An Opportunity Lost…for Social Security

One of the unfortunate aspects of the Bush second term has been the lack of any progress on the Social Security front. What a lesson on how an agenda can get killed by other fires. The second big opportunity lost is on tax reform. That will be the topic of a future post.

I still think a great way to think about privatizing social security is as follows. Why not let anyone with the right to future social security benefits securitize those benefits and invest the proceeds in a limited set of investment funds? Take the situation of someone who is 50 years old and has earned the right to maximum social security benefits under current law. I believe that is, in current dollars, around $3,000 per month. If that person, let’s say it is me, were to start taking benefits in 20 years, and collect them for 15 years, the present value of the benefits at a real interest rate of 4% would be over $175,000. Not bad when you think about it. So let me sell my right to these future benefits to a bank, who will in turn pay me the $175,000 present value, less of course some transactions costs. A couple points right away: One, you might not want me to give up my entire social security benefits, but only 50% of them. Fine, I still have $87,500 to invest. Two, you might want to restrict me to certain investment vehicles. Fine, just give me Fidelity, Vanguard, and TIAA-CREF. Third, if you let me do this, I would be willing to even forego some percentage of my future benefits. I personally would consider an offer to get in cash today only 75% of the present value of my future benefits. The rest I would let the government pocket, which in turn would help solve the solvency problem of the Social Security system. Or you could tell me that in order to opt into this new regime, I will only be able to start benefits at age 72, instead of 70.5. I would still opt in. This is very important; by giving people choice, there is always a gain, and that gain can be shared.

Now where do the banks get all the cash from to give to the people selling their future benefits? They raise cash by selling bonds that are backed by the future benefits. For anyone interested in the prosperity of the banking sector, this is interesting. Think of the fees that this would create. Lots of bonds being sold, and in turn lots of cash coming into the equity markets. In a sense, the de facto liability that the government has in regard to future social security benefits just got transformed into real debt – but not on the US Treasury’s (accounting) balance sheet.

There are lots of details that I could discuss, for instance on how to deal with people who have not yet earned the right to the maximum benefit, or on new people coming into the system.

The question might be: what do we gain by this? I think one contribution is indeed what President Bush has said, about the value in having people own their retirement fund and in being responsible for their future security. Another contribution is in reduction of uncertainty. How many people have even thought casually about the present value of their social security benefits? How many people even believe that they will get anything? There is nothing like being able to look at the current value of your retirement investments to focus your attention on what you have and what you need to do in order to secure a future. Reducing economic uncertainty is always an improvement.

I think there are also some interesting political economy aspects to this change. What would happen to the political pressures to increase benefits to retirees? As a retiree would never see their benefit check, just the annuity or whatever they would be getting from their investment fund, I think the link between the government and the retiree’s well-being would be cut. For instance, when I retire, if I don’t have enough income to live off, am I going to blame my employer, who provided me with a defined contribution retirement plan?