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Rethinking Social Security


How Private Accounts Can Aid Strapped Workers

Sunday, January 23, 2005; Page B03

Contrary to popular belief, Social Security was never intended to provide senior citizens with anything more than a minimal safety net. But that safety net has been a secure one, protected against inflation, financial market fluctuations and the risk of outliving one's assets.

Social Security has honored this commitment to working Americans for 65 years. And as a recent Brookings Institution book by Peter Diamond and Peter Orszag convincingly demonstrates, its solvency for future generations can be ensured through a combination of modest benefit reductions and modest revenue increases. Those who argue otherwise are using the specter of an impending financial crisis to destroy Social Security, not to preserve it.

_____Also In This Series_____
What Crisis?
What's Behind It?
What's Wrong?
The Age Dividend
Add to Savings
Keep It Simple
Go Private
Social Security: By the Numbers
Over the Years

But Social Security does not -- and was not meant to -- provide an adequate level of retirement income. This is where many Americans, especially in moderate and low-income households, face a real crisis because they are not saving enough. Even households that save at high rates might not be able to save enough for a comfortable retirement because their income levels are so low.

That's where a proposal to create private accounts as an add-on to Social Security could come in. It could address the dilemma of what to do about inadequate retirement saving among moderate and low-income families by supplementing, not replacing, traditional Social Security benefits. Contributions to these accounts would be voluntary but would be encouraged by generous tax incentives and federal matching contributions to enable households of modest means to build adequate retirement savings. These accounts would offer only a few investment choices -- such as a broad-based indexed fund of stocks and Treasury inflation-protected securities -- that would pay a guaranteed rate of return. Limiting the choices would keep the plan simple for unsophisticated small investors and keep a lid on costs.

The proposal to create these "Social Security plus" private accounts differs from President Bush's initiative -- which hasn't yet been spelled out in detail -- in two important ways.

First, Bush would allow individuals to divert some of their payroll contributions to Social Security into private accounts. This diversion would create a real financing crisis since these contributions are already committed to honoring the system's entitlement benefits. In contrast, general tax revenues would fund the incentives and grants used to foster Social Security plus accounts, and payroll taxes would continue to be dedicated to traditional Social Security benefits.

Second, Bush appears likely to propose that private retirement accounts be run through private financial firms. Under the Social Security plus model, such accounts would be run through the Social Security Administration. Since the system already keeps accounts for virtually every American worker, the administrative costs of establishing supplemental private accounts within Social Security would be low. By contrast, the administrative costs of running such accounts through private financial firms would be substantial.

Bush is promoting private Social Security accounts as part of an "ownership society," but that doesn't mean that Democrats need to let the White House claim sole proprietorship of the idea. Combining the creation of Social Security plus accounts with modest changes in benefits and payroll taxes to safeguard the system's long-term solvency would both preserve the basic entitlement and address the retirement savings crisis looming over millions of American families. This is a reform plan that Democrats could be proud of.

By Laura D'Andrea Tyson, dean of the London Business School, is a Business Week columnist. She was chairman of President Bill Clinton's Council of Economic Advisers.

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