Privatizing Social Security is Bad, Particularly for Women

by Dr. Catherine Hill

Dollars and Sense magazine, November/December 2000


You've probably heard the rumor that Social Security won't be there for you when you retire. And you've also probably heard that presidential candidate George Bush promised to "save" Social Security by allowing individuals to divert 2% of their wages (or earnings) into individual accounts. Stocks generally have higher returns than government bonds, so setting up individual accounts that take advantage of these higher returns should mean more money when you retire. Right? Wrong. In fact, privatizing Social Security will mean less income in retirement for almost all American workers, and it will be particularly damaging for women.


Every year the Social Security Trustees forecast the long-term revenues and expenditures for the program over the next 75 years, based on demographic and economic assumptions. In the early 1980s, the Trustees forecasted a financial shortfall (misreported in the press as a "crisis"). In response, Congress increased the payroll tax rate slightly and increased the retirement age (eligibility for full Social Security benefits) from 65 to 67. These changes generated billions of dollars in surpluses for Social Security, which were placed in the Social Security Trust Fund (currently valued at a little more than $896 billion). The Trust Fund earns interest, and both principal and interest can be used to supplement payroll tax revenue during the peak Baby Boom retirement years. In 1991, the Trustees decided to use more pessimistic assumptions about future economic growth, resulting in the prediction that Social Security would not be able to pay full benefits after 2034. Strong economic performance in the last few years has resulted in a lengthening of the projected solvency to 2037. If the economy does not slow down as much as predicted, and payroll tax revenues continue to grow at a healthy rate, Social Security has no long-term solvency problem. In any case, if the economy does slow down, the Social Security program is well-positioned to continue paying full benefits for at least another thirty-seven years. After 2037, Social Security can provide three-quarters of promised benefits, and with small policy changes, Social Security can continue to pay full benefits indefinitely.


Privatizing Social Security would be the largest undertaking in the history of the U.S. financial-services industry.

It could also be the most profitable, and Wall Street knows it. For nearly two decades, Wall Street and its conservative think tanks have been cultivating the public's fear that Social Security is "going bankrupt." As Jesse Jackson and other progressive leaders have noted, financial firms such as Morgan Stanley, Quick & Reilly, Inc., and State Street Boston Corporation have given millions of dollars to conservative groups like the Cato Institute to push privatizing Social Security. However, with the facts so squarely mounted against them, the movement appeared to lose momentum, and for a while, it looked like the campaign to privatize Social Security had run its course. Activists breathed a sigh of relief and went about tackling other issues. However, this summer, privatizers got a second wind when Presidential candidate George Bush pledged to "partially privatize" Social Security by diverting 2% of the payroll tax (a little less than a sixth of the program's revenue) into individual accounts. The fight is on and the privatizers have come out swinging.


There are four major hidden flaws of privatizing Social Security: the enormous transition from a "pay as you go" to a pre-funded system, the costs associated with purchasing equivalent life and disability coverage (or maintaining the current disability and life insurance program in the context of a 16% cut in revenue), market risk, and higher administrative costs.

* Transition Costs.
Privatizers face a costly transition period lasting 40-70 years. If pre-funded individual accounts were to be adopted, the generations living through the transition would have to pay for two systems at once, saving for their own retirement while paying for the Social Security benefits of their parents and grandparents.

* Replacing Disability and Life Insurance.
A sleight of hand used by many privatizers is to compare "returns" from Social Security-a social insurance and retirement program-to returns from private savings that provide only retirement benefits. Social Security taxes pay for disability and life insurance as well as retirement benefits. The program provides life and disability insurance to American workers and their families at an estimated value of a $230,000 disability policy and a $354,000 life-insurance

Since 1935, Social Security has been America's most successful social program, currently providing income to 48 million retired and disabled Americans and their families. More than three fifths of retired households depend on Social Security for more than half of their income. For 25% of older women living alone, it is their only source of income. Without Social Security, half of elderly people in the United States would be poor (meaning that an elderly couple would have an income under $ 10,000 annually and an elderly individual would have less than $8,000 to live on).

A payroll tax supplies the revenue for Social Security. The tax is currently 12.4% on wages up to $72,600 and is split between employers and employees (6.2% each) with self-employed people paying the full tax themselves. (Workers also pay 1.45% of wages or earnings for Medicare.) Note that, because most of the payroll revenues are immediately used to pay benefits, diverting "only" 2% of wages means a one-sixth reduction in the money available to pay benefits.

Social Security benefits are available to all workers and their families regardless of income. For this reason, Social Security has historically enjoyed a stronger base of political support than programs that provide benefits only to those who can document poverty, such as Supplemental Security Income (SSI). The average monthly check for a retired worker is $825 with a maximum benefit of $1,373 for a worker with a consistently high salary over a full career (35 years). While no one gets rich from Social Security, it is an important source of income for almost all retired and disabled Americans' policy for a typical worker. Privatizers argue that individuals can purchase disability and life insurance from private insurance firms. However, evidence from other countries' experiments with privatization suggests that insurance similar to Social Security would be costly. For people with pre-existing conditions, private disability and life insurance may not be available at any price.

* Overly Optimistic Returns on Stocks.
Another problem with privatization is the assumption that the stock market will perform as well in the coming decades as it has in the recent past-a risky assumption. In fact, many economists believe that the stock market may be at a peak, and many stocks may be overvalued. Privatizers can't have it both ways-either the economy will be strong and the solvency problem projected for the current system won't materialize, or the economy will slow and the rate of return on stocks will drop, lowering the balances of individual accounts. Even if the stock market does well on average, individual accounts mean that there would be winners and losers. People who have greater knowledge and more money to invest will get higher returns than others. For low earners, who have less to invest and are less able to take risks, attaining average rates of return is unlikely. People who are unlucky or unwise could end up losing most or all of their money, placing additional burdens on SSI and other government programs that provide some safety net to poor people.

* Administrative Costs.
Another problem with the privatizers' arithmetic is the failure to account for administrative costs. It costs a lot more to administer 150 million individual accounts than a single centralized system like Social Security. Experts conservatively estimate that it would cost about $25-$50 per participant per year to administer on top of the current system, which costs about $16 per person. Even small increases in management costs that are assessed monthly or annually can result in a large loss of value over one's lifetime. For example, if the costs of operating a system of individual accounts were 1% of account balances each year (a conservative estimate of the administrative costs of a 401 (k) plan), these costs would consume approximately 20% of funds in personal accounts over a 40-year career, in addition to (not instead of) the current costs for administering Social Security. For lower income workers who have smaller accounts, administrative costs would absorb a greater percentage of their total value.


Social Security is important for women because older women enter retirement with fewer economic resources than men. For example, in 1998, older women had a higher poverty rate (12.8%) than older men (7.2%). Women of color are particularly at risk for poverty in their old age. Overall, there is a substantial gender gap in all sources of retirement income including Social Security, pensions, savings, and post-retirement employment. The greatest disparity lies in accumulated pension wealth and savings, with Social Security credits partially compensating for this gap.

Furthermore, the Social Security system is progressive. Those with lower incomes have a higher proportion of their earnings replaced, which is valuable for women since they tend to earn less than men do. Income inequality would be further exacerbated in a privatized system because women investors, who have fewer resources, would get a lower yield on their investment as they would (appropriately) avoid risk.

Another important component of Social Security for women is the spousal benefit available to wives (or husbands) or widows (or widowers) who earned significantly less than their spouses. A married person is eligible for the larger of either 100% of his or her own retired worker benefit or 50% of his or her spouse's retired worker benefit. Women (or men) divorced after ten years of marriage can claim spousal benefits, even if their former partner remarries. Women make up the vast majority of recipients using the spousal benefit provision. In 1997, 13% of women beneficiaries claimed spousal benefits compared with 2% of men. While the spousal benefit is an imperfect acknowledgement of unpaid care-giving, it is preferable to a system of individual accounts which allocates no monetary reward for child-rearing or elder care.

Social Security's "gender neutral" benefits mean that women don't have to pay more to compensate for their longer life expectancies-another advantage that would be lost in privatization.

The fact that Social Security provides an inflation adjusted benefit guaranteed for life is particularly important to older women (who live on average three years longer than men).

Another aspect of Social Security that is especially valuable to women is the life and disability insurance, which includes benefits to spouses caring for children under 16 if the worker retires, becomes disabled, or dies. As women provide the bulk of care-giving in our society (for the elderly and disabled as well as for children), any shortcomings in disability and life insurance caused by privatization would have a special adverse impact on women.


Having looked at the serious drawbacks of privatizing Social Security, we can return to the real issues facing Social Security. Certainly, it is true that people are living longer and that prudent financial planning dictates that the government should maintain adequate reserves. To the extent there are long-term solvency concerns, there are a number of ways to increase revenue into Social Security. For example, the cap on the earnings subject to the payroll tax could be lifted, meaning that everyone-even those who make six or seven figures-would pay the same payroll tax rate. Another (no doubt unpopular) approach would be to allow all Social Security benefits to be taxed as income and use these revenues for benefits. Investing a portion of the Trust Fund in higher-yield public or private securities is another option. This recommendation differs from proposals that privatize Social Security through individual accounts because investments would be made by a central, independent organization, sharing risk across the entire system and holding down administrative costs. Moreover, only a small portion of the Social Security fund reserves would be dedicated to this alternative investment strategy, thus limiting the system's overall exposure to risk.

It is also true that Americans, especially low- and moderate-income Americans, don't save enough for retirement. Even with generous tax deferment for pensions, it is increasingly clear that private pension plans will never cover the entire workforce. More than two decades after the Employee Retirement Income Security Act (ERISA), more than half of American workers are not covered by a pension plan. The economic situation for older women is particularly bleak. Among the elderly, women are only about half as likely as men to receive income from private pensions (including income from a spouse's pension), and those who do receive pension benefits that are only about half as large as men's benefits. For example, in 1996, pension income for women averaged $3,679, compared with $6,442 for men.

Differences in access to pensions represent a significant gap in federal resources. Because pension funds' earnings are not taxed, because employer contributions to pensions are considered tax-deductible business expenses, and because employees are not taxed until they retire (and begin drawing a pension), there is a significant tax advantage for pension holders. For example, in 1999, the Office of Management and Budget estimated that the federal government lost $84 billion in tax revenue. Thus, unequal access to pensions means that these tax favors are also unequally distributed.

There are a number of ways to give low- and moderate income families access to the tax benefits associated with pensions (now disproportionately enjoyed by their wealthier counterparts). Vice President Gore's recent proposal for Retirement Savings Plus accounts would be a step in the right direction. This program would help middle income and even low-income families save for retirement by matching private savings with government money. Lower income families would get the most help (families making less than $30,000 would receive $3 for every dollar they save), but middle- and upper- income families would also benefit (families making $100,000 would receive one dollar for every $3 saved). The accounts would be limited to $2,000 annually and savings would grow tax-free until withdrawal, like an individual retirement account or a 40l(k) plan. But remember, these "individual accounts" should come on top of, rather than as a partial substitute for, guaranteed Social Security benefits.

Last, but not least, progressives should begin fighting to improve Social Security benefits. The safety net for the poorest elderly and disabled people is dropping lower and lower as means-tested programs, such as SSI, fail to keep pace with a growing economy. Under constant pressure to protect Social Security from Wall Street's wrecking ball, advocacy groups and politicians have shied away from increasing benefits for anyone. However, there is ample evidence that such improvements are needed-particularly for disabled people and older women not living with men, who are at high risk for poverty. Again, Gore's proposals to increase benefits for widows and people who took time out of the labor force (or worked part-time) to care for children are another step in the right direction. Now is a time of great prosperity, and we can afford to begin mending the safety net so frayed over the past two decades-perhaps, even raise it!


Catherine Hill is o Study Director of the Institute for Women's Policy Research (IWPR} -

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