Can Social Insurance Be Reformed?

and Kathryn Hickok

The financial uncertainty currently gripping the American and global economies raises more questions about our financial prospects over the next few decades than anyone has answers for. Politicians in Washington have been debating the future solvency (or lack thereof) of Social Security for years. The current Wall Street meltdown has American workers, counting on their individual retirement accounts, uneasy about the prospects of using the stock market for retirement “savings.”

On the other hand, there is no question that massive reforms must be made, and soon, if Social Security is to be afloat for the next generation. Keeping the status quo is not an option. Yet, at the moment, American investors regard with a wary eye putting their retirement eggs entirely in one basket or another. Is there any other response to this meltdown on both fronts? Can government provide retirement security to all American workers under a system created for the economy of the 1930s? In a slowing economy, is there a better way for workers to meet their own needs than government Unemployment Insurance? Can private investment accounts be counted on for either retirement or unemployment?

These are difficult questions for the best economists and financial analysts, but some background on social insurance programs in the United States, and related solutions being tried in other countries, can help illuminate the discourse.

Social insurance programs have become a very costly and a politically divisive aspect of government domestic policy, not only in the United States but also in many other countries. In the U.S., these programs are mainly made up of Social Security, Medicare and Unemployment Insurance. Together these three programs account for 9% of the Gross Domestic Product (GDP). This percentage is rapidly increasing with the aging population.

Social insurance programs differ from both private insurance and government welfare programs. They are income-transfer programs that deal with risks like job loss or inadequate assets during retirement, but they are not the same as private insurance. They require mandatory participation and are stimulated by government subsidies. Social Security and Unemployment Insurance programs may appear to be redistributing income to those in need, but they are not chiefly a redistribution policy lever.

One problem with broad-based social insurance programs is that they promote blanket “solutions” that are the same for all with no opportunity to customize according to individuals’ or families’ unique needs. Everyone must contribute to them, whether they meet people’s needs or not. This is why the option of a hybrid system combining government insurance with individual investment-based accounts cannot be overlooked anymore.

Martin Feldstein, a renowned economist at Harvard and a regular contributor to the Wall Street Journal, has done extensive research on Unemployment Insurance. He suggests that one way of saving social insurance programs from crumbling altogether is to consider a hybrid arrangement of government insurance and individual-based accounts””in unemployment’s case, Unemployment Insurance Accounts backed by a government line of credit or Personal Retirement Accounts that supplement ordinary pay-as-you-go Social Security benefits.

Conversion of Unemployment Insurance (UI) to Individual Asset Accounts (IAAs), coupled with a small common-pool fund to subsidize certain low-balance accounts, is a way to reform the present UI arrangement. This could be done by having most of the current UI payroll tax placed in the individual worker’s account, with a small portion of it shared with joint accounts for hardship cases where IAAs might be inadequate.

IAAs would accumulate tax-free for life and could be used at the discretion of each worker for unemployment insurance or mid-career job training or professional development. They can also accumulate in Individual Development Accounts, which is an existing asset-building medium for low-income individuals. If the funds are never used for the above purposes, they could be merged with the worker’s IRA upon retirement, thereby providing long-term incentives to manage the money wisely.

IAAs are inspired by the present UI system in Chile. Individual Unemployment Accounts have been implemented successfully in Chile since 2002. In the Chilean system, the employee payment of 0.6% of wages goes directly to the worker’s IAA, while the employer makes a payment of 2.4% of wages. The 2.4% is split between the worker’s IAA (1.6%) and a joint account to help subsidize low-balance accounts (0.8%). In contrast to the U.S. system, workers in Chile receive benefits regardless of whether they quit or were fired. This solves one significant problem of the present Unemployment Insurance system: Currently, there is a financial incentive for workers to remain unemployed for as many weeks as government benefits are available to them.

The United Kingdom, Australia, China, Sweden and Chile are in the process of restructuring their social insurance programs along these lines. This transformation is driven by two main factors: growing fiscal liability to the government and recognition that these programs have substantial undesirable effects on individual incentives and broader economic performance.

Interest is growing around the world in personal savings accounts as a useful tool for reorganizing social insurance or social expenditure, replacing traditional pay-as-you-go schemes with defined benefits systems. Hybrid arrangements can be used to save social insurance programs like Unemployment Insurance and Social Security from complete dilapidation before it is too late.

Sreya Sarkar is Director of the Asset Ownership Project at Cascade Policy Institute, Oregon’s free market public policy research center. Kathryn Hickok is Publications Director at Cascade.

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  • Rupert in Springfield

    Concerned about the stock market, and think it really makes you wary of privatizing SS?

    Ok, lets consider that. Yes, the stock market had a recent severe down turn. Ok, that’s pretty bad, you could suffer a loss, I mean things went down didn’t they?

    Well, yes they did, but only in a short term perspective. If you had somehow saved your entire retirement under a mattress, and then invested it all in the Dow Jones stocks in July, and now were looking to withdraw it all at once today because you just got diagnosed with terminal cancer and have a month to live. Well, then your retirement did just get totally flushed. However that’s probably not the case, Retirement savings more likely consisted of stocks bought when the Dow was lower than it is now, some when it was higher. Yes, a paper gain was wiped out, but that’s all it was, a paper gain. If you stay in, in all likelihood things will improve. If you invest now, you stand the chance to make a killing. If you are invested in mutual funds, that is probably what the managers of those funds are doing right now.

    Lets compare this to Social Security.

    If you are under 48 or so, one would be hard pressed to invest and suffer as bad a loss as Social Security. You are assured a negative return on your money, and that’s using current projections, which are pretty rosy. Consider the managers of those Social Security funds. Yes, they are trusty government servants, sworn to integrity and honesty, not like those scurrilous wags on wall street aren’t they?

    You think so? I sure don’t feel they are any more trustworthy. They just up and raised the retirement age on you a few years back didn’t they? That’s theft, they just stole several years of retirement that previously you had been promised. You think they wont do it again?

    Get real, Social Security was a con game from the get go. FDR started it as a way to rip people off by setting the retirement age beyond life expectancy at the time. Guaranteed revenue for the government, guaranteed loss for the people. How long do you think it will be before someone opens a history book and figures out that little scam again?

    And in case you didn’t forget, Congress just wrote a $1T check to pay for the mess that caused the stock market to fall that they created in the first place. Still think they are any more honest than the thieves on wall street?

    Ill tell you what, pardon me if I yawn when one of the Wall Street guys does the perp walk to jail, big whoop, some guy takes a fall for stealing a few million. When you have Chris Dodd doing a perp walk for his part in stealing $1T that will mean something.

    On Wall Street thievery is in the millions, on capitol hill Barney Frank et. al. make the Wall Street guys look like shoplifters at Woolworths.

    As for the stock market –

    A paper loss on Wall street that might turn around into a substantial gain versus a guaranteed loss with Social Security?

    I know which one I’d pick.

  • John Fairplay

    I don’t think the federal government’s going to do anything with Social Security, Medicare, etc until there’s a fiscal crisis that makes the current downturn look like a picnic. At that time, I expect huge benefit cuts, enormous tax increases and lots of politicians turned out of office. The kind of funny-money games SS is playing are no different then what has been happening on Wall Street and the bundling of loser mortgages to try and make them seem like they have some worth. This is why I’m not counting on ever receiving a penny from SS. Instead, I am piling money into the stock market (buying like crazy right now). With dollar cost averaging over years and years, almost none of what I’ve bought is currently under water.

  • Jerry

    Anything NOT involving the government might work. Nothing the government is in charge of is going to work.
    Look at what they have done so far.

    • David from Eugene

      Lets see, what about the Post Office, the conduct of World War II or the Interstate Highway System?

  • eagle eye

    More dreaming going on here. Look where Bush’s modest social security reform went when he had Republican victories in Congress in 2004 — nowhere. Now there’s going to be much bigger Demo majorities in both houses, and probably Obama as President. And with the financial crisis, privatizing social security is going to smell about as good as the former CEOs of Lehman, AIG, etc.

    The only chance is if the Democrats are so liberal that they turn around and do something that you would only think the conservatives would favor, or vice-versa — as we’ve seen here and in various countries at various times.

  • dean

    What makes social security essential is its government guarentee, just like the government guarentee of bank deposits was the only thing preventing a complete meltdown. If you take away social security and shift everything to individual private accounts you are going to end up with a whole lot of impoverished geezers. Why? Because when people fall on hard times, they lose a job, they have a health crisis, an accident, their house slides down a hill and insurance does not cover it….they will have to tap their personal retirement account. In this country, where bankruptcies from health problems is higher than anywhere else on earth, this is a real risk.

    Social security will be funded now and into the far future. THe reason is because we have an aging population, and geezers vote. The cap will be raised so higher income people contribute more, and a few adjustments in when folks can collect will do the rest. Medicare is a much bigger problem, as is our entire health insurance system.

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