Posted by: maroonmaurader | September 24, 2011

Social Security and the Chilean Model

So Herman Cain recently promoted the “Chilean” model for Social Security in the primary debate. For those unfamiliar with the term, in brief: the payroll tax was made optional – you could either continue paying payroll taxes and receive public SS on retirement, or you could get a refund for your contributions to date and enter a private system (but there was a “pension mandate” for people who opted out of the public system, as well as government support and oversight of the pension funds).

The first, and most entertaining, thing to spring up from this is in fact that pension mandate. Unlike in Obamacare, where most courts so far have found that the individual mandate can be struck down without invalidating the whole law, striking down a hypothetical “pension mandate” would eliminate the whole purpose of a Social Security system – to provide a security blanket which ensures people will have at least some income after retirement. Which means if Obamacare’s individual mandate is ruled against based on an “activity/inactivity” distinction, I have to think that any attempt to privatize Social Security would require either effectively killing SS, or a full-blown Constitutional Amendment.

The second point worth considering is whether we can make this transition. Note the key elements of the transition period for Chile’s system: everyone currently collecting social security checks from the government would continue to do so. Everyone who chose to opt out would get a refund for what they had paid so far. And 95% of workers opted out. This means effectively to make the same transition here, Social Security would have to be solvent enough to pay out refunds to everyone under 65, while continuing to pay benefits to everyone over 65 with essentially no further revenue besides interest. If I’m reading this report correctly, SS currently has $2.5 trillion in assets. If SS suddenly stopped receiving payroll taxes (representative of a mass exodus to private pension funds by current workers), it’d develop a $500-billion hole in the budget each year, and be bankrupt half a decade later – with no additional revenue incoming.

Of course, the above assumed a near-100% opt-out rate (although it also ignored the refund costs). An alternative would be to offer a refund, but only a discounted refund (e.g., 50% of “your” money back if you switch, and you just lose the other half). This would simultaneously encourage older workers to stay in the current system (keeping some payroll income), and decrease the amount which would be lost to refunding those who did switch. Or we could simply not offer any refund at all. Presumably if we did so, only the youngest workers would switch. But if only the young workers switch, Social Security’s expenses are left basically unchanged for the next few decades, while it’s revenue takes a small hit in the short term which grows to a large hole 20 years from now. So that sort of switch also still leads to SS’s trust fund being exhausted within the next couple decades and the question of how to pay benefits beyond that point (since that would also be the point at which revenue would be plunging towards nothing due to fewer workers buying in). All told, I’m struggling to see how the transition is made without raising taxes or cutting benefits – as Romney put it, our SS (mis)management would have been called criminal in the private sector. It’s caused enough damage already that there’s no easy way to get out of the system we’re in.

So any proposed transition to a privatized model is simply a (very) long-term fix, and significant changes to tax and/or benefits would need to be made in order to get through the current and next generation of retirees. It’s those changes that are most difficult to build consensus around. A politician who touts the “Chilean” model as the solution to our Social Security woes either hasn’t worked through the numbers or is deliberately ignoring the thornier aspects of the problem.

The last question is whether the Chilean model actually is better. It’s a lot harder to track down straight figures on this (depending on which think tank or NGO’s figures you take, the average rate of return has been anywhere from 3% to 9% for those who switched in Chile, compared to about a 2% rate of return for U.S. Social Security; I haven’t been able to find any assessments by sources I would trust to be impartial). Of course, one presumes even the U.S. government could manage better than a 2% rate of return if Congress didn’t view the Social Security Trust Fund as it’s own private piggy bank, but that sort of mismanagement may be intrinsic to any system where the money is held by the government. With all that said, the keen observer will have noted that even the low-end 3% figure is still better than the 2% the government is currently getting us, so I would give a transition my qualified support – if it could be made smoothly without bankrupting the current system or bleeding the first adopters of the new system twice, and if proper oversight, regulation, and guarantees could be made and enforced.

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