From Milton Friedman

Social Security has become less and less attractive as the number of current recipients has grown relative to

the number of workers paying taxes, an imbalance that will only get bigger. That explains the widespread

support for individual investment accounts. Younger workers, in particular, are skeptical that they will get

anything like their moneyʼs worth for the Social Security taxes that they and their employers pay. They

believe they would do much better if they could invest the money in their own 401(k)s or the equivalent.

But if that is so, why replace only part and not all of government benefits? The standard explanation is that

this is not feasible because payroll taxes—or part of them—are needed to pay benefits already committed to

present and future retirees. That is how they are now being used, but there is nothing in the nature of things

that requires a particular tax to be linked to a particular expenditure.

The Myth of Transition Cost

The link between the payroll tax and benefit payments is part of a confidence game to convince the public

that what the Social Security Administration calls a social insurance program is equivalent to private

insurance; that, in the administrationʼs words, “the workers themselves contribute to their own future

retirement benefit by making regular payments into a joint fund.”

Balderdash. Taxes paid by todayʼs workers are used to pay todayʼs retirees. If money is left over, it finances

other government spending— though, to maintain the insurance fiction, paper entries are created in a “trust

fund” that is simultaneously an asset and a liability of the government. When the benefits that are due

exceed the proceeds from payroll taxes, as they will in the not very distant future, the difference will have to

be financed by raising taxes, borrowing, creating money, or reducing other government spending. And that is

true no matter how large the “trust fund.”

The assurance that workers will receive benefits when they retire does not depend on the particular tax used

to finance the benefits or on any “trust fund.” It depends solely on the expectation that future Congresses will

honor promise made by earlier Congresses—what supporters call “a compact between the generations” and

opponents call a Ponzi scheme.

The payroll tax is a bad tax: a regressive tax on productive activity. It should long since have been repealed.

Privatizing Social Security would be a good occasion to do so.

Should Social Security Be Mandatory?

Should a privatized system be mandatory? The present system is; it is therefore generally taken for granted

that a privatized system must or should be as well.

The economist Martin Feldstein, in a 1995 article in the Public Interest, argued that contributions must be

mandatory for two reasons. “First, some individuals are too shortsighted to provide for their own retirement,”

he wrote. “Second, the alternative of a means-tested pro- gram for the aged might encourage some lowerincome

individuals to make no provision for their old age deliberately, knowing

that they would receive the means-tested amount.”

The paternalism of the first reason and the reliance on the extreme cases of the second are equally

unattractive. More important, Professor Feldstein does not even refer to the clear injustice of a mandatory

plan.

The most obvious example is a person with AIDS who has a short life expectancy and limited financial

means, yet would be required to use a significant fraction of his or her earnings to accumulate what is almost

certain to prove a worthless asset.

More generally, the fraction of a personʼs income that it is reasonable for him or her to set aside for

retirement depends on that per- sonʼs circumstances and values. It makes no more sense to specify a

minimum fraction for all people than to mandate a minimum fraction of income that must be spent on housing

or transportation. Our general presumption is that individuals can best judge for themselves how to use their

resources. Mr. Feldstein simply asserts that in this particular case the government knows better.

In 1964, Barry Goldwater was much reviled for suggesting that participation in Social Security be voluntary. I

thought that was a good idea then; I still think it is.

I find it hard to justify requiring 100 per- cent of the people to adopt a government-pre- scribed straitjacket to

avoid encouraging a few “lower-income individuals to make no provision for their old age deliberately,

knowing that they would receive the means-tested amount.” I suspect that, in a voluntary system, many

fewer elderly people would qualify for the means-tested amount from imprudence or deliberation than from

misfortune.

I have no illusions about the political feasibility of moving to a strictly voluntary system. The tyranny of the

status quo, and the vested interests that have been created, are too strong. However, I believe that the

ongoing discussion about privatizing Social Security would benefit from paying more attention to

fundamentals, rather than dwelling simply on nuts and bolts of privatization.