Privatizing Retirement and Social Security

With the Markets taking a bath in the last few weeks the idea of privatizing social security has come back around in political discussions. John McCain has backed off the standard Republican position that we should supplement social security with private retirement accounts. He has joined Barack Obama in supporting social security with vague “what it takes” style messaging. I believe that both candidates know that something bad must be done to fix social security, but know better than to say that during the election. Eh, that’s politics.

However, the market taking a bath doesn’t change the upside of privatizing retirement and social security. If anything, NOW is the time to have the discussion and figure out what needs to be done as we add trillions more to our government debt. The United States can’t even manage to balance a budget on a yearly basis, have “borrowed” trillions from social security to fund spending, and even if that was returned we’re behind on what it will take to pay for retirement and medicare in the future.

The Case for Retirement Insurance

I do not believe that a person, working in the United States for their entire life, should face the prospect of never being able to retire. Risk is a part of life, but I believe that American’s have a social obligation to provide for the retirement (at a certain age) of those who have helped build this country.

That being said, the current mechanism of Social Security does not tackle the issue as a question of retirement insurance, but of a government pension system. This has lead to a huge infrastructure and trillions of dollars being held in the public trust for later distribution. This money has been invested (manditorily) in government bonds, soaking up over half the debt. We’ve basically laundered our debt through our retirement and now must raise this money again to restore the trust fund.

Changing the social security system to a retirement insurance system would only require a few minor changes.

First, social security related taxes must be levied on ALL INCOME earned, not just the first 102,000. Since this is an Insurance fund, we must all contribute to the risk.  In the same way that all people pay the taxes used to help support disaster relief efforts, we must all contribute. Luckily, the payouts from an insurance plan would be greatly reduced from the current payout rates. This would, over time, greatly reduce the size of this tax.

Second, social security payouts would be limited to only those who do not reach their defined benefits through withdrawal from 401ks, pension payments, or current income past retirement age. This payment would only serve to raise their annual income to the defined benefit range. An allowance could be made, similar to many pension funds, to proportionally decrease social security benefits based on earnings. This would allow retirees to work part time or withdraw from savings part time to boost social security benefits, but only by a small amount. There is no reason for us to send checks to people with millions in retirement savings, adding a few percentage points to their annual income. Additionally, this does not cut benefits for anyone depending on social security.

Third, we must eventually push back the retirement age. This change can be phased in over many years, but as medical care improves and people live longer we should expect them to work longer as well. It might be worth indexing social security retirement age to life expectancy such that social security retirement age always produces an expected 12 years of retirement or similar. This change is important to control costs down the road.

The Case for Private Retirement Savings

The Social Security Trust Fund currently hovers around 2 trillion dollars. By changing social security from a pension to an insurance plan many of these trillions could be freed up for investment in the economic development of the United States. Social Security collections in 2006 represented about 5% of GDP. Even if we assume that the insurance conversion would still require 75% of the collected funds we would add 1.25% to GDP nationally.

Economic improvement aside, my real desire is the democratization of wealth. We hear common complaints about the disparity in income between the wealthy and the poor but rarely hear about the barriers to wealth between the wealthy and the poor. Ignoring the obvious “more money” aspect the poor typically are shut out of even simple wealth building activities. For example, at a major American university white collar workers are permitted to participate in a 401k style plan while blue-collar esq. workers such as janitors and secretaries are required to participate in the defined benefits pension plan. These people will receive a moderate retirement, but will only receive a limited amount of money to pass down to their children or family. The assets of the 401k fund can be dispersed to build family wealth. Wealth transfer is part of the cycle of generations, and we’re trapping families in the lower wealth stratum by locking them out of private saving opportunities. Such wealth can be used to start business or attend school when low income loans and scholarships miss or fail these families.

An additional aspect of the democratization of wealth is the increased access to corporate governance. Now, I’ve written before about the need for reform in how proxy votes are handled with regards to Mutual Funds, Pensions, and ETFs. I want people using these products to have equivalent access as if they held a proportional amount of securities directly. We need to return to the days of direct stock holding, where people understood that they held a voting share of that company, not just a portion of its profits. This is the both the solution to cleaning up corporate America and spreading wealth throughout the country.