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July 22, 1997

SSP No. 10

Common Objections to a

Market-Based

Social Security System:

A Response

by Melissa Hieger and William Shipman

less risky than the current Social Security

Executive Summary

system and can be handled by even inexpe-

T

he debate over whether Social Security

rienced investors.

needs to be reformed is largely over. The

· Because Social Security has a progressive

question now is what type of reform. Many

benefit formula, some assert privatization

experts suggest moving toward a saving and

would hurt low-wage workers. Moreover,

investment structure wherein some portion of

others claim that a privatized system would

the Social Security tax is invested in markets.

appeal only to the wealthy and most savvy

Opponents of privatizing Social Security,

investors. However, because of its much

higher returns, a privatized Social Security

however, warn of numerous and formidable

system would actually benefit low-wage

risks associated with markets. Among other

workers and would appeal across all individ-

issues, they raise questions of market risk,

ual income and education levels.

retirement benefits of low-income workers in a

privatized structure, potential difficulties for

· One of the most common criticisms of pri-

vatization is that private financial institutions

unsophisticated investors in a market-based

would charge excessive fees, thereby reduc-

system, and the plight of survivors of deceased

ing retirees' returns to unacceptable levels.

workers.

However, actual fees and administrative

None of these objections survives a careful

costs for existing investments are generally

examination of the evidence. In fact, most rep-

well below 100 basis points (one percent).

resent a misunderstanding of financial markets

Assuming fees of this magnitude, yields

and Social Security and how a privatized Social

would still be much higher than benefits cur-

Security system would work. For example:

rently provided by Social Security.

· Critics claim that private markets are dan-

· Finally, critics claim that a privatized system

gerously risky and that only knowledgeable

could not provide survivors' benefits. In real-

and experienced investors can successfully

ity, a market-based retirement system would

handle such risks. In reality, however, long-

provide better survivors' benefits than the

term investment in private capital markets is

current system.

Melissa Hieger is a vice president and William Shipman is a principal with State Street Global Advisors.

Mr. Shipman is co-author of Promises to Keep: Saving Social Security's Dream and co-chairman of the

Cato Project on Social Security Privatization.

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