Commentary

Finding Solution at Home

By Aaron Steelman
February 26, 1998

Proponents of fundamental Social Security reform argue that the United States should look abroad for guidance. And with good reason.

Several countries - including Chile, Mexico, Peru, Great Britain, and Australia, have privatized their pension systems in full or in part. The reforms have increased benefits, national savings and economic growth. But our states and localities have also demonstrated that money is better invested by individuals than by governments. Michigan has been the leader in such reform.

In December 1996, Michigan converted the state pension system from a pay-as-you-go, defined-benefit program to a fully funded, defined-contribution program. State employees hired after March 31, 1997, entered the new system; employees hired before that date have the option of remaining in the old system or entering the new one.

Under the new system the state contributes 4% of the worker’s salary to an individual retirement account and will match another 3%. The worker also may contribute an additional 13% that will not be matched by the government.

The reason for the change? According to Donald Gilmer, who chaired the state’s Appropriations Committee when the reform was proposed, the answer is twofold: “First, we had to look at the issue in the long term, because the old system simply wasn’t sound from an actuarial standpoint.” Furthermore, the system discriminated against short-term employees.

Under the defined-benefit system — in which it took state employees 10 years to become fully vested — more than 60% of workers never drew a dime of benefits. Under the new system, employees are fully vested after four years and able to take all their pension contributions to another job. The system also allows for partial vesting for short-term workers.

Such a change, Mr. Gilmer argues, is family friendly: “The old system discriminated against women because they are the ones, of course, who get pregnant and who often have to leave their jobs to have the kids and to raise them. And many mothers never got the 10 years of service that were required to draw benefits.”

Opposition to the change came from a predictable source; labor unions. Although unions representing the state’s public school employees ultimately were successful in excluding their members from the reform — a particularly unfortunate fact given that two-thirds of such employees never become vested under the defined-benefit system — their arguments didn’t resonate with the public as expected.

Kim Rhead, principal sponsor of the bill, thinks that’s because people rejected the paternalism of the unions. According to Ms. Rhead, “What the opponents of defined-contribution plans are saying is that people are too stupid to take care of their own pensions. That just isn’t true.”

Many Michigan counties have also adopted defined-contribution programs, as have Lansing and Kalamazoo. And Michigan is not alone.

Several states and dozens of local governments have either instituted similar reforms or are considering them. For example, employees of public colleges and universities in California now participate in a defined-contribution system.

Lawmakers in Washington should pay close attention to these developments because, Ms. Rhead says, ”If we look at it realistically, making Social Security a defined-contribution system is our only hope.”

Aaron Sttelman is a staff writer at the Cato Institute.