A Tale of Four Countries- Part 2: Chile and Social Security Reform

One of the biggest programs enacted under Roosevelt’s New Deal was Social Security. Since then, the system has been sacrosanct in American politics. However, Social Security as the be-all-end-all of retirement security was never the goal nor the intentions of Roosevelt. When enacted in 1935, there were about 44 working age Americans for every retiree. At that time, more than 50% of seniors were living in poverty, a situation made worse by the Great Depression. Like any insurance program, however, it was never intended to become an entitlement, yet that is what it has become.

Conservatives need to get back to their core principles and cease falling in line when liberals and Democrats bring up the subject of Social Security. Both sides have, at various points, used social security to curry favors and votes from senior citizens. Growing a spine and stressing the need for fundamental reform now is a necessary start.

Roosevelt’s own actuaries noted the system as enacted then would not survive without future reforms. Most of what passes as reform is merely tinkering and kicking the can down the road when outright accounting gimmickry is not used. Roosevelt believed that Social Security would be one prong of three towards retirement income security. The other two would be personal savings and participation in pension plans. Generally, unions have pension plans. Sometimes available to the non-union workforce are 401(k) programs and even Individual Retirement Accounts. Obviously, pension plans (except in the case of unions) and 401(k) plans and the like are voluntary. They apply to only those who can afford them which are usually middle and upper income earners. Many employers have dropped these optional plans in recent years or cut back on employer matching funds. With regards to savings, the bulk of the paycheck of a low earner goes to living expenses with very little left to “save.” Ironically, it is these people most dependent on Social Security upon reaching age 65 which keeps them trapped in a cycle of poverty or near poverty.

Some of the problems with Social Security are obviously structural, but a large part of the problem is demographics. In 1935, the average life span for a male was 60 years; today it is 75. This translates into more years of benefits. Also, women were not a large part of the labor force in 1935. By 2030, the proportion of the population older than 65 will increase 7 percentage points while the proportion of the population of the working age people will decrease 4 percentage points. While there are 3.3 working Americans for every retiree today, by 2030 that number will drop to 2.2. Hence, not enough revenue will be generated to produce the promised benefits of future retirees. It is this actuarial fact that Roosevelt realized 75 years ago. Unless changes are made, by 2035 government spending on Social Security will be 6.1% of GDP compared to 4.3% today. Additionally, the current system, because of the way benefits are calculated, disfavors minorities and women who often, for various reasons, have gaps in employment and wage earning history.

In a 1939 address to Congress, Roosevelt said that Social security was a development towards a goal rather than a finished product. It was the base upon which everyone was to build their own individual retirement security based upon their own individual efforts. Instead, Democrat and Republican alike have abandoned that goal and created an entitlement.

And perhaps the best way to realize the promise of Roosevelt is through privatization of social security. Obviously, the mere mention of this word brings about instant attack. One need look no further than the reaction against George W. Bush in 2004 and Paul Ryan recently. Obviously, every policy proposal is met with a “what if” scenario and not all of those “what ifs” can be be answered definitively or to the satisfaction of all. There will no doubt be some hardships along the way during a transitional period or gradual phasing in of a private system. But, the positive dividends far outweigh the negatives. The biggest problem, from this writer’s view, would be the politicization of the program. Assuming the government was to play, in effect, the “broker” or “manager” under a private system, I can visualize an Al Gore testifying before Congress pleading that no money be invested in oil or coal companies.

Actually, the liberal opposition to this plan is no different from that espoused by the likes of SEIU and AFSCME and other unions- it would become a viable alternative to pension plans they offer thus costing them “revenue.” Current evaluations are based on computer models. But, there is a very real world example- Chile. Chile actually had a social security system since 1925, ten years before the US. In 1981, mainly in response to a realization that the current system could not sustain itself, much like here, they converted their system to one run by private brokers, not the government. In the short span of 20 years, the various private plans had accumulated over $36 billion in profits. The program is so successful that over 95% of Chilean workers participate in the program.

They, along the way, discovered that the decision of when to retire was left to the workers instead of mandated by the government. Since the old system mirrored our current system, there were huge variations among different job classifications as to when to retire because the benefits were based upon wage earning history. For example, a factory worker could not retire until age 65 to receive annual benefits equal to 50% of their wage history. Yet, white collar workers could retire at 55, bank employees at 45 and politicians at 35. In other words, the system was dictating retirement ages rather than personal choice as to when to retire. After the reforms, Chile found that factory workers were retiring earlier and white collar workers stayed in the workforce longer.

Since 1981, given the success of the Chilean model, most Latin American countries have converted to a private retirement system. In effect, the model recognizes that those at the lower end of the income spectrum cannot and will not voluntarily save for retirement. Since payroll taxes are going to be withheld regardless, diversion of a portion or all of those taxes to this private system forces the savings with a greater rate of return than a government run system. Hence, by not reforming and privatizing Social Security, the government is effectively blocking lower earners (and minorities) from entering the investor class.

Obviously, there are pitfalls. Many people worry about the rise and fall of the stock market daily and its effect on the value of their 401(k) or other retirement investments. But, over the average working life of an American, there will generally be gains. If the system can adjust to minimize risky investment choices as one nears retirement age- which the Ryan plan does- then workers should come out a lot better than under the current system. Naturally, until the current crop of Social Security beneficiaries are “gone,” some of the remittances will have to fund their benefits. Also, we can even means-test participation to keep higher earners, who are more equipped to establish their own pension portfolio without government help, out of the program.

The government, because of nothing more than political posturing, is denying lower earners and even more middle income earners the opportunity to control the age at which they will retire and their benefits in retirement. A good case can be made that with private choice, there will be a great rate of worker participation. Payroll taxes are going to be collected in the form of weekly deductions regardless. Doesn’t it make sense to put that money to greater use than the current system? Doesn’t it make sense to finally realize the ultimate vision of Roosevelt? Roosevelt started the ball rolling, but subsequent administrations have stopped it in its track. The present system is a disaster waiting to happen. Liberals are fond of scaring seniors with the line that conservatives and Republicans want to end Social Security as we know it. Either way, “Social Security as we know it” will cease to exist in the not too distant future. It makes better sense to follow the example of Chile and do in the very near future what Chile had the political guts to do in 1981.