| SSP No. 1 |
August 14, 1995
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Dismantling the Pyramid: The Why and How of Privatizing Social Security
by Karl Borden
Karl Borden is a professor of financial economics at the University
of Nebraska.
Executive Summary
Social Security is an unfunded pay-as-you-go system, fundamentally
flawed and analogous in design to illegal pyramid schemes. Government accounting
creates the illusion of a trust fund, but, in fact, excess receipts are spent
immediately. The government's own actuaries predict the system will be bankrupt
by 2030, but Social Security could face financial crisis as early as 2014. Moreover,
Social Security's relatively poor rate of return makes the program an increasingly
worse investment for today's young worker.
The liabilities already created, which are unrecognized by the
government accounting system, represent sunk costs that cannot be recovered.
Only adjustments in spending patterns can pay for those commitments. Short-term
fixes to increase revenue or reduce benefits will be unsuccessful in the long
run. The system design itself is fatally flawed and cannot be repaired. It must
instead be replaced by one derived from free markets and operated by a free
citizenry making individual economic decisions in their own self-interest. The
choice remaining is between continuing to support a bankrupt system and building
a financially sound structure for the future.
Reform is long overdue. If we fail to act soon, our children
will either inherit a bankrupt system or be forced to pay an impossibly high
level of taxes. Only private pensions with individual property rights to accumulated
fund balances can create a secure pension system. Chile, which privatized its
system in 1981, provides evidence of such a system's effectiveness. Chile's
new system has been both successful and popular, but it stops short of full
privatization. Various plans have been proposed for the United States, including
recent legislation by Sens. Alan Simpson (R-Wyo.) and Bob Kerrey (D-Neb.), but
each suffers the effects of compromise with central-planning approaches.
A much bolder approach is called for. A plan that achieves the
dual objectives of security and personal liberty would divert current Old-Age
and Survivors and Disability Insurance payments to private personal retirement
accounts, similar to individual retirement accounts, managed by the financial
securities industry. Modern risk-management methods should be used for the portion
of the account necessary to finance minimum retirement needs. Personal risk
preferences should be allowed to guide the investment of fund balances in excess
of the minimum. Individuals should be free to choose their own retirement age.
Government intervention and regulation should be minimized.
Transition to a new system requires the recognition of current
intergenerational commitments and the making of choices that minimize transaction
costs as we liquidate obligations to ourselves and integrate system liabilities
into a privatized financial structure.
Index of Social Security Choice Papers
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