Social Security Reform without Illusion: The Five Percent Solution

Policy Reports | Social Security

No. 272
Friday, December 17, 2004
by Andrew J. Rettenmaier & Thomas R. Saving


Countries around the globe are reforming their government-sponsored pension programs. Many of the reforms involve shifting away from pay-as-you-go financing in favor of partial or fully funded programs. Often, these reforms involve the creation of some form of individual accounts. The motivation is the same almost everywhere: To secure adequate retirement incomes without incurring mounting taxpayer burdens in future years.

“Workers should be given incentives to save more for their retirement.”

If we make real economic investments today, the income from those investments will pay for some or all of Social Security’s future scheduled benefits. If these investments are individualized, people will own their future retirement funds. This will reduce the likelihood of political interference in investment choices and eliminate the government’s ability to spend surplus payroll taxes on other programs. But there is no free lunch. To guarantee their retirement benefits, current generations must bear higher costs than would otherwise be required.

A transition to a funded system has several benefits:

  • First, we will avoid the high taxes the current system promises to impose on future workers.
  • Second, we will ensure that currently scheduled Social Security benefits for future retirees will actually be paid on average.
  • Third, when workers own their individual retirement accounts, they have a property right lacking in the current program.
  • Finally, the increase in savings resulting from growing personal account balances will expand the nation’s stock of capital, leading to more plant and equipment, and higher wages for future workers.

Because today’s pay-as-you-go Social Security system allows individuals to avoid saving for their own retirement, the nation’s current stock of capital is lower than it might otherwise be. Reversing the process will provide an economic gain for future generations, although at the cost of lower consumption for the generations that increase their saving.

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