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Economic SYNOPSES
short essays and reports on the economic issues of the day
2005 ■ Number 12

Social Security, Saving, and Wealth Accumulation
Daniel L. Thornton
ocial Security is a publicly run, mandatory retirement program. A number of analysts have suggested that the program
be privatized. I discuss here the difference between the current Social Security program and an effectively equivalent private
program with respect to wealth accumulation and saving at the
individual and national levels.
Under current law, Social Security requires each covered
worker to pay into the program 12.4 percent of their taxable
income (6.2 percent each from employee and employer). In
return, those covered by Social Security receive payments that are
determined by several factors, including age at retirement and
the amount of payroll tax contributions made while working. In
an essentially equivalent private program, the government could
require each covered worker (and/or the employer) to pay into a
private investment account 12.4 percent of their taxable income
and prevent workers from accessing these accounts until they
retired. In the private program, however, workers would own their
accumulated contributions and earnings. That is, workers would
accumulate wealth. Individuals would thereby have considerable
flexibility. They could be given some discretion on how the funds
are invested. Moreover, unlike the one-size-fits-all approach of
Social Security, individuals could be given considerable discretion
as to how the funds would be disbursed upon retirement. Those
who were interested in providing their children with opportunities they never had might decide to work longer and pass all or
most of their wealth to their heirs. Alternatively, individuals with
relatively short life expectancies might opt to retire at the earliest
possible date and/or disburse funds more quickly. In the event of
an untimely death, the wealth accumulated in their account could
be passed to their heirs or given to philanthropic causes. This
flexibility could be particularly important to low- and moderateincome earners who may find it difficult to save beyond what they
are required to contribute to Social Security. Private accounts
would give these earners a greater opportunity to accumulate
wealth that they could use at their discretion, which would provide them opportunities not available under the obligatory Social
Security annuity.
Economists have long known that current consumption and
investment—at both the individual and national levels—do not
depend so much on current income as on permanent income,
which is to say, wealth. It is difficult to estimate how much private
wealth accumulation would have differed had Social Security been
administered privately rather than publicly. However, the Social

S

Security trust fund balance—the accumulated Social Security
tax receipts less Social Security payments plus earnings—at the
end of 2004 was $1.68 trillion, about two-fifths as large as the
federal debt held by the public.
Whereas private savings are channeled through financial
markets and ultimately lent to individuals, businesses, and governments—state, local, and federal—currently, the Social Security
trust funds are not being allocated through competitive financial
markets and are not earning a market-determined rate of return.
Thus, unlike private saving, Social Security taxes are not directly
available to finance private spending and investment.
This year’s Social Security tax receipts are used to pay this
year’s Social Security benefits. In years when tax receipts are
greater than benefits paid, Social Security experiences a surplus.
If the surplus were used to reduce the national debt, the funds
available for private consumption or investment would be essentially the same as under a private system. This has not been the
case, however. Since the early 1980s, Social Security has been running a persistent surplus. Instead of reducing the national debt
and, thereby, increasing the pool of funds available for private
spending, most often Social Security surpluses have been used to
fund “on-budget” deficit spending. This practice has had the effect
of making the unified budget deficit smaller than would have
been the case had Social Security been privately run. In reporting
to Congress recently, Federal Reserve Chairman Greenspan noted
that “[t]he major attraction of personal or private accounts is that
they can be constructed to be truly segregated from the unified
budget and, therefore, are more likely to induce the federal government to take those actions that would reduce public dissaving
and raise national saving.”1 The government would not be able
to simply divert Social Security surpluses to cover on-budget
deficits. Rather, it would have to compete in financial markets
with private investors for private savings.
The extent to which fostering private wealth accumulation and
increasing the flow of funds into competitive financial markets
would promote economic growth or reduce the incentives for
government borrowing (and spending) is difficult to say. Nevertheless, it is clear that the current system diverts funds from competitive financial markets and reduces the control that low- and
moderate-income earners have over their retirement funds. ■
1
Testimony of Chairman Alan Greenspan, Future of the Social Security Program
and Economics of Retirement, before the Special Committee on Aging, U.S. Senate,
March 15, 2005.

Views expressed do not necessarily reflect official positions of the Federal Reserve System.

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