Social Security Choice Paper No. 9

Social Security Privatization: One Proposal

Executive Summary

As Social Security’s problems become more apparent, there is growing support for privatizing the retirement program. As the debate intensifies, it becomes more important to move beyond generalizations and provide detailed proposals for accomplishing privatization. Without endorsing any specific proposal, the Cato Project on Social Security Privatization will present a number of possible privatization scenarios.

In this study, David Altig and Jagadeesh Gokhale offer a proposal based on the following key elements:

  • Workers under age 32 would be allowed to divert up to 46 percent of their payroll taxes to individually owned, privately invested accounts, similar to individual retirement accounts or 401(k) pension plans. The remainder of the payroll tax would be used to continue to provide benefits for the currently retired and those who will retire soon.
  • Assuming private investment returns below historic averages, individuals in the privatized system would receive retirement benefits equal to or greater than those currently promised by Social Security. However, individuals would receive no recognition of or benefits based on past payroll taxes paid.
  • During the early years of the transition, the government would issue new debt to supplement revenues from the continuing portion of the payroll tax. Once benefits to current and soon-to-be retirees had been paid, the continuing portion of the payroll tax would be used to service and retire the debt.
  • No new taxes are required to finance the transition.

The authors make the important point that the window of opportunity for such a privatized system is narrow. For example, if the system were implemented immediately, workers under the age of 32 could shift to the privatized system, diverting 46 percent of their payroll taxes to individual accounts. However, if privatization were delayed until 2011, only individuals under the age of 20 could move to the new system, and those individuals could divert only 22.1 percent of their payroll taxes. Therefore, moving to a privatized Social Security system takes on a new urgency.

Read the Full Social Security Choice Paper

David Altig is vice president and economist and Jagadeesh Gokhale is an economic adviser at the Federal Reserve Bank of Cleveland. The views contained herein do not necessarily represent those of the Federal Reserve Bank of Cleveland or the Federal Reserve System.