Let Us Count the Ways: The Costs of Social Security Privatization are in the Details

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Social Security privatization is once again on the front burner of the public policy discussion. President Bush has indicated that he wants to make it a top priority of his second term to replace part of the existing social insurance with a system of individual accounts.

Privatization not only exposes workers to additional risks, it also substantially raises the costs of saving for retirement. A number of these costs have been well-documented. Workers would have to pay management fees for their accounts. In addition, they would have to pay insurance premiums to private insurance companies if they want the same level of protection that Social Security offers for themselves and their families. Further, they would have to bear an enormous burden to pay for the transition from one system to the other.

Another cost of individual accounts – so-called labor market risks – has often been ignored in the public debate. Typically, workers’ earnings are below average in a recession, when it would be most opportune to purchase stocks because of a concurrent stock market decline. This risk affects all workers to some degree.

The exposure to labor market risks is greater for women and minorities than for others. In essence, they accumulate fewer savings for each dollar they invest in their individual accounts compared to men and whites. This is especially pronounced for women, who consequently face costs that are comparable to the costs of turning their savings into lifetime monthly benefits – annuities.

The link between the labor market and individual accounts essentially punishes women and minorities twice. For one, they have lower lifetime earnings than men and whites and thus proportionately lower savings. Second, they accumulate fewer savings for each dollar they put away because of greater fluctuations in employment and wages.

Social Security is the only way to reduce the labor market risks. In the current setup, benefits do not depend on the performance of the stock market. Furthermore, Social Security pays proportionately higher benefits to low lifetime earners than to high lifetime ones.

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For more on social security, read our September report, "Alan Greenspan Should Read His Speeches More Carefully".