Social Security Privatization And Economic Growth


As America moves into the 21st century, two public policy issues are becoming increasingly important. We need to reform our soon‐​to‐​be‐​bankrupt entitlement programs, such as Social Security, and we need to spur economic growth, create jobs and improve wages. Recent evidence suggests that it may be possible to solve both problems simultaneously.

Americans understand that the Social Security system will start losing money by 2012 and will be completely insolvent by 2029. The rate of return for young workers grows steadily worse. Indeed, most young workers will receive a negative return on their Social Security taxes — less than they paid in.

However, less attention has been paid to the impact of Social Security on the economy. Virtually everyone agrees that countries that save and invest more grow faster and have more rapid improvements in their standards of living. Yet Social Security’s pay‐​as‐​you‐​go financing mechanism reduces national savings, leading to a decline in capital investment, national income and economic growth.

The United States has the lowest national savings rate in the industrialized world. One of the principal reasons for the low national savings rate is the large deficits run by the federal government. There has also been a significant decline in personal savings. That is particularly important because, with the government a negative saver, personal savings have become an increasingly important component of national savings. However, personal savings have declined to barely more than 4 percent of personal disposable income, from a high of more than 9 percent during the 1970s.

Clearly, the Social Security tax reduces private savings. Workers are required by law to pay Social Security taxes. That precludes their investing those lost wages in private savings or investments.

Some might argue that that wouldn’t matter, if the private savings and investment were replaced by government savings and investment. However, even granting that rather dubious premise, approximately 86.5 percent of the money collected in Social Security taxes is not saved or invested in any sense of the word; that money is simply paid out in the form of benefits.

Moreover, “investment” of the remaining 13.5 percent is more semantic than real. That money is used to purchase federal Treasury obligations that are credited to the Social Security Trust Fund; the government then uses the money it has borrowed from the trust fund to meet current operating expenses.

The present trust fund surpluses are a temporary phenomenon. Beginning as early as 2012, every penny collected in Social Security taxes will be used to pay benefits. Indeed, the payroll tax will not be sufficient to pay all the benefits that are promised, which will force the federal government to turn in the bonds in the trust fund to obtain the cash needed to finance benefits.

The current Social Security system is helping to reduce private savings and limit the pool of capital available for new investment. In addition, by reducing savings and capital accumulation, Social Security reduces the ratio of capital to workers, leading to a reduction in productivity. As a result, wages are lower than they would otherwise be.

A privatized Social Security system would allow people to invest their Social Security taxes in financial assets such as stocks and bonds. The movement of so much capital into private markets would have a significant impact on economic growth. Professor Martin Feldstein of Harvard University, for example, estimates that “the combination of the improved labor market incentives and the higher real return on savings has a net present value gain of more than $15 trillion, an amount equivalent to 3 percent of each future year’s GDP forever.”

America is currently going through one of the slowest periods of economic growth since the Great Depression. If privatizing Social Security can increase growth, raise wages and provide more jobs — while ensuring a dignified retirement for future retirees — isn’t that a nice bonus?