As the election season heats up, opponents of reforming Social Security with personal retirement accounts are painting them as reckless, untested and dangerous. Experience from around the world, however, indicates that this just isn't the case. In fact, 80 million people in 20 countries are already living under reformed Social Security systems that include a private investment component. The experiences of these countries demonstrate that personal accounts are safe, common and profitable for workers and retirees alike.
Reform is badly needed – Social Security cannot continue to function the way that it is currently structured. While the program is running surpluses now, these days of plenty won't last forever. In just 15 years, Social Security will begin paying out more in benefits than it collects in taxes. And the debts grow larger and larger with each passing year.
This is happening because the system relies entirely on the taxes paid by today's workers to fund the benefits of today's retirees, and the number of retirees is increasing faster than the number of new workers. When the program was formed, there were 42 workers paying into Social Security to support each retiree collecting benefits.
Today, there are only three workers for each retiree. By the time today's teenagers retire, the ratio will be only two to one. Clearly, the taxes that must be collected from each worker will increase higher and higher. To keep the program in balance, we'll either have to raise taxes by a half on future workers (leaving them less to save for their own retirement) or cut benefits for future retirees (reducing an already meager retirement benefit).
The U.S. is not the only country that established a "pay-as-you-go" pension system, and it is not alone when it comes to a declining worker base to support a growing retiree population. Where we differ is that many of the other systems around the world have already been reformed to include some version of a personal retirement account.
The idea behind personal retirement accounts is to allow younger workers the opportunity to invest into an individual account a portion of the taxes they already pay, reap the rewards of compound interest collected over their working lives and draw part of their Social Security benefits from their account after they retire. Because workers would essentially be pre-funding part of their own retirement pension, the cost to future taxpayers to support them would decline significantly.
The experience of these other nations' reform efforts was examined recently in a study for the National Center for Policy Analysis by Estelle James. James, a former economist at the World Bank, found that while there are differences among the many reformed systems, they have much in common. For example, in most cases contributions to the accounts are mandatory for new entrants to the labor market and investment decisions are regulated.
James also found that the collective experience of such nations as Australia, Chile, Croatia, Switzerland and the United Kingdom, among others, provide several lessons that reformers in the United States can learn from. First, that private sector control over personal retirement accounts is more profitable than a centrally controlled pension reserve. In fact, the average privately managed pension fund in developed nations around the world earned a 4.1 percent average annual rate of return, while the average publicly managed pension fund lost an average of 8.4 percent per year.
Second, contrary to what many domestic critics argue, costs of a reformed program can be kept low. The experience of the world shows that personal accounts can be created in a way that minimizes administrative fees. Additionally, while reform does involve a certain degree of transition costs, the world's experience shows that most often with reform, the total pension obligation of the government is actually reduced.
Third, reform can create a less risky and fairer system. The risk associated with investing in the private capital market can be reduced by encouraging diversification or instituting a minimum guaranteed benefit. In addition, reformed systems can redistribute income from high earners to low-income earners better than traditional pay-as-you-go programs, which are biased against people with shorter life expectancies.
While Congress dawdles on how to fix Social Security, an additional 10 countries are moving to introduce reforms, including China, the Dominican Republic, Germany, Kosovo, and Macedonia.
When it comes to securing our public retirement security program, the U.S. – which supposedly has a commitment to individual liberty and free enterprise – is falling further and further behind.