Common Objections to a Market-Based Social Security System: A Response
by Melissa Hieger and William Shipman
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.
The debate over whether Social Security needs to be reformed is largely over. The question now is what type of reform. Many experts suggest moving toward a saving and investment structure wherein some portion of the Social Security tax is invested in markets.
Opponents of privatizing Social Security, however, warn of numerous and formidable risks associated with markets. Among other issues, they raise questions of market risk, retirement benefits of low-income workers in a privatized structure, potential difficulties for unsophisticated investors in a market-based system, and the plight of survivors of deceased workers.
None of these objections survives a careful examination of the evidence. In fact, most represent a misunderstanding of financial markets and Social Security and how a privatized Social Security system would work. For example:
- Critics claim that private markets are dangerously risky and that only knowledgeable and experienced investors can successfully handle such risks. In reality, however, long-term investment in private capital markets is less risky than the current Social Security system and can be handled by even inexperienced investors.
- Because Social Security has a progressive benefit formula, some assert privatization would hurt low-wage workers. Moreover, others claim that a privatized system would appeal only to the wealthy and most savvy investors. However, because of its much higher returns, a privatized Social Security system would actually benefit low-wage workers and would appeal across all individual income and education levels.
- One of the most common criticisms of privatization is that private financial institutions would charge excessive fees, thereby reducing retirees' returns to unacceptable levels. However, actual fees and administrative costs for existing investments are generally well below 100 basis points (one percent). Assuming fees of this magnitude, yields would still be much higher than benefits currently provided by Social Security.
- Finally, critics claim that a privatized system could not provide survivors' benefits. In reality, a market-based retirement system would provide better survivors' benefits than the current system.