The political centerpiece of President Bush's effort to reform Social Security is allowing younger workers to invest part of their payroll taxes in private retirement accounts. Critics often point out -- correctly -- that establishing such private accounts will not, by itself, fix Social Security's long-term financing problem. But that doesn't mean it's a bad idea.
A carefully designed system of personal Social Security accounts offers three important economic benefits. First, personal accounts would extend to all workers the benefits of asset ownership that are now, in practice, limited primarily to the upper half of income earners.
With personal Social Security accounts, every worker would have another opportunity to build a retirement nest egg through low-cost, diversified investments in real financial assets. Workers who dislike risk could invest in safe assets such as bonds; those who wish to take on more risk in search of higher expected returns could invest in diversified stock portfolios.
The Social Security Administration's nonpartisan Office of the Chief Actuary says that a system of private accounts could be centrally administered with annual costs of only 0.3 percent, much cheaper than the average mutual fund. These accounts would come with enforceable property rights, including the right to pass the financial assets to one's spouse and children as an inheritance.
Second, personal accounts could improve work incentives. The complexities of the current system make it nearly impossible for the average person to determine how, if at all, another dollar paid to Social Security translates into higher future retirement benefits. By providing a clearer link between individuals' Social Security contributions and the benefits that employees receive, personal accounts could increase the perceived rewards for work and thus boost economic activity.
Finally, personal accounts could increase national saving. We are currently poised to heap trillions of dollars of unfunded obligations on our children and grandchildren. We could reduce this burden by saving more today.
Unfortunately, our federal government has shown again and again that it cannot reliably save money for the future. For the past two decades, while Social Security collected more tax revenue than it has needed to pay benefits, the rest of the federal budget consumed these surpluses rather than putting them aside. That's not a flaw in Social Security, but a political reality.
To ensure that these surpluses are saved and not spent, we need a "lock box" that actually works. Personal accounts would put the control of these contributions into the hands of individuals, not the government, making it much more difficult for politicians to use these funds to mask increased spending on other programs.
If the transition to personal accounts were partially funded from new revenue or decreased spending, then national saving -- and thus the size of the economic pie -- would increase. Including personal accounts as part of Social Security reform provides an opportunity to expand asset ownership, improve labor supply incentives and reduce the fiscal burden on our children and grandchildren.
We should embrace this opportunity.
Author's e-mail: Jeffrey_R_Brown@hotmail.com
By Jeffrey Brown, assistant professor of finance at the University of Illinois at Urbana-Champaign and an economist who served on the staff of the President's Commission to Strengthen Social Security in 2001.