Mises Daily Articles
What If Social Security Were Completely Scrapped?
Social Security privatization is, once again, a dead issue. President Bush did ultimately propose a reform. Unfortunately, the Bush proposal aimed at establishing a bureaucratically managed national savings program, instead of genuine privatization.
Ironically, Democrats saved us all from Bush's national savings program by characterizing it as a "risky scheme to privatize Social Security." While the Democrats who attacked the Bush proposal for Social Security were "useful idiots" for those who want genuine Social Security, it is still worthwhile to expose the illogic, and factual error, and ideology behind their rhetoric.
Opposition to authentic privatization, which means elimination of the program, derives from a combination of faulty reasoning and collectivist ideology. Among the many misconceptions surrounding opposition to Social Security privatization, there are a few that appear most common. Defenders of Social Security deny that it is a Ponzi scheme, and instead claim: It is a grand success; Private citizens would not set aside adequate savings to fund their retirement; People would lose their life savings on risky stock market investments and other get-rich schemes; The overall rate of private savings is too low.
Social Security offers a guarantee, they insist, a type of insurance for all citizens. Social Security is a "social compact," a sacred promise between generations. And of course, there is the most mindless slogan: Social Security is the "Crown Jewel of the New Deal."
The idea that ordinary people save too little to fund their retirement is unfounded. Several recent studies indicate that most people make adequate provisions for their retirements, and some supposedly save too much. Economists Paul Smith, Lucy McNair, and David Love have found that 88 percent of all households with breadwinners over age 51 have accumulated enough assets to avoid poverty in their retirement. Of course, 12 percent of these people are risking poverty in their retirement, but the vast majority of people appear to be acting in a personally responsible manner, and the motives and aims of the remaining 12 percent are not clear. Some of these 12 percent may be shortsighted and irresponsible, but others may intend to work late in life, or may not have particularly high life expectancy. Also, some of these 12 percent may have had unexpected expenses that impinged upon their savings plans. In any case, the idea that people generally cannot be trusted to save their own money is not generally true.
John Karl Scholz, Ananth Seshadri, and Surachai Kitatrakhun published a study in the Journal of Political Economy, which found more than 80 percent of households headed by Americans born between 1931 and 1941 have accumulated their optimal wealth targets for retirement. Once again, most people have acted rationally in their own interests.
Some recent studies on personal saving indicate that some people worry too much about retirement, and overlook current consumption. Some of the misconceptions concerning American retirement funding may come from the financial industry. Economist Lawrence Kotlikoff has tested the retirement calculators on the web sites of Fidelity, Vanguard, American Funds, and TIAA-CREF, and found the savings recommendations ranged from 36 to 78 percent too high, compared to his software's calculation. According to Kotlikoff "The simplistic calculators on companies' web sites are primitive tools that have no connection to modern mathematics or economic theory," he says. "Five-second financial checkups are really financial malpractice." Also, "There is a risk from overdoing it when you're young — you squander your youth rather than your money," he says. "It makes no sense to have a huge bundle in your 401(k) and have not gone to Hawaii, or gone skiing with the kids. It's not all about the end game — it's about the middle game and the short game, too."
In other words, people need to plan their finances according to their time preferences. The financial industry has an obvious motive for encouraging people to save and invest. Every person who acts on their apparent misinformation is a new customer. New customers increase revenues and profits for these businesses. While there is certainly nothing wrong with earning a profit, those who reap profits by disseminating misleading or false information do the consuming public a disservice.
Fortunately, there are those, like Kotlikoff, who attempt to provide more accurate information. However, the most important thing to note is that people are acting rationally upon available information. Some of this information may be misleading, but ordinary people are acting rationally. Hence, all we need is greater accuracy in information in the private sector for people to use for private decisions. We do not need government politicians and bureaucrats to tell us how to save for retirement.
It is also the case that retired people often have lower expenses than younger people. Ty Bernicke recently published an article (in the Journal of Financial Planning) where he found that Americans over 65 spent an average of 26 percent less than their younger peers. According to Bernicke, reduced spending by the elderly is voluntary, rather than in response to a lack of income. According to a 2002 consumer survey people aged 45–54 spent $2,565 on entertainment, $9,173 on transportation, $6,693 on food and alcohol, and $15,476 on housing. In the 55–64 age group these figures fell to $2,297; $8,448; $5,979; and $13,831 respectively. In the 65–74 age group these figures fell further to $1,371; $5,732; $4,803; and $10,052. Over-75 people spend only $896; $3,178; $3446; and $8252 in these areas, on average.
This makes perfect sense. The elderly typically do not have dependants living in their households, cease to commute to work, move to retirement areas with low housing costs, far away from the expensive urban centers where they used to work, and often give up the expensive activities or hobbies they indulged in when they were young or middle aged. As we slow down physically we often require less income to fulfill our wants, simply because our remaining wants are less expensive. Health care costs do rise as we age, but not as much as you might think. The average health care expenditures for the aforementioned age groups were $2,550; $3,007; $3,588; $3,564 in the 2002 survey. Overall living expenses decline from $48,748 in the 55–64 age group, to $44,330; $32,243; and $23,759 in the next three age groups.
These facts are important to our understanding of the myth that Social Security is needed to prevent poverty among the elderly. Not only do the vast majority of people make adequate provisions for their retirement, the financial burdens of retirement are not as severe as many believe. Retirees can and often do live cheaply. Consequently, many of the 12–20 percent of people who seem not to save enough for retirement may not be in serious trouble. At the very least, the alarmists who speak of a crisis in national savings are grossly exaggerating this "problem."
One such alarmist is economist Alice Rivlin. According to Rivlin, Americans save too little and the economy is not growing fast enough to support Social Security. Rivlin believes that the government must act to increase the rate of national saving, and that increased national savings must be "used well." Her solution to these alleged problems is to pay down the national debt. This will spur economic growth and make the funding of baby boomer retirements easier.
While Rivlin acknowledges serious problems with Social Security funding, she ignores privatization as an alternative to her proposal. This is strange since numerous studies have shown that Social Security has in fact reduced the rate of national savings, and with it the long-run rate of economic growth. In particular, Harvard Economist Martin Feldstein has estimated that Social Security reduces total private savings by nearly 60%. This is, of course, a rational response by ordinary Americans to the availability of Social Security as a supplement to their retirement income. Since people feel secure in that they will receive something from Social Security, they feel less of a need to save. Were Social Security to disappear, people would boost their private savings to make up for this. Yet Rivlin is not necessarily concerned with the efficiency aspects of Social Security. In her own words:
"Social Security has served us well. It has been enormously successful in enhancing the well-being, independence and dignity of older people. It is extremely popular and well entrenched in our culture, with other retirement and insurance programs built around and on top of it. Its universality, its contributory nature and its redistributive effects seem to me huge pluses worth preserving. We should be reluctant to scrap or drastically alter a program that has worked so well for more than half a century, when options for preserving its merits, while correcting its defects, are available." (Alice Rivlin, Business Roundtable, Social Security Symposium, Washington, D.C. April 6, 1999)
Rivlin favors Social Security as a redistributive scheme. As such, Rivlin has deviated from value-free economic analysis, and is instead offering value judgments. In other words, she is not speaking as an economist, but is making a political statement.
While her opinions will surely offend those who value individual liberty, Rivlin is flatly wrong about the redistributive affects of Social Security. As a leftist, Rivlin obviously wishes to redistribute from rich to poor. Social Security does not do this. The rate of return that anyone gets from Social Security depends upon life expectancy. People with higher incomes tend to live longer than those with low incomes. Consequently, Social Security tends to transfer income from poor to rich. For example, a woman approaching retirement (age 60) in affluent Franklin Lakes, New Jersey can expect a 2.32% rate of return on Social Security. While a young (age 20) man from Newark, New Jersey can expect a return of minus 1.39%, after a lifetime of providing a high rate of return to affluent Social Security recipients.
Redistribution from poor to rich goes against the collectivist beliefs of those, like Rivlin, who defend Social Security for ideological reasons. So it is a myth that Social Security redistributes from rich to poor. Since affluent white women have the highest life expectancy and poor black men have the shortest life expectancy, Social Security does serve to transfer income from poor minorities to affluent white Americans.
Libertarians oppose all redistribution, but even staunch welfare-state liberals should oppose this sort of redistribution. Why then do they revere Social Security as the "Crown Jewel of the New Deal"? This is a hard question, but one possible answer is that many welfare-state liberals are mindless government worshippers who refuse to think critically about Social Security.
Of course, supporters of Social Security do try to appear sensible. For example, Christian Weller argues that privatizing Social Security is too risky:
"While the real rate of return of the stock market has averaged 6.6 percent over the past 100 years, its average rate of return over 35-year periods has fluctuated between 3 percent and 10 percent." (Center for American Progress, December 14th 2006)
Market volatility is something that many people would want to avoid. Many people would prefer a guaranteed return of 6.6 percent to a range of possible returns from 3 to 10 percent. Yet Social Security does not deliver an average rate of return of 6.6 percent. Most people can expect a rate of return from Social Security from 2½ to minus 2½ percent, depending largely upon life expectancy.
Why do returns on Social Security tend towards zero? Because it is, as its defenders sometimes note, a transfer program. Social Security does not involve real investment that would make a positive rate of return possible. Social Security transfers income between generations. It does nothing to promote capital accumulation through saving, because it does not involve saving. It is true that some American, especially the earliest recipients of benefits, have gained a low positive rate of return on Social Security. However, this is only possible because other Americans, especially those presently under 30, can expect a negative rate of return. In other words, Social Security is a Ponzi scheme, contrary to what its defenders claim.
Yet Social Security is an odd type of Ponzi scheme. In the original Ponzi scheme, those who got in early enough made a high rate of return. Older Americans can expect only about a 2–2½ percent rate of return — if they reach their life expectancy. This is below the minimum of 3–10 percent rate of return that Mr. Weller tells us we can expect from the stock market. In other words, we all lose from the Social Security system. Yet its defenders cling to the myths that Social Security offers guarantees of retirement security, and that private investment offers prohibitive risks. Leftists like Mr. Weller simply do not want to make real comparisons between the private- and public-sector alternatives for retirement. They prefer myths to facts.
The debate over Social Security privatization is a contest between those who choose to use their reason to think through this issue and ideologues and demagogues who oppose and avoid rational discourse. Some might believe that the ideologues and demagogues would have an advantage in trying to sway public opinion. After all, there have been many instances where the public has ignored reason and opted for emotionally driven arguments. Social Security itself was obviously not the product of rational thought. Yet reason has won out on numerous occasions in recent history. The ideas of classical liberalism won out during the Enlightenment. Our current prosperity derives largely from the free-trade policies that came from the triumph of classical liberalism.
The recent debate over Social Security shows that privatization is not yet popular enough to pass through the political process, and that many people do not understand what privatization really means. Yet the fact that there was a serious debate over privatization recently indicates that we have made progress since the time when Social Security was the third rail of American politics. The myths surrounding Social Security are gradually being dispelled. One day Social Security will go from being a reality supported by myths to a memory whose myths were debunked by reason.
"Is there a Savings Crisis? Measuring the Adequacy of Household Retirement Wealth," by Paul Smith, Lucy McNair, and David Love (PDF)
"Are Americans Saving 'Optimally' for Retirement?" by John Karl Scholz, Ananth Seshadri, and Surachai Kitatrakhun Journal of Political Economy
"Is Conventional Financial Planning Good for Your Financial Health?" by Laurence J. Kotlikoff (PDF)
"Social Security and Saving: New time Series Evidence," by Martin Feldstein, National Tax Journal, 1996.