Should the United States Privatize Social Security?

• Author: Seidman, Laurence
• Position: Review

By Henry Aaron and John Shoven.

Cambridge, MA: The MIT Press, 1999. Pp. xii, 178. $24.95.

This book is must reading for anyone interested in the debate over Social Security reform. The papers and comments are superb, and there are sharp clashes among the distinguished authors. The book consists of papers and comments presented at the second Alvin Hansen Symposium on Public Policy at Harvard University on April 27, 1998. The two main papers are "Social Security Reform: Two Tiers Are Better than One," by John Shoven, and "Social Security: Tune It Up, Don't Trade It In," by Henry Aaron. There is an introduction by Benjamin Friedman, comments on the two papers by Robert Barro, David Cutler, Alicia Munnell, and James Tobin, and responses by Shoven and Aaron.

But let me go straight to my main disappointment. None of the proponents of creating individual accounts under Social Security attempts a serious critique of a fundamental alternative: "funding" Social Security. "Funding" Social Security means accumulating a large trust fund and investing it in a conservative diversified portfolio so that trust fund investment income supplements payroll taxes while preserving the defined-benefit structure of the current Social Security program and avoiding the creation of individual accounts. Munnell emphasizes this crucial omission. In a section entitled, "Privatized Account Advocates Ignore the Real Alternative: A Partially Funded Defined-Benefit Plan," she writes:

Thus, the Social Security debate in this forum is not about whether to accumulate reserves through the Social Security program to increase national saving. Both proposals to maintain Social Security's existing defined-benefit plan and proposals to institute individual accounts involve a substantial accumulation of assets. Nor is the debate about whether to broaden the investment options for Social Security participants. Everyone here agrees that those covered by Social Security should have access to the higher risks and higher returns associated with equity investment. In other words, the questions of prefunding and of broadening the portfolio are not at issue.

Rather, the debate is--given prefunding and given the desire to invest in equities--whether this is better done in the central Social Security Trust Funds or in privatized accounts. My view is that the economics argue strongly in favor of a pooled defined-benefit approach over privatized accounts. Thus, Shoven heads down the wrong path right in the beginning when he omits a partially funded defined-benefit plan from the list of proposals that he intends to analyze. (p. 135)

In his paper, Shoven does a superb job of presenting the case for creating individual defined-contribution accounts within Social Security and describing how these accounts would be implemented. But Munnell is right that his paper is silent on the alternative of funding Social Security. Only in his response to Munnell does Shoven comment briefly on this alternative, as follows:

In principle, as Munnell and Cutler point out in their remarks and as Aaron stresses in his paper, a funded defined-benefit plan could contribute just as much to national saving as a supplementary defined-contribution plan. But, none of the advocates of the single-tier DB [defined benefit] approach are...