Can we finally kill the terrible idea of privatizing Social Security?

Can we finally kill the terrible idea of privatizing Social Security?

Can we finally kill the terrible idea of privatizing Social Security?

Making government work better.
Feb. 4 2009 6:59 AM

Privatize Social Security?!

Can we finally kill this terrible idea?

"We told you so" is just about the most annoying sentence one can utter. But when it comes to the debate over Social Security, this is a moment for Democrats to say: We told you so. Use your time machine to travel back four years: In his 2005 State of the Union address, delivered during a period of economic and stock-market growth, President Bush made the privatization of Social Security the centerpiece of his domestic agenda for his second term.

The grand domestic project of the Bush administration was to repeal the two major components of New Deal ideology: the regulatory apparatus of the federal government and the social contract embodied by social welfare programs—Social Security, Medicare, Medicaid. The effort to roll back the regulatory agencies—the SEC, EPA, OSHA—and place all faith in an unregulated market has been well-chronicled, as have been the ensuing market collapse and suffering. The effort to repeal Social Security, which is what privatization amounts to, was to have been followed by private health savings accounts.

Fortunately, the effort failed, and much damage was avoided. But it is worth taking a quick look at some of the debate about privatization, especially in the context of today's market turmoil, just to make sure the issue does not, like a bad sequel, return.

President Bush and all who support privatization began with the proposition that private accounts invested in an array of stocks and bonds would outperform the current formula based on wages earned and overall wage appreciation. Well, let's go to the videotape, as they say. Since Jan. 1, 2005, the year President Bush proposed the idea, the Dow Jones industrial average has dropped from 10,783 to around 8,000, a drop of more than 25 percent. OK, we are in a trough after a steep period of appreciation. Fine. Since Jan. 1, 2000, the Dow has dropped from 11,497 to 8,000, a drop of more than 30 percent. So what would this have meant to an average recipient of Social Security?

Let's try to quantify this, albeit roughly. Under the current system, a couple earning a household income of $100,000-$150,000 per year would get slightly more than $3,000 every month in Social Security benefits. And their benefits would be inflation-adjusted every year. Suppose the couple were to invest for retirement in the private markets. With an income of that size, the couple would be able to save about $500,000. As Allan Sloan calculated in Fortune, a couple retiring at age 66 at the end of 2007, having accumulated $500,000 in a private savings account, would have been able to purchase an annuity delivering $3,000 per month until the death of the longest living of the two. In other words, that couple would get an annuity worth about the same amount as their Social Security benefits. A couple retiring at the end of 2008, by contrast, would have been able to purchase an annuity delivering only $2,000 per month—a 33 percent loss.

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In other words, if Social Security were in private accounts, the payout you'd receive would be more correlated to the timing of your retirement than to anything else. With a privatized system, those retiring in 2007 would have been reasonably pleased—though they still wouldn't have made a windfall compared with normal Social Security benefits—while those retiring now would be devastated, receiving vastly smaller retirement payments.

If insurance against catastrophic economic loss and deprivation in one's retirement years is the underlying purpose of Social Security, we cannot permit the dramatic cyclical nature of market returns to place at risk a substantial portion of people's retirement accounts. The very purpose of the Social Security system is to have a guaranteed return, not one subject to the risk of a volatile market. Indeed, it is inconceivable that we would tolerate retirees descending into poverty after a cataclysmic market collapse such as what we have just seen. Suppose we had privatized Social Security before the recent declines: In order to prevent mass poverty among the elderly, we would have been obligated to re-create traditional Social Security to redress the failure of the privatized system.

Furthermore, as Paul Krugman has pointed out, the would-be privatizers make incredible—even impossible—assumptions about the likely performance of the market to justify their claim that private accounts would outdo the current system. According to Krugman, their worldview would require the price-earnings ratio in the market to be around 70 to 1 by midcentury. That would make the market at the height of the last bubble look grossly undervalued. Their performance numbers simply do not work.

Supporters of privatization also use the backdrop of impending Social Security bankruptcy as an argument for privatization. That, too, is a canard. Wherever one comes out on the urgency of Social Security's financing problem—and there is fair debate about it—privatization would undoubtedly make the problem worse, not better. Social Security is, as we all know, a Ponzi scheme that would make Bernie Madoff proud. Today's contributions by workers pay for today's payouts to recipients, with some being saved in a trust fund that, given changing demographics, will be exhausted several decades from now. If we were to create private accounts for current contributions, invest those accounts in the market, and thus withhold those dollars from the system for current payouts, the shock to the system would be enormous. Where would the money come from to pay current recipients? We would incur a "transition cost" to privatization, as it is politely called, in the trillions of dollars—money that would have to be borrowed in the market to cover the lost cash flow into the Social Security system.

And that fact makes clear the fallacy of the next argument often proffered by privatization supporters: They claim that the flow of dollars into the private accounts and then into the equity markets will stimulate the economy. The problem is that for every dollar put into the market through a private account, the government would have to borrow a dollar in the market to cover existing payouts. Thus the supposed benefit is entirely eliminated, as the net impact on the capital available for investment is zero.

We surely want—indeed, need—to encourage greater savings and investment to re-energize our economy. Yet asking workers to sacrifice the certainty of a Social Security payment for the potential upside of a marginally greater return from a private investment account is the dead wrong way to do it. The market collapse should be the final nail in the coffin of Social Security privatization.