Most people know something is wrong with social security. It is hard to avoid reading an article forecasting the imminent collapse of the system as a result of the large number of baby boomers poised on the brink of retirement. Most people also know that President Bush has proposed privatizing social security. Beyond that, many remain are the dark.
What exactly is privatization? How does the current social security system work? If privatization isn't the answer, what is? I will address these questions and hope to dispel the common misconception that privatization on its own might prevent the collapse of social security.
For those unlucky souls who did not take macroeconomics, the United States' social security system is based on a "pay-as-you-go" system. "Pay-as-you-go" means that the current retired population receives benefits directly from the current working population. So when you pass age 65, you will be entitled to social security benefits that will come straight out of your children's (and friends of your children's) pockets. You will get to collect more in benefits than you originally paid in social security taxes because the population is growing (there will be more workers contributing toward your retirement benefits) and because wages are increasing (each worker will pay more in social security taxes).
One way to view a "pay-as-you-go" system is as a pyramid with each successive generation representing an additional layer added to the bottom. As long as the latest generation is large enough to support the previous generation, the pyramid is structurally stable. Extending the metaphor, the baby boom generation is like a bulge in the pyramid that cannot be supported by the underlying generation.
Many mistakenly believe that privatization would fix this problem. In fact, the issue of privatization is completely independent from the issue of whether or not the system will be able to support future retirees. Privatization involves taking the social security taxes that workers pay and putting them in private accounts, where they will increase in value at the private investment rate.
In the current "pay-as-you-go" system, instead of putting the money aside the government either hands it immediately over to retirees or spends it on other government programs. Thus, privatization would require the government to borrow enough money to pay current retirees and put the social security taxes from current workers into private accounts.
Esteemed economist Martin Feldstein argued in "Would Privatizing Social Security Raise Economic Welfare?" that given the current economic conditions in the United States, privatization would be a good thing (in economist-speak, "a good thing" translates to "increased present-value consumption"). But privatization would require a large sacrifice on the part of the current population for the good of future generations.
Although privatization might be an economically beneficial policy choice, it would do little to solve the bigger social security problem. Regardless of whether social security benefits are paid out of a private account or directly from the current workforce's taxes, the baby boom generation is still too large to be supported by the current system. The only solutions to this problem are politically difficult. The government could cut benefits for future social security recipients, take out an even larger debt or jack up taxes on the current workforce.
In order to make an informed decision about the amount by which taxes should be increased, benefits cut and debt increased, the government needs to know what impact such changes will have on the average American. Perhaps Americans have read so many articles detailing the doom of social security that they have saved enough to live comfortably without social security benefits. At the other extreme, perhaps most Americans trust that the government will come through with the promised benefits. Or, more likely, people believe some combination of the two.
My thesis for the Economics Department attempts to measure to what extent the American people have decreased their savings in the anticipation of social security benefits. Put another way, how vulnerable are Americans to the possibility that social security won't be there when they retire?
One way of answering this question would be to ask every person in the United States what they think about the future of social security. Using such an approach, economists Jeff Dominitz, Charles F. Manski and Jordan Heinz found that 30-year-olds are 60 percent sure that they will not be able to collect social security benefits when they retire. I take a more quantitative approach in my thesis in the hopes of improving on previous estimates of the effect of social security on savings published by Feldstein.
An accurate estimate of expected social security benefits will give policy makers an idea of how heavily Americans are counting on them. Potentially, such estimates could then be used to determine the appropriate amount by which to cut social security benefits.
-- John Papp is a senior majoring in quantitative economics.
