Countries including Chile, Great Britain, and Australia have had great success with their partially privatized pension programs. Nevertheless, a number of concerns have been raised against the idea of privatizing Social Security. This appendix answers some of the more common concerns about Social Security privatization.

Lower-income people who do not have any private savings today will be the greatest beneficiaries under privatization.

Why does Social Security need a drastic overhaul? Can’t it just be fixed the way it has been in the past?

Past changes made to Social Security were designed to postpone the final "day of reckoning" and they included cutting benefits, hiking payroll taxes, and raising the retirement age. The trouble is that the day of reckoning is here. Longer-term trends, starting about 2012, show that Social Security will be taking in less money per year than it must pay out in benefits to retirees. Changes in demographics (there will soon only be two workers to support every one retiree, down from the 16-to-1 ratio when Social Security began in 1935) will make earlier fixes not only unpopular but also unfair and immoral. Any payroll tax increase will have to be confiscatory to meet the coming burden, and raising the retirement age still further will only cheat more workers out of ever seeing a return on their lifetime of taxes paid into the system. Dramatic and systemic change is needed.

Why is "privatization" the best alternative for Social Security reform?

There are three main reasons why privatization of pension funds is the best alternative to the failing government-funded system. The first is that market-based investment returns have historically been much higher than those of Social Security, which means that retirees can enjoy greater benefits in their golden years. The second reason is that privatization does not rely on an unstable "pay-as-you-go" pyramid scheme where current taxpayers are forced to subsidize current retirees rather than save for their own retirements. Privatization instead allows each worker to own and control his own retirement savings account. Third, increased private investment and savings will provide the economy with new sources of capital, which fuels growth and job creation.

Isn’t private investment in the stock market too risky? Wouldn’t I stand to lose my nest egg if I invested my retirement funds for myself?

Investment—whether in savings accounts or bond and equity markets—always carries with it some risk. However, the essential point regarding retirement accounts is that they are invested over an entire working lifetime, which means that short-term economic fluctuations are less important factors. Over longer periods of time, investments do well: Since 1800, there has never been a 20-year period in the United States when investment returns were not positive. For bond markets, the average 20-year return has been 3 to 4 percent while stock market returns have averaged an impressive 7 percent. Keep in mind that this century has had several major upheavals including the two World Wars, the Great Depression, and many weather-related catastrophes including earthquakes, storms, floods, and droughts. All of the long-term investment gains take these disruptions into account.

But couldn’t I lose it all during a stock market crash like in 1929?

That is unlikely. Workers are far more likely to suffer poor returns from Social Security than they are to suffer huge losses in their private investments. Over a working lifetime of 30 to 40 years there will be some ups and downs in markets as well as the economy. Recessions, wars, depressions, and economic stresses from temporary factors such as fires and floods are part of history, and neither markets nor government programs are immune from them. Lifetime planning can yield compounding growth rates of 4 to 7 percent on investment returns and provide tremendous increases despite short-term disruptions. Government-sponsored pensions, by contrast, never promise more than two percent returns, which is even less than long-term inflation rates.

How do we know privatization works?

Several countries such as Chile, Great Britain, Australia, and even Sweden have already made the change to either partially or totally privatized pension programs. The results have met or exceeded expectations, with retirees under the new plans seeing greatly increased benefits and earnings. In the United States, three counties in Texas opted out of the Social Security system in 1981 and designed their own privatized pension plan. County employees now enjoy retirement benefits three times greater than what Social Security would have paid. Likewise, private retirement savings plans such as IRAs or 401(k) and 403(b) plans routinely outperform Social Security.

Won’t poor people who can’t afford to save any money lose under privatization?

No. Lower-income people who do not have any private savings today will be the greatest beneficiaries under privatization. Here’s why: 5.26 percent of their pay is currently taken for Social Security taxes. Because that money is immediately transferred to current retirees, there is no nest egg being built up for the low-income taxpayer. If instead all or part of that 5.26 percent were privately invested on behalf of the worker, he would own and control his own retirement account and could count on greater returns for his money. Those people who have no savings would be able to accumulate funds for their own retirement without any noticeable difference in their paychecks.

How can I find out more about what privatization of Social Security would mean for myself, my family, and my retirement?

The Cato Institute, a Washington, D. C.-based public policy research institute, has studied Social Security privatization for the past several years. Research from their Project on Social Security Privatization can be found on the Internet at www.socialsecurity.org. The interactive Web site features a calculator tool that allows you to input personal data such as age and income level to calculate what you stand to gain if your Social Security taxes were invested in a privately managed retirement account under your control.

For further reading, please see Appendix C for a bibliography.