Making Social Security Private Has Downside

To some, proposals to privatize Social Security sound great. Money invested in stocks, they assume, will provide a more generous pension, freer from government bureaucracy.

But to economist Dean Baker, the idea includes some elements of a "shell game" pushed by a profit-seeking Wall Street.

Discussion of privatization promises to build. Former Colorado Gov. Richard Lamm, who tossed his hat into the presidential race Tuesday, has dealt with this issue as director of the Center for Public Policy and Contemporary Issues at the University of Denver. His campaign, he says, will focus on restoring fiscal sanity to the federal budget, including reining in outlays on popular entitlement programs like Medicare and Social Security.

The Clinton administration's Advisory Council on Social Security, unable to agree, expects to issue a divided report in mid-August containing three plans for putting a portion of contributions into private investments. One of the 13 members, Carolyn Weaver, is an adviser on Social Security to candidate Bob Dole. She has been an advocate of the most radical of the three plans. It would create individual retirement accounts managed by each individual. Almost half of the 12.4 percent payroll tax would be diverted into these accounts.

If history is repeated, advocates note, these accounts could grow handsomely. Since 1926, stocks have gained an average of 7.2 percent a year, adjusted for inflation, compared with 2.36 percent for corporate bonds and 1.81 percent for long-term government bonds.

But Mr. Baker, an economist at the Economic Policy Institute, a liberal think tank in Washington, sees privatization as "faddish, ill-considered," and "perhaps the most serious threat to date" to the Social Security system. "It would place individuals' retirement savings at considerable risk, force the creation of huge government bureaucracies, and leech Social Security assets out of the system and into the coffers of brokerages and banks," he says.

More concretely, here are some of the critics' objections:

*Privatization would be inefficient. The cost of administering Social Security was less than 0.7 percent of the approximately $300 billion dispensed to 35 million people in 1994. Wall Street takes a much larger chunk of the money invested in its hands. Life insurance companies pay out in benefits about 60 percent of the premiums they bring in each year. Profits, administrative expenses, and sales commissions eat up much of the rest.

Many mutual funds charge sales commissions up front. But all funds, including "no-load" funds, must pay commissions on security transactions in their portfolios and other expenses that eat about 1 percent of fund assets, more or less, a year. Thus, the return on most stock funds is less than market averages. If individuals spent 10 hours a year managing their own investments, Baker says, that expenditure of time would be about $30 billion.

*Privatization involves greater risks for Social Security pensions. If individuals make their own choices of investments, they may make bad ones. Also, stock-market price trends may be less favorable. Baker notes that from the peak of the market in mid-1967 to the present, stock prices rose an average of 5.5 percent a year after inflation, not the 7.27 percent for the longer period.

Also, in recent decades the United States economy has been growing on average about 3 percent after inflation, supporting stock prices with good corporate profits. What happens to stock prices if the economy slows to a 2 percent real growth rate, as the Social Security Administration assumes in making its less-than-cheery, long-term predictions for the system?

*The privatization plans under discussion would weaken the income-redistribution effect of Social Security. People who had low incomes in their working lives get high returns from the current system; those with high incomes get poorer returns. Also, the system provides a progressive transfer of money from a more prosperous younger generation to their retiree parents. So far, in the post-World War II years, affluence has risen each generation.

The fact is that each generation of workers provides the goods and services needed by retirees and children. At present, retiree needs are financed partly through Social Security taxes, partly through private pensions and investments. If Social Security was partially privatized, as proposed, more of retiree needs would be financed through private markets. But workers would still pay for that portion through higher prices in private markets.

"There is no manna from heaven," Baker says.