August 14, 1995

Social Security poor investment, study says

Americans could retire with a significantly higher standard of living if Social Security taxes from each worker's paycheck were instead deposited into a private market account, according to a new Cato study.

In "Retiring with Dignity: Social Security vs. Private Markets," William G. Shipman says Social Security provides workers an extremely poor rate of return compared to private investment markets.

Shipman, a principal with State Street Global Advisors in Boston, says the current system threatens the retirement security of millions of Americans.

The current system's structural flaws have produced high taxes and low benefits.

Because of the system's looming financial crisis, benefits will fall still further in the future.

Financial security will grow increasingly unlikely for elderly citizens dependent on social security for their retirement income.

He says that without substantial changes, retiring with financial dignity will be a thing of the past.

Private market solution -- Six times the benefits, fraction of cost

Shipman says that the only viable solution to Social Security's problems is to privatize the system, allowing people the freedom to invest their Social Security taxes in financial assets such as stocks and bonds. He shows that with only a fraction of the money now paid by an individual in Social Security taxes, investment returns from stocks and bonds would exceed retirement income needs.

Assuming historic rates of return, Shipman says that if an individual born in 1970 were allowed to invest the amount he currently pays in Social Security taxes in stocks, he could receive nearly six times the benefits that he is scheduled to receive under Social Security -- as much as $11,729 per month.

A tried and true solution

The idea of privatizing a public pension system is neither new nor untried, Shipman says in the study. Where privatization has been properly implemented, it has been remarkably successful. For governments, privatization is the only viable answer to Social Security's inherent problems; for individuals, it provides a way to retire with dignity.

Date: Tue, 15 Aug 1995 11:10:40 -0500
From: Cato Institute <>
Subject: Cure for Social Security Problems


August 14, 1995

Private pensions antidote to looming Social Security crisis, study says

Social Security is a fundamentally flawed program that faces an impending financial crisis if significant reforms are not made, according to a new Cato study.

In "Dismantling the Pyramid: The Why and How of Privatizing Social Security," Karl Borden compares the current pay-as-you-go program to illegal pyramid schemes. He says a shift to a mandatory private pension system would alleviate the financial crisis and provide a more adequate lifestyle for pension recipients.

The looming crisis

Estimates suggest the social security trust fund will go broke by 2030, but Borden says the real financial crisis could begin as early as 2014 when the trust fund peaks and starts to decline. At that point the trust fund managers must cash in federal bonds to finance benefits. Since the federal government has no cash or assets with which to pay off those bonds, it can obtain the needed funds only by running a bigger deficit, increasing taxes, or cutting government spending.

The private pension system

Borden says that even if these financial problems could be fixed, Social Security would remain a bad deal for today's young workers. He says payroll taxes are already so high that Social Security benefits provide a below-market return compared to potential earnings from through private savings, investment, and insurance.

After reviewing options for reforming Social Security, Borden concludes that a private system, similar to the pension system adopted by the Chilean government in 1981, would provide pension recipients with the best quality of life.

Borden's private pension plan would do the following:

Establish personal retirement accounts (PRA) by redirecting an individual's social security taxes into a private account. These PRAs would operate much like individual retirement accounts.

Allow individuals to make contributions to their accounts in excess of the mandated amount.

Ensure minimum retirement security by requiring a minimum amount of account funds to be allocated to limited-risk investments.

For deposits that exceed the minimum, low-risk level, allow individuals to determine the level of risk they want to assume.

Allow individuals to choose their retirement age, provided their account is sufficiently funded to ensure a life income equivalent to the real national minimum wage.

At the onset, allow individuals to transfer money from existing retirement accounts into their new PRAs.

Keep fund distribution options simple and flexible.

Minimize government involvement in the program, allowing the financial securities industry that today provides IRA and 401K plans to manage PRA activity.

Why it matters

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. Politicians have long understood the coming catastrophe, but they have been unwilling to confront the hard choices necessary to meet it. The question now is whether they will have the courage to act, or whether our children will be the next victims of a failed and unsustainable system.

The full text of this study is posted on the Cato Institute's website.