What Would Privatized Social Security Mean for Americans?

One of the largest, oldest, and most popular U.S. government programs, Social Security has outlasted several efforts to make it smaller by cutting benefits and the payroll taxes funding them. Several of those failed reform proposals had a common element: the full or partial privatization of the system.

Social Security pools payroll tax receipts from current workers and uses them to pay benefits to current retirees, investing any surplus solely in special debt securities issued by the U.S. government.

Self-directed retirement accounts would replace Social Security taxes and benefits to some extent in a privatized retirement savings system. Taxpayers could invest a portion of their payroll contributions in a separate account for their own benefit, and the account's value would fluctuate with market prices of investments that might include equity index funds.

Privatization Pros and Cons

Proponents of privatization say the Social Security trust funds don't generate sufficient returns. They argue that privatizing the system would fix that, delivering higher benefits for participants.

Those who oppose privatization counter that it would subject participants to unwarranted investment risks and costs and that it would cost too much to transition from the old system to a new one. Critics also contend that privatization undermines the very principle of the social safety net and the guarantee that it provides older citizens.

Polls show that Americans are well aware of Social Security's funding challenges and they're skeptical that they'll collect all the benefits to which they would be entitled under existing rules. But they remain opposed to dramatic changes in the program.

Some polling suggests that Americans oppose Social Security privatization despite the claims that letting workers save and invest on their own behalf might improve their returns. Other polls have come to the opposite conclusion in the past.

Some skeptics may simply prefer not to rock the boat. Others are passionate defenders of Social Security's design as an insurance fund with dedicated funding from tax revenue and a benefits formula geared toward alleviating poverty among lower-income retirees.

For whatever reason, campaigns on behalf of Social Security privatization have tended to stall when lawmakers gauged the reaction of their constituents.

Today's Social Security System

Payroll tax receipts are immediately available under the existing system to fund the benefits paid out to current retirees, along with interest income and any accumulated reserves.

Social Security preserves a link between career earnings and the size of the Social Security benefit, but it allows lower-income beneficiaries to receive benefits in excess of their contributions. The formula keeps millions of older Americans out of poverty, even though the average monthly benefit affords recipients wholly reliant on it few, if any, luxuries.

But Social Security's main trust fund is on pace to run out of reserves in 2033, according to a 2023 report by the system's trustees. That's a year earlier than the 2022 estimate of 2034. The program will only have enough income to pay about 77% of scheduled benefits after that year.

The growing number of retirees relative to the number of workers supporting them caused Social Security to pay out more in benefits than its tax receipts for the first time in decades in 2021. Annual deficits are projected to grow rapidly going forward.

How did this happen? Life expectancy has increased. American men at age 65 had a remaining life expectancy of 15.3 years in 1990, up from 12.7 in 1940. Women at age 65 could expect to live 19.6 more years versus 14.7 years in 1940.

Ongoing retirements by baby boomers, an unusually large generation, have aggravated the problem. The number of workers supporting each Social Security beneficiary is expected to decline from 2.8 in 2022 to 2.3 in 2035.

History of Privatization Plans

Proposals to replace some or all of government-run Social Security with private retirement savings plans have been around for a long time, grounded in the conviction that there's nothing the public sector can do that the private sector can't do better. Such efforts gained momentum during the late 1990s, helped along by the rapid growth of the financial industry and a historic bull market in stocks that made Social Security's interest income from government debt look increasingly lackluster.

U.S. President Bill Clinton and House Speaker Newt Gingrich reportedly agreed in 1998 to pursue Social Security reforms that were to include government-funded personal retirement savings accounts for workers. Clinton proposed "investing a small portion" of the increased government funding for Social Security "in the private sector" in his 1999 State of the Union address. Funding was to come from government budget surpluses that Clinton said would persist for the next 25 years.

A presidential sex scandal and impeachment followed, scuttling bipartisan cooperation on Social Security. The budget surpluses of 1998 through 2001 had already given way to mounting deficits following the adoption of the tax cuts he advocated by the time President George W. Bush revived the Social Security privatization effort in 2005.

The Bush proposal for personal retirement accounts consequently did not preserve the Social Security system's funding, allowing workers to divert payroll tax contributions to the private accounts instead before repaying the government, with interest, out of their future benefits.

Bush spent months campaigning for the plan after his re-election, but it proved steadily more unpopular in polls until the President finally had to acknowledge that his plan did not address the system's funding shortfall. Republicans in Congress never pursued the issue.

How Privatization Might Work

Privatization is the transfer of a government-owned business, operation, or property to a non-government party in the private sector. In the context of Social Security, privatization would allow workers to save toward their own future benefits, with many of the proposals retaining some form of partial government funding and benefit guarantees.

Chile became the example frequently cited by privatization proponents after successfully privatizing a failing public system in 1981. But Chileans' trust in their pension system plunged following the financial crisis of 2008 when funds in the system lost about 20% on average. Public retirement benefits in Chile remain inadequate for a significant proportion of the population as a result of insufficient contributions, increased life expectancy, and years of poor investment returns.

Privatizing the U.S. Social Security system would involve diverting some or all of the mandated payroll tax contributions into private accounts managed by contributors for their own eventual benefit. Many such proposals would make benefits derived from such accounts inheritable.

Workers could have the option to increase their contributions to retire earlier or to increase their payouts in retirement. Proponents have argued that the accumulation of assets in private retirement accounts would lead to a big rise in the savings rate, making it easier to afford the burden of a large retired population.

The High Cost of Switching

The cost of the transition from the pay-as-you-go plan is one challenge that would confront any privatization plan. If all payroll taxes could be diverted into private accounts, the government would have to cover benefits to workers who contributed to Social Security and are already retired or will retire soon. Policymakers would have to find money to pay those retirees while leaving younger workers with the means to build up the private retirement accounts.

The benefits of future retirees might have to be cut or current workers' contributions increased, along with federal borrowing, to bridge the gap.

Americans would have to be willing to accept these sacrifices and abandon Social Security's social insurance principles to gain additional discretion over retirement savings.

The Bottom Line

If exchanging the Social Security system's certainties for the disputed benefits of privatization sounds like a big ask, it's probably because Americans have repeatedly demonstrated their lack of interest in such a trade.

"Keeping more of your wages to save for yourself" should be a winning slogan, but pesky details like who will pay for current retirees and those without the means to support themselves in the future keep getting in the way of privatization. But as long as Social Security's long-term funding remains inadequate, expect the program's critics to continue proposing alternatives.