Social Security
And the Single Investor

By HERBERT STEIN

Two important points are commonly missed in the current discussion of Social Security reform. First, privatizing the Social Security funds would not add to national saving, private investment or the national income and would not allow the system to earn more income without anyone earning less. And second, if the purpose of Social Security is to provide a certain benefit upon retirement, then an investment policy that yields a probable, even though possibly higher, benefit is not appropriate.

The first point may be easily seen. Private investment equals the saving available for private investment. That is equal to private saving minus that part of private saving required to finance the federal deficit. (For simplicity I include with private saving state and local government surpluses and the inflow of capital from abroad.) The federal deficit has two parts--the deficit in the rest of the government, other than Social Security, which I call ROG, and the surplus in Social Security. So private investment equals private saving plus the Social Security surplus minus the deficit in ROG.

Private Savings

Here is the key point: The amount of private investment does not depend on how the Social Security surplus is invested. The more of the Social Security surplus is invested in financing the ROG deficit, the less the ROG has to borrow from the private saving available for private investment.

I will consider some possible qualifications to the argument. But up to this point, privatizing Social Security investment has not added to private saving. Therefore, it has not added to total investment and has not added to the national income generated by the stock of productive capital. But still, everyone will say, the Social Security accounts will be invested in assets with a higher yield than government bonds and will earn a higher income. How can this be? Where will this higher income come from if there has been no addition to saving, investment and national income? Since there are only three players in this game--the Social Security accounts, the ROG and private savers--the gain to Social Security must come from one or both of the two others.

Private savers will have a portfolio more heavily weighted with low-yield assets--government bonds--and less heavily weighted with private high-yielding assets. They will have a lower-yielding portfolio than if the Social Security accounts had bought the government bonds. But in order to induce private savers to make this shift in their portfolios--to surrender some of the private assets to the Social Security accounts and take on more of the government bonds--the yield of government bonds will have to rise, increasing the burden on taxpayers, or the yield of private assets will have to fall, or both.

Some people think that if workers manage their own Social Security accounts they will learn to love finance and will save more. It seems to me equally likely that promised a larger Social Security benefit they will decide to save less in other forms. It may be that if workers see a larger and more secure Social Security benefit deriving from their work they will work more. Yet if the government has to impose higher taxes to pay the costs of higher interest rates on its borrowing, that may inhibit work and other income-earning activity. Possibly, if the government does not have a captive market for its bonds in the Social Security accounts, but has to borrow entirely in the open market, it will be more cautious about deficit spending. Possibly, but I wouldn't bet on this effect being very large.

Privatization per se does not add to the national saving, but there may be other arguments for it. One could argue for a redistribution of income from other savers and taxpayers to workers. But one should not think that there is any free lunch here.

Now, to the question of the proper criterion for investment of Social Security funds collected by a tax on wages. Suppose there are two kinds of investment. One will yield at retirement a certain 50% of the retiree's final salary. The other will yield a probable 60%, with a 50-50 chance of yielding zero and a 50-50 chance of yielding 120% of the final salary. Which of these is suitable for a Social Security system? The example, to be sure, is extreme. But even if on average over long periods of time investments will all yield a specific return, the returns earned by particular investors in particular portfolios over particular periods differ enormously.

One can say that the workers are consenting adults and if they choose investments that will make some of them very rich and some very poor, that is up to them. But if you say that, you have to ask why we have a Social Security system, with mandatory contributions, at all. Why not just leave the workers free to save or not and to invest whatever they save in the way they like? If there is no social interest in the income people have at retirement, there is no justification for the Social Security tax. If there is such an interest, there is a need for policies that will assure that the intended amount of income is always forthcoming. It is not sufficient to say that some people who are very smart or very lucky in the management of their funds will have high incomes and those who are not will have low incomes and that everything will average out.

I find it helpful to think of the Social Security system as having two parts. One provides an assured equal minimum retirement benefit to all workers. The investment for this part would have to be in very secure form, probably involving some government guarantee. But this part would be much smaller than the total system we now have and could be financed by a much smaller payroll tax.

Defining Public Interest

What is the rest of the system and the rest of the payroll tax for? One possibility is that there is some national interest in the size of the retirement benefits that individual workers receive, beyond the flat minimum just mentioned. In that case it would be necessary to control the investment and use of the funds generated by each worker's mandatory contribution to assure that the desired retirement benefit is forthcoming.

But we could say that there is no public interest in the retirement benefits workers get beyond the flat minimum already mentioned. In that case workers should be allowed to manage their savings as they like. But in that case it is unclear why there is any mandatory contribution to Social Security, beyond that needed to finance the flat minimum. Let the worker decide how to manage his savings and how much to save.

Mr. Stein, an American Enterprise Institute fellow, chaired the president's Council of Economic Advisers, 1972-74.