Contact: June Gates, 216/579-2048

Privatizing Could Prevent Bankruptcy of Social Security System

Although the United States may be able to avoid bankruptcy of its Social Security system by increasing taxes or reducing benefits, there may be a third, more efficient alternative, according to two Federal Reserve Bank of Cleveland economists.

Writing in the Bank's Economic Commentary, Vice President and Economist David Altig and Economic Advisor Jagadeesh Gokhale argue that the solution to Social Security's ills lies in privatizing and fully funding the system. Under the current, pay-as-you-go system, most current worker contributions are immediately transferred to retirees in the form of benefits. Since the number of retirees will begin to grow rapidly early in the next century, the system is expected to be bankrupt by 2030.

To avoid that outcome, the authors outline a proposal whereby workers age 42 and younger would have only a portion of their Social Security contributions used to fund the benefits of current retirees as well as workers over age 42. The balance of younger workers’ contributions could be invested in private capital markets with higher rates of return than those earned through continued participation of younger workers in the current Social Security system.

Under this plan, current workers and retirees would receive benefits at least as great as they would get under the present system, and younger workers' benefits could be greater than those offered under the current system. Privatization would increase incentives to work hard by strengthening the link between worker contributions and benefits. And by investing contributions in private assets, privatization would enhance future productivity and economic growth, translating over time into higher living standards for everyone.

Full Text 19K