Social Security Privatization and the Economy

October 5, 2001

With the American econ0my moving into a recession, it is worth remembering that Social Security privatization could help stimulate economic growth. While certainly not a short-term stimulus measure, allowing workers to invest their Social Security taxes is likely to provide significant long-term economic benefits.

Social Security operates on a pay-as-you-go basis, with almost all of the incoming funds paid out immediately to current beneficiaries. This system displaces private alternatives under which the funds coming in would be saved and invested for the future benefits of today's workers. The result is a large net loss of national savings, which reduces capital investment, wages, national income, and economic growth. Moreover, by increasing the cost of hiring workers, the payroll tax substantially reduces wages, employment, and economic growth as well.

A shift to a private system, with hundreds of billions of dollars being invested in individual retirement accounts each year, would likely produce a large net increase in national savings, depending on how the government financed the transition. This would increase national investment, productivity, wages, jobs, and economic growth. Replacing the payroll tax with private retirement contributions would also improve economic growth, because the required contributions would be lower and those contributions would be seen as part of a worker's direct compensation, stimulating more employment and output.

Harvard economist Martin Feldstein estimates that privatization of Social Security would produce $10 trillion to $20 trillion in present value net benefits to America. (See, Martin Feldstein, "Privatizing Social Security: The $10 Trillion Opportunity," Cato Institute Social Security Paper no. 7, January 31, 1997). That is essentially his estimate of the present value of the improved economic performance that would result from the reform. Most of that net benefit would probably come in the form of the higher returns and benefits earned for retirees through private investment accounts. But some would come in the form of higher wages and employment for working people.

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