Commentary

Destiny of Freedom for Social Security?

By Peter J. Ferrara
July 21, 1997

Last December El Salvador became the seventh nation in Latin America to allow its workers a private option to Social Security. While Chile is famous for being the first, Argentina, Peru, Colombia, Bolivia and Mexico have now followed, as well as E1 Salvador.

El Salvador’s reform rivals Chile’s as the strongest. In the private system, employers pay 6.5 per cent of payroll into an individual account for each worker. The worker pays another 3.5 percent into the account, as well as up to 3 percent for life insurance, disability insurance and administrative fees.

Workers choose from a range of private investment management firms approved by the government to handle their accounts. These firms then pick the individual investments for the workers. At retirement, the accumulated funds finance an annuity that pays monthly benefits to the retiree for life.

The entire system is indexed for inflation, as in Chile. That is possible because the private capital investments supporting the system earn real returns, in excess of inflation, over the long run.

The system also guarantees workers a minimum retirement benefit. If the private benefits that can be financed by the accumulated account funds fall below this minimum for some reason, the government will pay supplemental benefits to bring total benefits up to the minimum. As a percentage of pre-retirement income, this minimum is close to the average benefit under the U.S. system.

Those already in the work force who switch to the new system receive specially issued government bonds—called recognition bonds—to compensate them for their past taxes paid into the old system. These bonds will be sufficient to pay a proportion of the old system’s benefits in retirement equal to the proportion of lifetime taxes the worker paid into the system.

At standard market investment returns, workers in the new system can expect three times or more the benefits that the U.S. Social Security system promises, as a percent of pre-retirement income. Moreover, these benefits would be fully funded, and not subject to the long-term financing gaps of the U.S. system.


If Congress doesn’t start paying attention soon, America will be left behind in this galloping international trend.


As in Chile, where the savings rate is now more than 25 percent, El Salvador can expect a massive increase in national saving and investment through the private accounts, which will sharply increase economic growth. Of course, the poor in El Salvador will benefit most from the higher retirement benefits and higher economic growth the private system will provide. All workers will benefit as well from increased freedom of choice and control over their money.

Such reform is likely to spread elsewhere around the globe. Little-known is that the World Bank has been actively pushing such reform at least since its publication in 1994 of a landmark study recommending the change for countries all over the world. Great Britain already has an option, under which almost 80 percent of its workers have opted out of half the system there. In the recent British elections, both parties promised to explain this option further.

In the United States, Harvard economics professor Martin Feldstein has been heavily promoting such reform from his platform as president of the National Bureau of Economic Research. He joins other top economists and Nobel Prize winners in this view, including Milton Friedman, James Buchanan and Gary Becker.

These efforts are now taking hold. Top national polls are showing huge majorities in favor of such reforms. In 1994, Frank Luntz asked workers under 35 whether they would support the idea “of redirecting part of the Social Security taxes to a personal retirement account like an IRA which could be kept at any financial institution they would like, and receiving less in Social Security benefits from the government,” He found 82 percent saying yes. In 1995, in a poll of an adults, Mr. Luntz found Americans supporting the idea by 77 percent to 14 percent. In 1996, Bill McInturff of Public Opinion Strategies, perhaps the leading candidate polling firm, found the public favoring the idea by 68 percent to 11 percent.

Moreover, last month Oregon may have started a national trend as its legislature passed a remarkable resolution calling on Congress to enact a waiver system for Social Security that would allow each state to adopt a private option for its residents. This proposal is based on the highly successful waiver option for national welfare programs, which has avowed states to adopt quite effective reforms for those programs. Efforts are under way to adopt such resolutions in other state legislatures.

If Congress doesn’t start paying attention soon, America will be left behind in this galloping international trend. Left behind as well will then be the freedom and prosperity of the American people.

Peter J. Ferrara is general counsel and chief economist at Americans for Tax Reform and an associate scholar at the Cato Institute.