Government Spending on the Elderly: Social Security and Medicare

Policy Reports | Federal Spending | Health | Social Security

No. 247
Friday, November 30, 2001
by John C. Goodman and Matt Moore

Alternatives for Reform

The alternative to funding retirement benefits by income transfer is to fund them through savings. The alternative to creating escalating burdens for each successive generation of workers is for each generation to save for its own retirement benefits and pay its own way. This approach is rational, as shown by international precedents.

"Some countries have reformed their pay-as-you-go systems."

Retirement Security Reform in Other Nations. Like Social Security, the vast majority of the world's retirement security systems are pay-as-you-go. Not only do they face the same demographic problems we face, but most of the developed countries are in worse shape. To reiterate: by the time today's college students reach retirement age (in 2050) our elderly will make up 20 percent of the population - compared with only 12 percent today.32 Other developed countries are facing the same population crisis as the U.S., but to a greater degree. For instance, Italy and Germany will have only one worker for every retiree by 2030.33

Some countries have already reformed their pay-as-you-go systems to deal with these emerging demographic trends, laying a course for other nations to follow. Among the notable alternatives to pay-as-you-go retirement security are the following:

  • In May 2001, the German Parliament adopted a plan to partially privatize a portion of its pay-as-you-go national retirement system. The plan encourages workers to invest up to 1 percent of their wages in private pension plans beginning in 2002 and up to 4 percent beginning in 2008.34
  • Chile paved the way for reform in 1981 when it transformed its pay-as-you-go system into a system that requires workers to invest in individual retirement accounts, managed by private funds that must invest in a diversified portfolio of assets.
  • Seven other Latin American nations have adopted the Chilean model to some degree, including Peru (1993), Argentina (1994), Colombia (1994), Uruguay (1995), Bolivia (1997), Mexico (1997) and El Salvador (1998).35
  • Britain allows employers and workers to opt out of the state pension system's second tier by setting up private pension plans with benefits at least as generous as the government system.36
  • Singapore's Central Provident Fund (CPF) requires employees and employers to contribute jointly to individual accounts, which may be used not only for retirement and for hospital expenses but also to finance college tuition or purchase a home.
  • Several start-up systems are based on the Chilean model, including those in Hong Kong, Hungary, Poland and Kazakhstan.

Advisory Council Proposals.37 A 13-member bipartisan Advisory Council on Social Security, appointed by the Clinton administration, recognized that the stock market historically has provided returns two or three times higher than those from government securities. However, the council couldn't agree on a single approach to Social Security reform, and instead proposed three different ones, none of which was supported by a majority of the council.

"Several proposals would allow individuals to invest through personal retirement accounts."

One proposal would have the government invest 40 percent of the Social Security trust fund - an inflation-adjusted $800 billion - in the stock market over 15 years. Investments would be in a broad range of stocks much like stock-index funds, and the government would not vote its shares. But politicians would be tempted to try to influence investments that would control as much as 10 percent of the nation's equities. They would almost certainly try to use their control to encourage or discourage certain industries, achieve social goals, reward friends or punish enemies. Critics note that this is what has happened with similar plans in Sweden and Japan.

The other two proposals envisioned individual investments in the equities markets. One would allow individuals to invest 5 percentage points of the 12.4 percent payroll tax in Personal Savings Accounts for retirement. The other would increase the Social Security payroll tax by 1.6 percentage points, allowing individuals to invest the amount of the increase in their personal retirement accounts.

"We need to replace Social Security with a system under which each generation pays its own way."

Public Support for Reform. While Social Security is popular, much of the public recognizes that the system cannot be sustained. Social Security reforms that include personal retirement accounts have been popular with the public and with politicians of both parties. President George W. Bush grabbed hold of the fabled "third rail of American politics" and survived to tell about it - despite incessant attacks from his political opponents. Reform plans have been proposed by Members of Congress from both parties and both houses. Recent evidence indicates that former President Bill Clinton was holding regular meetings with financial experts to examine the feasibility of personal accounts as a fix for Social Security.38 In addition, polls consistently show that Americans are in favor of the concept of personal retirement accounts.

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