The Definitive Case Against Privatizing Social Security

40 Responses

  1. Excellent argument, Warren. This is clearly a fallacy of composition. All pensions are a transfer, no matter how they are “funded”. A direct transfer without transaction costs and unequal returns is the optimal way to do it.

  2. There are good reasons for not privatizing, but I’m not sure the best way of describing the argument is fallacy of composition. It’s a bit ambiguous. In fact, the real effect on macro distribution or composition of existing returns is the only valid reason for considering it. There’d be a redistribution of existing stock ownership from non-Soc Sec investment to Soc Sec investment. Non-Soc Sec investment would become more liquid in exchange, at the margin (having sold its stocks). And there’s definitely a change in the allocation of existing macro returns.

    The main fallacy has more to do with the fact that redistribution of equity ownership has no effect on real investment. Greenspan made this point quite forcefully in Congressional testimony on Soc Sec.

    So the operative fallacy here is that increased saving will create increased investment – where the operative truth is that investment creates saving.

    This isn’t exactly the same as the well known Keynesian composition fallacy that too many people trying to save can reduce macro saving. I don’t think there’s the risk of an overall reduction in saving due to a switch to stocks here. People are expecting a change in the distribution of returns, which is a reasonable expectation (notwithstanding the risk question). And they’re expecting an increase in investment, which is an unreasonable expectation.

    1. Anon,

      Really enjoy your perspectives. The one silver lining that I could see in privatizing soc sec is all the money managers out there who like to charge 1% to manage a portfolio would freak out. They are always selling people on the fact that soc sec is unsustainable (irrational fear) and you better invest your cash with me because you need capital appreciation in order to have enough funds to retire on. So if part of their soc sec were to be privatized the average Joe could simply elect to have some of the retirement invested in some “blue chip stocks” and let the rest be managed by the govt. Low and behold you have the cheapest diversified portfolio out there.

      I wonder if they have thought of that????

      1. Thanks! You seem to be the first.

        Asset mix has always been the overarching critical factor in financial asset management. Unless MMT succeeds in destroying financial capitalism, it will remain so, with differentiation down the financial capital structure.

        I could see a blend of fiscally funded Soc Sec plus private sector financial assets. But the plan itself doesn’t need to be privatized to do this. It could be done within a government sponsored plan – something like the Canada pension plan.

        The problem is that MMT gives no credence to the differentiation of risk and return when it comes to government sponsored financial obligations. Everything is resolved by a stroke of the pen at the risk free rate. The fact that the government is not financially constrained supersedes all other variations on financial management, according to MMT.

  3. This is hardly the definitive case against privatization of Social Security. It is rather the definitive case against the fallacy that Social Security is bad because it gives participants a poor return on their money.

    Social Security is bad because it is poorly designed, unfair, and it creates the wrong incentives.

    Poorly designed? Yes, because 1) it is funded by an extremely regressive tax on labor; and 2) it did/does not properly take into account advances in life expectancy and the overall health of “young” seniors.

    Unfair? Yes, it punishes people with lower life expectancies, along with their families (e.g. men in general, black men, people with inadequate access to health care, people who work in hazardous occupations).

    Wrong incentives? Yes, it taxes labor, and it encourages even healthy and productive 65-year old people (or younger) to retire. Furthermore, the system has overpromised benefits in terms of real goods and services, and this leads people to overconsume now, not properly plan for their future retirement, and then end up disappointed with the result.

    Would partial privatization go some way to mitigating these problems? Yes, I think it would, particularly with respect to the unfairness aspect and the problem of incentives. Transparency would be increased as well. It is much easier to figure out the present value of your private account than a political promise to pay benefits for the remainder of your life, starting many years in the future.

    There may even be an ancillary benefit of increasing financial literacy among the general public. Everybody with a social security number would have an investment account, and that would certainly spark some interest in the stock and bond markets, how they work, and the effect that government policies have on the value of those accounts. I think that would be a good thing for society.

    1. We already have a mechanism for the government to take private sector income. It is called taxes. If the government wants to divert a certain proportion of dividend and interest payments into payments to retirees, it can do this by taxing corporate profits directly, rather than going through the kabuki play of taxing households, using the proceeds to buy assets, and then diverting the payments from those assets to retirees.

      Other than giving the financial sector a transactional cut, and further politicizing the capital allocation process, what does such a kabuki play achieve?

      In general, the capital markets should not be politicized. Prices should float. As soon as you do something like this, you will find that politically incorrect firms — e.g. non “blue chip” firms will have higher funding costs than whatever the government happens to favor. And of course you are introducing volatility and the inevitable government bailouts when it goes in the wrong direction. It is the private sector that should be accumulating claims on government by purchasing assets. Government’s claims on the private sector should be administered via taxation, not capital markets.

      1. RSJ,

        I completely agree with you, but that’s not what my idea of privatization is really about. To me, privatization means giving each social security participant an investment account which he owns and has some measure of control over. “Ownership” is an important feature. The participant is not dependent upon an arbitrary and uncertain political process to make sure that his retirement is comfortable, and he can pass on the proceeds of his account to his heirs. It would be like an IRA, except that contributions would be required rather than voluntary.

        A bare-bones social security system would remain as a safety net. The level of benefits would be lower, and the benefits would be means-tested. And it could be paid for out of general revenue — no specific wage tax to cover it (that should appeal to the progressives on this site).

      2. Yes, I know you want ownership, but you can’t have it.

        The only thing you can own is the goods that you bury in a hole in the ground to leave for your children. They may or may not want those goods, and in any case you would earn a negative return.

        Apart from that, you are dependent on others. Investments may fail to perform. Future generations may vote to cut your benefits. You cannot force them to pay you a certain level of benefits anymore than you can force them to pay you what you want for your assets. They may decide your house isn’t worth that much, and that your stocks aren’t worth that much either. Bond issuers may default, and inflation can eat away at government returns.

        All that happens because, at the end of the day, each year we produce output and each year we consume it. Attempts to profitably defer consumption in exchange for “credits” are contingent upon the economy continue to produce enough in proportion to the growing level of claims on that future production. You can’t “own” an assurance of future consumption.

        The best assurance is the system we have now — a legal requirement to pay a certain income. Still the laws can be changed, but this is much more stable than investment returns, which go through multi-decade bull and bear cycles.

        Apart from hole digging, all other means of savings rely on transfers that are, in the end, voluntary and state contingent. People don’t like that, and they want guarantees of future outcomes.

        In terms of social security “credits”, you cannot donate these to your children. They will have to earn their own credits by working, just as you did.

      3. I should add that the senior population in the US has tremendous political power because they are motivated to vote and have the time to do it. The social security system provides an incentive and a mechanism for the elderly to use the political process to take more and more resources away from the young. It has become a ratcheting process. Social security benefits keep going up — even in 2008 when inflation was negative, social security recipients were granted their COLAs.

        Partial privatization would make it harder for the old to use the political process to take from the young. Of course, that means it’s going to be difficult to change the system we have now, which is probably why people like Stephen Moore are using deceptive reasoning to get there.

      4. ESM: “A bare-bones social security system would remain as a safety net. The level of benefits would be lower, and the benefits would be means-tested. And it could be paid for out of general revenue — no specific wage tax to cover it (that should appeal to the progressives on this site).”

        I would agree that SS should be a safety net and not “insurance.” It was sold as insurance, but it really is not that. We should call it for what it is and operate/fund it as such. The mechanics are a political question, but I would put it along with other social programs that are best funded publicly, including military, security, health care, education, basic infrastructure, basic science, and other aspects of the social safety net. These are issues not only of national prosperity but also national security.

        In a modern complex economy, government must ensure that the basic needs of the people are adequately provided, where the private sector is either unwilling to do so, or unable to do so effectively and efficiently on the profit motive. Of course, this doesn’t mean that government has to do everything, just fund it.

  4. Moore: “approved, high quality stocks…”

    Like…Major Oils (BP), Money Center Banks (Citi), Telephone Cos. (Worldcon), Utilities (Enron), Tech Equipment (Lucent), Mortgage Cos. (Countrywide), Investment Banks (Lehman), Ha!

    Why not just consider the current SS your ultra safe or “bonds” portion of your retirement portfolio…leave it alone and recognize that the checks will never bounce, and stop over-taxing the working stiffs to “pay for it”. Putting these funds into equities will just support the stock option scam for insiders that the whole world of public equities is in reality.


    1. Couldn’t agree more, Matt. It’s Wall Street that is push the pols for privatization because they want to increase trading in financial assets, which favors their interests. With a mandated “investment” program it would delivering a significant portion of GDP to them, from which to extract all they can.

      I agree that SS should be bond without bonds, and the unconscionable repressiveness should be eliminated from the “payment” portion, too.

      IMHO, it would be much wiser economically to make health care, pensions, education, etc. entirely public instead of tying them to benefits. What happens is that employees of large corps do very well, while small business and the self-employed get pinched. This is just building up the foundation of the corporate state.

    2. Agreed. Government should not be in the business of encouraging investment in one asset or another. Don’t promote blue chips, don’t promote the agencies — let these assets be priced on their merits, and not because there is a government- created asset demand for them.

      Government should be in the business of guaranteeing a minimum pension level, just as it guarantees a minimum wage level. That the transfer is regressive is a problem, but not that the transfer occurs.

      If anything, we should lower the retirement age and increase the benefits, so that they are indexed to labor productivity growth rather than just inflation.

      1. SS benefits should be linked to target inflation.

        Right now, SS is pro-cyclical Govt spending, and it needs to be counter cyclical so it adds to automatic stabalization effect.

        Besides, key argument against this SS privatisation is “”I like it because I believe in privatization. I believe that you can invest your money better than government can.””

        He is wrong. Most people are terrible investors and should not be put in investing business. This is one of big problems with conservatives, they are too horatio alger and ignore actual needs of real peoples.

      2. Agreed. Counter-cyclical makes most sense.

        Given my anecdotal perspective, putting ordinary people in the market is like leading sheep to fleecing. Most people are in no position either to manage their account or select someone to do it from them.

        It’s like rational expectations economists assume that everyone thinks like they do in making decisions. Most people don’t even know how, and it they did, would they actually take the time?

      3. Absolutely! Most people have real jobs which take up real time to produce real things. I wouldn’t let ‘investors’ do my work either, why should I be expected to do theirs? Let alone in my spare time…

      4. “Most people are in no position either to manage their account or select someone to do it from them.”

        I had intended to write “for them” instead of “from them.” But on reflection, “from them” is more representative of the facts.

  5. Social security is the combination of two parts each of which is considered offensive in detail. A regressive wage tax and a transfer program for being old.

    Put together and they are mother’s milk.

    It is the great mystery of American Government.

  6. Warren, I have learned a lot from you and read this website daily. Thank you for what you do. I am not in favor or privatization, but I do not understand your argument. For your consideration, your point seems to be imcomplete.

    Let’s assume Steve Moore’s concept is implemented and the top 25% of stocks are eligible investments for Social Security (the percentage really does not matter that much for this example; 10% would be fine too). I will call them “elite companies.” Your argument is looking at the mechanics of the investment at a particular point in time and on any given day your description would be accurate. However, respectfully, over time you would be wrong. The privatization argument is about the long term and that is what is missing from your argument. Elite companies going forward would behave differently. For example, they would issue MORE stock and alot more at that and much less debt. Elite companies would have a large pool of investors and investment dollars willing to stand in the first loss position. Unfortunately, defining the investment options for Social Security as stock in elite companies assures more stock to be issued. Elite companies would be able to issue stock to retire bonds. Stock prices do not exist in vacuum and can effect almost every financial decision especially for elite companies in this example. Elite companies can demonstrate to banks and line of credit providers that they are significantly better risks than non-elite companies and their stock prices would have support defacto institutionalized by the US goverment by being on the list of eligible investments for Social Security. New projects, expansions, and acquisitions would be more likely to funded with a higher percentage of equity than under current conditions. Elite companies would have a huge competitive advantage over competitors who do not have elite status. For those competing against elite companies, getting on the list of eligible investments for Social Security would be a priority to maintain competitiveness. Obviously, the elite company concept and the limiting of investment options for Social Security would create bubble potential in the stocks of elite companies.

    In short, I am not in favor of privatization. I do submit that your analysis was too snap-shot or balance sheet account oriented rather than long term change or income statement oriented. Best regards.

    1. thanks, and agreed there are other negatives to the proposed privatization proposals.

      and yes, the special status already given the s and p 500, for example, already creates distortions as you suggest. there are ‘investors’ who do nothing but try to profit on stocks that will go up when the get into the s and p and fall off when they exit the s and p.

  7. I am against complete privatization of SS. I rather am for welfarizing SS here are some reasons:

    1. The SS tax forces people to invest when they are young even though they are generally poorer when they are young.

    2. The best investments might be in family and investments in ones own physical assets.

    3. With lower SS payments productive people might work longer producing more.

    4. In many families SS amounts to a transfer from the children to the parents but the parents thank the politicians not the children. Further total utility might be higher for some families to live under one roof yet SS makes the utility higher for the parents living apart at the expense of the children whose utility would be higher with more money and living with their parents.

    5. Lower SS might encourage more saving and investment which increases productivity in the long run assuming good monetary policy (a difficult assumption I know). This because many people over react to risk.

    Here is my blog post on SS

    1. you have a few things backwards causation wise

      savings is the accounting record of investment. loans create deposits, etc. see the 7 deadly innocent frauds in the left margin of this website

      in real terms savings is current production not currently consumed but set aside to contribute to future consumption. hence only people working/producing can contribute to real savings

      that’s in a post or two also on this website somewhere

      1. One of my problems with these discussions is that saving can be defined in multiple ways. For example if I take current income and divert it from consumption and buy a stock that yields a dividend is that spending or saving? If I intend to live in home for the rest of my life and I divert from current consumption and invest in more insulation for that home isn’t that saving. If I buy land out of current income…..

      2. BTW In the other hand if I buy a treasury bill or pay into SS or put money in a demand deposit account nothing is really saved (assuming it is not used to build a long term asset like a road).

        If I make bread and I use some of the income to buy a bread making machine, that is saving.

  8. Social Security is more than old age pension. It includes disability benefits and life insurance provisions. These are often forgotten about but are very valuable, particularly for those with children, well before they achieve retirement age.

    A large portion of the working population does not have to pay federal income tax. So if it’s the enforced collection of taxes that places value on the government’s designated currency, it is essential that most everybody participates. That these taxes are currently “flat” is the issue. Also an issue is that they are “hidden” in that the employer pays half.

    Rather than have a separate “social security” tax, why not just roll it into the federal income tax – they all go to the same place anyway (obliviion, per W.M.). It immediately becomes progressive. It eliminates a gigantic bureacracy, both in the government and corporations. The real plus is it changes the terms of the argument from ridiculous statements like about it going bust or that you “deserve” to collect it since you paid into it.

    1. 1. You are assuming that government funds itself with taxes?

      2. The sole reason when all is said and done for the separate SS tax is to create the illusion of a government run insurance plan. This is bogus.

      3. Inclusion of disability, etc., in addition to the pension portion shows that it is a social welfare program, and a very effective one. These programs could be made even better if the debate were reality-based instead of myth-based.

      SS and Medicare are fully funded by the government’s capacity to issue currency. Taxes don’t enter into the picture as a financial requirement, and there are no “unfunded” obligations when government funds itself directly.

      The whole kerfuffle is just made up. It’s a result of an illusion created by voluntary restraints adopted to mimic the supposedly “sound money” of the gold standard era that ended in 1971 when Nixon shut the gold window.

      1. Curiously enough, deficit cultist Pete Peterson was up at Camp David when Nixon shut the gold window.

        On short notice, Nixon summoned his key economic advisers to a climactic weekend gathering… Burns and McCracken were there; so were Shultz and his deputy, Caspar Weinburger, and the two Teutons who guard Nixon’s gates, H.R. Haldeman and John Ehrlichman, Peter Peterson, a presidential aide for international economic affairs, joined the sessions…,8816,909912,00.html

      2. Right. They knew exactly what they were doing, and they had to stick a finger in the world’s eye to do it. But Treasury Sec. Connally was right; everyone just rolled over and eventually lined up behind it officially in 1973.

        The idea that the people at the top are ignorant is just not credible to me. They know how a fiat currency works and are using it for their own purposes, concealing the mechanics behind the veil of voluntary restraints that can easily be avoided as required for their purposes, like war.

      3. Beo,
        Henry Paulson was an aide to either haldeman or ehrlichman also. Cheney was in the Ford admin.

        You know these people who put down the govt and seem to advocate for less govt involvement like perterson, et al, are the ones who have spent much time IN govt. IMO no elite MMTer out there has ever been IN govt. yet they are the ones advocating for proper public purposes of govt, etc… Ironic. Resp,

      4. Matt, Some of those in power know how the monetary system work, the rest know enough not to veer a millimeter from conventional wisdom or risk getting kicked out of the club… Richard Nixon got his start in politics because he was recruited to run for Congress by the Bank of America branch manager in Whittier, in large part because the incumbent (Jerry Voorhis) was prone to say some dangerously sensible things about public finance and banking (A “National Credit Account”, in contrast to present national debt, could be established on the central banks’ books in favor of the United States Treasury.“)

        The solution to this is…. well, have you seen Napoleon Dynamite? His buddy Pedro runs for student council president on the slogan, “vote for Pedro and all of your dreams will come through”. As it happens, by the end of the movie everybody’s dreams HAD come true. The point is, in our political system there are many people who want lower taxes (Americans for Tax Reform with their “no new taxes pledge”) and there are people who want more government spending for their favored programs (oh man, that’s a big club… think of every govt. program threatened with budget cuts, and if Social Security is threatened, nothing’s safe), and people who want universal healthcare (Physicians for a National Health Program), and people who want full employment (AFL-CIO and the other unions) and who want employees with lower payroll tax costs and customers with higher personal income (retailers and other small businesses).

        Every one of these groups is unhappy with the world as it is and are just waiting for someone to sincerely tell them (in so many words), “Vote for Warren and all of your dreams will come true”. :o)

    2. my first proposal is a FICA tax holiday to help restore incomes and demand from the bottom up, and support people working for a living who are in fact supporting all of us in real terms

      do i have your vote?


      1. I agree on the payroll tax holiday, but shouldn’t MMT’ers be pointing out that the (regressive) FICA tax is unnecessary since taxes don’t fund government expenditure in a fiat regime? It’s not only unnecessary, but also inefficient because it is regressive and also adversely impacts small businesses disproportionately.

        OK, calling for an end to FICA is going for broke right off the bat, and a stretch politically. So I’ll settle for incremental payroll tax holiday. After that, let’s talk functional finance straight up.The conservative “sound money” folks are going for broke and apparently winning. Shouldn’t we be just as bold about MMT and functional finance?

        You can’t compromise with the devil, as they say.

  9. I am just your “joe public” weighing in. I was referred to your site by a cousin. Anyway, I have always believed that privatization would be the best way to go. In reading your dialog I can see where the cons for this are quite substantial.. My problem is with the government in control, “we the people” are at their mercy. I do not have the right to decide where “my” investment will go or how I can spend it; when and where. As a young person I was under the misconception that I was building some type of retirement fund. Only as an adult and now a “much older” adult do I realize that “I” should have been planning better. I have always believed that a welfare was a safety net to help people through a bad time. Never in my wildest dreams did I ever think that Generations would be living off my dime!!
    Now, here we are, becoming a socialist society that no one will have to work unless they want too. What is wrong with this picture, or is it just the “Pollyanna” in me that thinks we should all pull our own weight. Unfortunately, now I am on disability, thank God my husband can work as I could never live off of what I get from SSA, and I truly do need my private insurance, medicare/medicade is a joke. I want some real meat to sink my teeth into for my children and my husband. Retirement funds and investing on our salaries is next to impossible, but if we had those tax dollars that are paid out and were able to put them somewhere profitable we might stand a chance of not being in the soup lines in our old age.

    1. Deb,
      Being in a soup line in old age is a political choice. Society is capable of producing a certain amount of goods and services. Social Security decides how much is taken away from those producing (workers) and distributed to those not producing (retired, disabled etc.). If investing privately gives everyone who is retired more money (due to a greater return) and the number of goods and services produced is the same, than inflation will result (more money chasing the same goods) and no one will be any better off. The true way to “save” Social Security is increase our productivity so we can produce more goods with fewer workers. Then decide politically how much of those goods we distribute to those retired while also increasing the living standard of those working to keep them happy.

      1. The privatization argument is based on the appealing notion of doing what is best for oneself (self-interest). This view is bolstered by the puerile view of “invisible hand” that adjusts the totality of self-interest to the self-interest of society economically, which is erroneously attributed to Adam Smith. Smith never held such a view, which is guilty of the fallacy of composition. As Warren has often pointed out, the fallacy of composition is well-illustrated by the fact that if one person stands up in a audience, that person gains an advantage. But if everyone stands up, the advantage is cancelled and everyone is disadvantaged.

        The notion that everyone can do better managing their own money than “the government” is fallacious. In the markets, there are winners and losers. Very few make money over the long run in real terms. In the end, a lot of people will be left out if privatization is adopted, and government will have to pick up the tab anyway to preserve good order.

        The government as currency issuer never has this problem, and it can always meet its financial obligations. SS is a good deal, and the coming generation doesn’t have “pay” for it with taxes. We should just remove the illusion of that created by FICA and recognize SS for what it, a welfare program rather than an annuity.

        While “welfare” has acquired a pejorative significance due to conservative propaganda, “promoting the general welfare” is listed as a basis for government in the preamble to the US Constitution. Promoting the general welfare is one of the things that government does to advance public purpose.

  10. @beowulf I think this description is much better than that of Jerry Voorhis:

    Who Owns the Fed? by Bill Woolsey

    The Federal Reserve System prints $100 bills at a cost of 6¢. So who pockets the $99.94 profit?

    It was in the late eighties. I was a new faculty member at The Citadel, teaching Money and Banking. A memo was in my box. There was a phone number and a note that someone had questions about the Federal Reserve.

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