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for themselves in a system ultimately des-

Introduction

tined to unravel.

It is generally accepted that under present

7. A market-based system would necessitate

law Social Security taxes will not be adequate

high administrative costs, reducing returns

to unacceptable levels.

to meet promised Social Security benefits. This

8. In many cases, Social Security pays bene-

financial dilemma reflects a demographic reali-

fits to survivors of deceased workers. In a

ty: the available number of workers to be taxed

privatized system, workers who die at an

will be insufficient to pay benefits at current

early age would not have amassed enough

levels to an ever-increasing number of retirees

Compared

wealth to care for their family members,

who are living longer. As our political, academ-

leaving them financially vulnerable.

with the

ic and business leaders wrestle with this prob-

None of these objections survives a careful

current Social

lem, more and more often they suggest moving

examination of the evidence. In fact, most rep-

toward a saving and investment structure

Security

resent a misunderstanding of financial markets,

wherein some portion of the Social Security tax

system, a

Social Security, and how a privatized system

is invested in markets. Advocates of this view

would work. Compared with the current Social

market-based

argue that because market returns are greater

Security system, a market-based retirement sys-

than those from the present pay-as-you-go sys-

retirement

tem would incur less risk and offer more bene-

tem, tax increases or benefit cuts will be less

system would

fits to low-income workers.

onerous.

incur less risk

Opponents, however, warn of numerous and

formidable risks associated with markets.

and offer

Objection #1: Low-income

Among other issues, they raise questions of

workers will suffer because

more benefits

market risk, retirement benefits of low-income

Social Security's progressive

to low-income

workers in a privatized structure, potential diffi-

benefit formula will

workers.

culties for unsophisticated investors in a market-

based system, and the plight of survivors of

no longer apply.

deceased workers.

Opponents of Social Security privatization

This paper examines such common objec-

worry that the level of benefits to low-income

tions to privatization as:

workers from a market-based system would be

1. Low-income workers will suffer because

less than from present-day Social Security

Social Security's progressive benefit for-

because Social Security redistributes wealth

mula will no longer apply.

from high-income to low-income workers

2. Financial security in old age should not

through a progressive benefit formula. It is true

depend upon the participant being a knowl-

that the current benefit formula is progressive;

edgeable investor.

that is, lower-income workers receive more for

3. Social Security is virtually risk-free

each dollar earned than do higher-income

because it is backed by the full faith and

workers. However, whether the formula intend-

credit of the government. A market-based

ed to achieve this actually results in a system

system, on the other hand, is inherently

that is progressive is subject to some disagree-

volatile. Moving toward a privatized sys-

ment.1 But whatever the conclusion, a more

tem, therefore, subjects workers to risk

fundamental question remains: is the objective

which is unnecessary.

4. Although the stock market rises over the

of progressivity to level retirement benefits

long term, it could collapse at the end of

across income classes, or is it to lift the lot of

one's working career, leaving little or noth-

low-wage earners? If it is the former, it is ques-

ing for retirement.

tionable whether Social Security is effective. If

5. Markets cannot handle the volume of

it is the latter, there is no question that Social

investment capital that a privatized system

Security is ineffective.

would create. This inability could cause a

To calculate benefits the Social Security

near-term "speculative bubble" during the

Administration adjusts the worker's wages (and

years baby boomers are paying into the sys-

self-employment income) earned prior to the

tem and then a market collapse as they

year in which the worker turned 60 by inflation

withdraw funds in their retirement years.

adjusting them using what is called the Average

6. Only the wealthy or the financially astute

Wage Index.2 Then the highest 35 years of earn-

would choose the market-based system,

ings are added and divided by 420 (the number

leaving the financially less-well-off to fend

2