Opinion Editorial

Monday, May 10, 1999  

Report On Privatized Social Security In Galveston, Texas

As debate on Social Security reform moves toward a consensus on private accounts to replace or supplement the current system, more and more attention is being focused on the practicality of a privatized retirement regime. For this reason, there is growing interest in the already-existing private Social Security system established in Galveston, Texas in 1981.

Before 1983, the Social Security law allowed state and local government workers to opt-out of Social Security. In 1979, government workers in Galveston County, Texas, decided to do just that. Under a program set up for them by First Financial Capital Corp. in Houston, governments and workers stopped sending Social Security taxes to Washington. Instead, they deposited approximately the same amount of money in private accounts. The funds are managed by the county and have achieved an average 8.64 percent annual rate of return since inception.

Unlike Social Security taxes, deductions from the Galveston workers' paychecks come out of before-tax income. This reduces current taxes in the same way that 401(k) accounts do. Also, all returns to the accounts go to individual workers, raising their benefits. By contrast, interest earned on the Social Security trust fund does nothing to increase anyone's benefits. Finally, Galveston workers have the option of taking their retirement benefits in a lump-sum or in the form of an annuity. Social Security provides only an annuity.

  • A new report from the Social Security Administration on the Galveston system found that for most single workers initial benefits would be considerably higher than under Social Security (see figure).

  • Only low income workers are slightly worse off, owing to the heavy redistributive aspect of Social Security.

  • Married workers do not do quite as well, due to the more generous spousal benefits under Social Security.

The most serious criticism of the Galveston plan in the SSA study is that because Social Security benefits are indexed to inflation while private pensions are not, over time Social Security recipients do better. However, the study assumes inflation of 3 percent per year indefinitely, an assumption that may not be valid in today's low inflation environment. Removing or reducing this assumption eliminates most of Social Security's advantage.

Finally, it is important to remember that Galveston workers do not lose benefits by working past age 65, as Social Security recipients do. And it must also be noted that the Galveston workers' funds are very conservatively invested. Had they been invested in a large stock index fund they would have almost doubled their rate of return, which would at least double their benefits.

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