have been almost 12%. The reason for this difference is in the fact that the retirement program invests in special issue bonds like public securities, but always stays with government-issued debt. Privatizing Social Security would allow some of those funds to be directed toward stock equity or mutual funds, creating more potential returns – especially if account holders give permission to take on more risk.
2. It could resolve the issue of cash shortfall expected to it the system.
2018 was a significant year for the Social Security program because it paid out more than it took in for the first time since the 1980s. The cash outflows are expected to increase as more Baby Boomers retire, which means the risk of a shortfall each year will continue to rise. Congress expects the program to see a shortfall of $13.2 trillion between 2034-2092. Instead of cutting benefits by up to 21% to solve this problem, proponents of privatization suggest that the gap could be covered by diversifying more of the investments that support the program.
3. It would not become privatized until the claimant takes control of their funds.
Under the current Social Security structure, the federal government mails out checks each month to the individuals who receive benefits. Some may qualify for a direct deposit program. What privatization proposes to do is to let each claimant become responsible for their funds, setting aside a portion, or all, of the benefits in a separate account that each person would control. The idea is that it would allow individuals to grow their wealth over time better than the government, giving retirees more of a reason to pay attention to the benefits they receive.
4. It could work to reduce the administrative red tape that exists in the system.
Another potential benefit of privatizing Social Security involves a potential reduction of the administrative barriers that claimants must navigate. If the government could reduce its responsibility for benefit distribution, then the costs of the system would potentially go lower. There could be more time for elected officials and government workers to focus on other pressing needs in the country. The program is already relatively efficient compared to the levels of revenue it manages, but proponents think that it could do even better if privatization were allowed to occur.
5. It might provide benefits to the U.S. economy over time.
Proponents also suggest that the privatization of Social Security could provide several long-term positive outcomes for the American economy. There would be up to 175 million workers who would have capital that could be invested in the stock market. This level of infusion could create a bull market that might run for quite some time. The added equity could help to fuel more jobs, higher wages, and more spending from retirees because they have more financial security to rely upon with their investment efforts.
6. It would allow individuals to have control over their retirement decisions.
When the idea of privatizing Social Security gained momentum in 2005, the idea was that individual retirees would be free to choose whether they wanted to exercise a personal account option or stay in the framework of the older system. When someone has access to a private account, then there is broader freedom of choice that speaks to American idealism. People tend to be successful when they have control over their decisions and the knowledge to support the actions they take. There would need to be some mandatory financial planning to reduce risks in this system, but proponents suggest that keeping the government out of people’s lives in another way will produce desired results.
7. It could create more certainty in the system.
Gallup conducted a poll in 2010 asking Americans about their confidence in the Social Security program. Only 40% of those surveyed said that they assumed that their benefit would be present when it was time for them to retire. Instead of paying into the government, these funds would be directed toward a private account with a better guarantee of income distribution. That money could then go into U.S. Treasury bonds that are paid with almost virtual certainty so that growth can occur while there is confidence in the amount received.
8. It would create a contractual right to receive retirement benefits.
The Supreme Court has already set the precedent that no one is eligible for guaranteed retirement benefits even if they pay into the system for enough years. In the 1960 Flemming v. Nestor case, a legal immigrant was denied their benefit despite paying into the system for 19 years because they were deported from the United States for being a member of the Communist Party. If the program were to become privatized, then each person would have full property rights over the amount in their retirement account. Every retiree would own the cash in them in the same way that they do in tax-advantaged plans like a 401(k) or an IRA.
9. It could be restricted so that only low-risk investments were permitted.
The biggest fear that people have with Social Security privatization is the amount of risk that would occur with investment choices. There could be restrictions placed on the system that would prevent someone from putting money into high-risk ventures or individual stocks. When plans for privatization almost came to fruition in 2005, the only permitted investments were a conservative mix of stock funds and bonds.
The tax rate has already risen from 2% to 6% as a way to cover the losses experienced by the system. If you are self-employed, then 12% of your income goes into this program. You must earn over $120,000 before you can eliminate this task. That means you could pay over $7,300 per year into the system to earn a 3% return. Most people could do better by themselves.
List of the Cons of Privatizing Social Security
1. It would duplicate the efforts of other retirement options.
Americans already have the right to invest in private retirement options through their 401(k) plans and IRAs. There are some additional tax-advantaged plans out there too. Social Security is meant to be the backup plan if the other options fail or an individual is unable to save anything for their retirement.
The average retiree, at the current savings levels, would only get $3,000 per year out of their 401(k). When you add that to the average Social Security benefit, most individuals are going to receive about $20,000 each year. That may not be enough to support a full retirement.
2. It would create more questions about how the program handles its liabilities.
The Social Security program has several liabilities that receive payment based on the structure of the current system. Workers provide a small portion of their earnings that go toward those debts. Placing money from the trust into a private account would make it almost impossible to stay above water because of the amount of money that other government budgets have borrowed from Social Security over the years.
Bloomberg Business estimated in 2005 that the plan to privatize Social Security would require at least $160 billion in borrowing each year until the new program established itself. The total cost would transfer up to $2 trillion to the national debt.
3. It would come with much higher administrative costs.
Because the Social Security program receives exclusive distribution through the government, the administrative costs of managing the fund stay relatively low. If it were to transition toward market-based, privatized investing, then the expense ratio would rise dramatically. With more costs to pay in the system each year, there could be a lower benefit for this generation to have available to them when they’re ready to retire. Cost is typically one of the most significant sources of lost performance for any fund over time.
4. It is not designed to be an investment program.
The Social Security program was not designed to be an investment vehicle to help people expand their portfolio for retirement. It is an insurance program that needs to create stable, safe returns for the life of the person in question and their family. There would need to be significant changes to the structure of the program for it to create outsized investment gains before any privatization effort at growth could occur. Those expenses would create an additional financial burden on taxpayers, along with the added costs of covering market losses if they were to occur in the system to ensure that retirees could still receive the guaranteed income levels they need.
5. It could cause some people to lose their entire retirement.
Critics suggest that the scariest component of privatizing Social Security is the fact that most Americans have very little financial knowledge. Giving them control over a private account with even a small portion of their benefits could result in severe, immediate losses. Only 6% of retirees can pass an 11-question financial literacy quiz, so asking people to take charge of their finances through this method could be devastating to the economy. It could cause some people to transition to different social welfare programs, creating even more costs for the average taxpayer to manage.
That’s just the beginning of the bad news. 61% of Americans don’t know what their APR is for their primary credit card. 45% say that they don’t know what a credit score represents. For adults over the age of 50, only 1 in 2 people could answer questions about inflation and interest.
6. It will not change the primary problem with the system.
Privatizing Social Security doesn’t do anything to change the underlying problem that the system faces today. Even with more personal control over a portion of their benefits, the government must address the fact that the worker-to-beneficiary ratio continues to fall. Longevity is steadily increasing in the system as well. Diverting a small portion of payroll taxes intended to go to the trust in favor of private accounts could hasten the time it would take to exhaust the system’s reserves.
When there is less money for the government to borrow because capital is being diverted in favor of program privatization, then the national debt level could continue rising at a faster pace as well. That outcome could result in additional stressors on the American economy over time.
7. It could expand bureaucracy instead of reducing it.
There were 42 million people receiving benefits through the Social Security program in 2014. Creating a tracking system in the private sector that would help to manage the status of individual accounts would likely end up creating more government intrusion and bureaucracy instead of less. It might even require hiring more than 10,000 new workers to help oversee the accounts, explain the system, and educate people on how to manage their money wisely. This disadvantage could see the administrative costs quadruple. As they stand now, they are less than 1% of total revenues.
8. It would reduce the value of a person’s guaranteed benefits.
Survivor’s and disability insurance protections that are in the Social Security program would see a reduction in the push for privatization. A 2005 study on this disadvantage found that the diversion of payroll taxes would reduce benefits by up to 44% from 2005-2052. If a teen in 2005 were to retire in 2055, then they would lose over $160,000 in scheduled benefits under the plan for privatization that was introduced during that time. Even with the option to invest privately, less than one-third of that loss would come back from those financial activities.
9. It could create more opportunities for financial fraud.
The Council of Economic Advisors estimated during the Obama administration, Americans lost over $17 billion on retirement investors that were arranged to benefit the advisors more than the investors. When the United Kingdom introduced privatization in the 1980s, salespeople advised many to invest in personal pensions and other high-risk options that result in a loss valued at more than $20 billion that the government ultimately paid.
There are already about 2,000 cases of commodities and securities fraud that occur in the United States each year. Some schemes can defraud thousands of investors at once, and it is the elderly who are typically the target of such efforts.
10. It wouldn’t take much to add more liquidity to the system.
The Congressional Budget Office noted in 2010 that a 15% cut in benefits could add 44 years of solvency to the system. A 2% payroll tax increase would do the same thing. Additional policy changes, such as an elimination of the payroll tax cap, could help to add more solvency to the system. Even if Congress allowed the trust to invest in equities in addition to bonds, there could be positive outcomes that wouldn’t require privatization and more risk in the system to try to meet everyone’s retirement needs.
Verdict of the Pros and Cons of Social Security Privatization
Social Security needs some help. Almost everyone can agree that the current system will remain untenable if nothing is done to fix the problems that it faces. The primary issue is that most of the proposed resolutions involve adding more money to the system instead of looking at the reason for shortfalls in the first place.
When there are more Social Security recipients than individuals in the labor force, then there isn’t enough money to sustain the reserves over time.
The pros and cons of privatizing Social Security suggest that there could be some financial benefits to taking such an action, but it would come at a substantial risk. If a majority of retirees were unable to grow their benefit accounts, then the pressure placed on the economy could be devastating for everyone.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.