So, what does that mean for people my age? First, it could mean exceedingly high taxes. Payroll taxes would need to be as much as tripled to meet future payments. Second, it could mean raising the retirement age. Workers would have to work more years and receive benefits for fewer years. Third, it could mean a reduction in benefits. Any of those changes would make Social Security an even worse deal for my generation. However, there is one reform that would give my generation a smaller tax burden and higher returns while not affecting those already in the current system: privatization.
Under a privatized system, workers would contribute a percentage of their income to a private retirement account (PRA). PRAs would function much like IRAs and be managed by the private investment industry. Individuals would have freedom to choose the managers of their accounts, and there would be regulations on portfolio risk to guard against unsound investment.
Adopting such a system would accomplish three important goals. First, it would increase the rate of return on each worker’s contribution. Today, the average return on Social Security is 2.2 percent — in 20 years, the rate of return will be negative. Compare this to the 9 percent average return historically achieved by funds that invest in stocks and bonds. Second, it would reduce payroll taxes. Given the higher rate of return on PRA contributions, benefits equivalent to those provided today could be financed with a payroll tax one‐fifth the size of the current one. Third, a privatized system would boost the economy. The immense flow of capital into private markets that would be unleashed by a privatized system would create new opportunities for investment‐hungry entrepreneurs.
Although many people are concerned about switching to a private system, it is not an untested idea. Chile privatized its government‐run pension system in 1981 and has since achieved a 12 percent return on contributions and a growth rate in real gross domestic product averaging over 7 percent. And Chile is not the only country that has switched. Many countries in Latin America and Eastern Europe, as well as Great Britain and even communist China are abandoning the American model of Social Security in favor of market‐based approaches.
Now is the time for America to privatize Social Security. Thanks to the baby boomers, the system currently runs surpluses from $25 billion to $50 billion a year. Given that, and given the budget surplus, we can allow young workers to open PRAs and at the same time pay benefits to those already in the old system. We have a window of opportunity, but this window could be missed if the politicians take the easy way out. Few people my age want to be forced into a failing system — and there is no reason for that to happen. There is a viable and tested alternative — privatization.