How Social Security privatization might work

Author: Anchor Renee Montagne, Reporter Kathleen Schalch

Published: November 11, 2004

RENEE MONTAGNE, host:

President Bush says reforming Social Security will be a top priority during his second term. He wants workers to be able to divert some of their payroll taxes into private accounts. They could invest that money in stocks and bonds to save for their own retirement. NPR's Kathleen Schalch reports on what privatization could mean and how it might be done.

KATHLEEN SCHALCH reporting:

President Bush says private accounts are the best way to strengthen Social Security for future generations. Michael Tanner of the Cato Institute agrees. He says there's not going to be enough money in the system to pay the benefits that have been promised. So, he says, you can trim benefits or hike payroll taxes...

Mr. MICHAEL TANNER (Cato Institute): Or you can make more efficient use of the money you have within the system by investing in real capital assets, such as stocks, bonds and things that earn an actual rate of return and increase the amount of money that you have within the system.

SCHALCH: Currently, workers and their employers pay 12 1/2 percent of their income as payroll tax. Under proposal 2, the leading plan drafted by President Bush's commission on Social Security, up to a third of that money could go into private accounts. This would be voluntary, sort of, according to Dean Baker of the Center for Economic and Policy Research.

Mr. DEAN BAKER (Center for Economic and Policy Research): But you aren't going to have the option--no one is going to have the option, say, 20, 30, 40 years out, of getting the benefit that they would be promised under the existing system. That part isn't optional.

SCHALCH: And the only way to compensate for this would be to get extra income from a private account. The incentive to have a private account would be small at first, but would grow over time.

Mr. BAKER: As benefits are now, they rise in step with the average wage, which is projected to grow at the rate of about 1 percent a year. So just sort of the simple arithmetic--20 years out, someone retiring in 2024 should, in principle, get a benefit that's 20 percent higher than a person retiring today. Now proposal 2, the second proposal, says we will no longer raise benefits with wages. So what that would mean is the retirement benefit for someone retiring in 2024 would be the same as it is today, or in other words, 20 percent less than what they're promised under the current system.

SCHALCH: So while older workers may shun private accounts, younger ones may want and even need them. People wouldn't have to become expert money managers. They probably wouldn't be allowed to wager everything on individual stocks or high-risk funds, even if they wanted to. Instead, they'd be steered into broad-based index funds and mixtures of stocks and bonds. Backers of privatization argue that most people would come out well ahead, since historically stock prices have climbed an average of 7 percent per year. But critics say this wouldn't provide the kind of income guarantee that the current system does.

Mr. HENRY AARON (Brookings Institution): Asset prices can go up and they can go down.

SCHALCH: Henry Aaron of The Brookings Institution says the current system factors in inflation.

Mr. AARON: So a retiree, a disabled person knows that he or she is going to get a benefit with certain real purchasing power, essentially come hell or high water. And that isn't something that any of the private account proposals can claim.

SCHALCH: And private employee pensions, the other main type of steady, guaranteed benefits retirees could count on in the past, are growing scarce as well. There are other potential drawbacks to privatization. The current one-size-fits-all system costs very little to administer. Even with a limited range of choices, economists believe the administrative costs for private accounts would rise sharply.

But the biggest hurdle to privatization is the cost. If workers divert some of their payroll taxes into private accounts, that money won't be available to pay benefits to current retirees. The government would have to make up the difference. Backers of privatization, including Grover Norquist of Americans For Tax Reform, say the government could cover the $2 trillion or more in estimated transition costs by issuing bonds. Norquist says this would more than pay for itself when you consider Social Security's obligations over the next 75 years.

Mr. GROVER NORQUIST (Americans For Tax Reform): There is, at present, a 12 trillion-dollar, with a T--12 trillion-dollar--unfunded liability. So you're going from $12 trillion in liabilities down to $2 trillion in bonds. It's a $10 trillion savings to taxpayers and to beneficiaries.

SCHALCH: But the government would find itself far deeper in the hole for several decades, according to Peter Orszag of The Brookings Institution.

Mr. PETER ORSZAG (The Brookings Institution): Individual account plans tend to create a more substantial problem over the next 30 to 40 years in order to generate a less substantial problem 80, 90, 100 years from now.

SCHALCH: Critics say that's a very long time. They think the savings from privatization could be modest, even in the long run. They point out that the government's already borrowing a billion dollars a day to pay its bills. Bill Gale, co-director of the Tax Policy Center, says the president's own fiscal policies have made prospects for fixing Social Security bleaker.

Mr. BILL GALE (Tax Policy Center): He started out with a long-term fiscal deficit. He's raised spending. He's cut taxes. He's made the problem far worse. And at the same time, he's pledged not to raise taxes, and he has no ability, it appears, to cut spending.

SCHALCH: Democrats fear that privatization would ultimately undermine the Social Security system. Michael Tanner of the Cato Institute predicts a pitched battle.

Mr. TANNER: This is going to be, perhaps, the most bloody and divisive debate on any political issue we've seen in many years. We're talking about the linchpin of the New Deal, something that people on both sides feel very passionate about, so the outcome is perhaps too difficult to predict.

SCHALCH: But privatizing Social Security could also be the linchpin of President Bush's broader agenda to create what he's termed an `ownership society,' where Americans rely more on markets and less on government. Grover Norquist points out that the president has already gone where politicians before him feared to tread.

Mr. NORQUIST: Remember, for the previous 30 years, to discuss reforming Social Security was to commit political suicide. And President Bush had to convince people that it was safe for a president to initiate the discussion and safe for congressmen and senators to participate in the discussion, and then win two elections in a row with that conversation before the American people.

SCHALCH: Now the president believes he has a mandate, and he says he intends to use it.

Kathleen Schalch, NPR News, Washington.

MONTAGNE: Summaries of the three reform proposals are at npr.org. Tomorrow, John Ydstie reports that even those who support the idea of private accounts say they won't necessarily solve the financial problems facing Social Security.

This is MORNING EDITION from NPR News. I'm Renee Montagne.