Jeffrey A.

Miron

by Jeffrey A. Miron*
July 16, 2001

n recent years, criticism of Social Security has escalated enormously. In part this reflects Social
Security's impending insolvency; under current law, the Social Security Trust Fund is likely to
be exhausted by mid-century. But more fundamentally, economists and others have highlighted
a range of negative effects due to Social Security. These include the distortion of labor markets
caused by high rates of taxation and the arbitrary redistributions both within and across age
cohorts that inevitably arise in a Pay-As-You-Go system. On top of all this, Social Security is a
complicated and costly system to administer.
In response to these problems, many critics have advocated the privatization of Social Security.
This means that participants would have portions of their income withheld and deposited in
standard saving vehicles, such as stock or bond mutual funds, rather than having these monies
paid as taxes into the Social Security Trust Fund. At the same time, the promises of Social
Security benefits in retirement would be eliminated; instead, retirees would consume out of the
savings accumulated in their private accounts.
In other words, privatization means both the elimination of Social Security and the creation of a
mandatory savings program. Thus, privatization as that term is currently being used does not
end government intervention in savings and retirement decisions; it instead accepts a
government role in dictating minimum savings rates, setting an age at which such savings can be
withdrawn to fund retirement, and limiting savings choices to particular savings vehicles.
Yet the justifications for government intervention in savings and retirement decisions are not
compelling. To the extent there is a role for government, mandatory savings programs (not to
mention Social Security) are far more interventionist than economic analysis suggests is
necessary. The arguments for a government role suggest instead that the maximum desirable
intervention is narrowly targeted, low-income insurance.

The Arguments for Government Intervention in Private Savings Decisions
The standard justification for government intervention in private savings and
retirement decisions relies on the assumption that some persons behave myopically,
consuming "excessively" during their earnings years and then finding themselves
with insufficient savings in retirement. There are no doubt some myopic persons, but this does
not by itself justify intervention. Economists typically assume that government should intervene
only when private actions adversely affect others—cause externalities—but the direct costs of
myopia are borne by the myopic. Thus, to justify government intervention one must either
believe that government should act paternalistically—protect people from themselves—or argue
that myopic behavior spills over onto others.

mandatory savings programs are a particular burden since they reduce disposable income during working years. policy can address this problem via low-income insurance. Again. purchasing life. myopia does not justify creating a mandatory savings program. The magnitude of this effect is usually overstated. An alternative argument is that myopic behavior in fact imposes externalities if society cannot restrain itself from bailing out those whose myopic behavior leaves them in dire straits. private mechanisms can mitigate this problem: by saving intelligently. In the name of protecting people from themselves. The third standard justification for government intervention in savings and retirement decisions is that. outlaw foods with saturated fat. In the absence of government policies to aid the profligate. Even if one puts aside such concerns. Examples include o persons who expect to work longer than average rather than retiring early. society can reduce these risks by sharing them across individuals. The Negative Consequences of Mandatory Savings Programs Mandatory savings program are not only more expansive than required. Such programs use funds from general revenues to provide a minimal income to those beyond a certain age. Indeed. For example. But even if this is not the case. It is possible that some persons would benefit from certain paternalistic policies. o or those who expect a big inheritance. there would be private mechanisms to aid many of these persons. just as they now help those in countries without government safety nets.The problem with the paternalism approach is that it can be applied in a broad range of contexts. these programs both protect the profligate against the effects of their myopia and insure that everyone contributes to helping such persons. and relying on relatives or charities. Most importantly. paternalistic policies typically penalize responsible persons in the name of helping the myopic. they have substantial negative consequences. nothing as expansive as a mandatory savings program is required. and accident insurance. governments might ban certain books. for persons who cannot easily save for retirement. even in the absence of myopic or low-income households. medical. but if a . but the potential for benevolent paternalism to evolve into totalitarian government is obvious. but again low-income insurance is a far better targeted response than a mandatory savings program. charities and relatives helped many such persons in the era before Social Security. A second possible justification for government intervention in savings and retirement decisions is that low-income persons cannot save enough for their retirement because their income during working years must be spent entirely on necessities. This problem can be ameliorated by making the mandated savings rate sufficiently low. o those who know their kids will care for them in retirement. Since these risks are significant at the individual level but far smaller at the aggregate level. There are certainly some persons in this category. mandate exercise and sleeping schedules. some people experience bad luck and see their wealth fall drastically near retirement. mandatory savings programs dictate that everyone save at the minimum rate or above even though for some households optimum savings rates will be lower than the mandated minimum. To begin. or prohibit "bad" television and myriad other activities. most persons can protect themselves against the worst-case scenarios. By so doing. The goal of helping the myopic can be accomplished with a low-income insurance program.

but for others it is appropriate to take additional risks. the message is that people must live with the consequences of their actions. And there many further problems with mandatory savings programs. such insurance will induce substantial numbers of households to reduce their work effort so as to qualify for the guaranteed income. the federal program that provides low-income insurance for those elderly not eligible for Social Security. so those costs are a given in any case. society strengthens the presumption that people should rely on government to make decisions for them. as will the disincentive effects on labor supply. The implied promise of retirement income gives government an additional excuse to regulate "risk" in financial markets. rather than taking responsibility for their own well-being. it makes no sense in the first place. lowincome insurance for the elderly already exists in the form of Supplemental Security Income. For all but the very poor. A different distortion caused by mandatory savings programs is that they limit the set of savings vehicles to standard. and this taxation is likely distorting. any distortions caused by the taxation will be modest. And most mandatory savings plans include low-income insurance for the poorest savers. Alternatively. those funds are not available for a downpayment. In addition. By so doing. every household in the country is incapable of making sensible savings and retirement decisions. Yet if these earners are forced to save via the mandatory savings accounts. Such vehicles are sensible choices for many persons. consider an aspiring entrepreneur who wishes to invest all her savings in a small business. no new bureaucracy need be created. Accumulations in the "private" accounts are tempting targets for taxation. relatively safe instruments such as broad-based mutual funds. This does not mean that low-income insurance is problem-free. Consider a family attempting to accumulate the downpayment on a house. Most importantly. Thus. by limiting government intervention to low-income insurance. It requires sufficient taxation to pay the guaranteed income. And if the guaranteed level of income is too high. such as investing in one's own business. and it provides insurance against bad luck. such programs have substantial administrative costs. So long as this is the case. This person is constrained from using the funds in the mandated savings accounts even when the small business is a better investment. Low-Income Insurance is not Perfect. even if these are . Plus. it protects those with low earnings. Even if the mandated savings rates are approximately right for most persons.mandatory savings program rarely binds. in effect. During the early years of working life. despite the fact that length of productive life varies widely. the sensible strategy is to use liquid assets that can be readily converted to cash at the time of house purchase. And anyone who suffers an accident or medical emergency might want access to some of his mandated savings. In addition. This requirement is likely to harm a broad range of households. Beyond these tangible negatives of mandatory savings programs. But It's Better The claim here is that low-income insurance simultaneously addresses all of the standard justifications for government intervention in private savings and retirement decisions. These considerations suggest that the income guarantees must be modest. Lowincome insurance guarantees a minimum income in retirement for those who undersave. mandatory savings programs also dictate that savings rates are the same every year. there is a crucial intangible effect of establishing a government program that says. Mandatory savings programs promote an economy-wide retirement age. policy can avoid the additional negative consequences of mandatory savings programs. the message society sends by operating a low-income insurance program is very different than that sent by operating a mandatory savings program.

that is indeed a cost of such a program. His email address is bastiat@mediaone. They nevertheless advocate privatization because they fear it is politically infeasible to eliminate Social Security and because they believe a mandatory savings plan. Boston University. Is a Mandatory Savings Program Necessarily Better than Social Security? Many advocates of Social Security privatization accept the critiques of mandatory savings plans described above. is better than Social Security.unpleasant. It is true that some persons will take advantage of a low-income insurance program. the most natural goal is to phase it out. By phasing in a higher age of eligibility and means-testing of benefit receipt. The bottom line. The comparison between a mandatory savings program and Social Security depends not just on the basic differences in structure but on the degree to which either program distorts economic decisions. even if the level of guaranteed income is low. But even that conclusion is debatable. the poor. not to replace it with a mandatory savings program. with all its warts. is that for those who wish to eliminate the negatives of Social Security. But at least this approach is the minimal intervention necessary to accomplish the stated objective of helping the myopic. * Jeffrey A. Miron is Professor of Economics.net. . therefore. Bastiat Institute. and President. or the truly unlucky. Social Security's ill effects on the economy could be reduced substantially while simultaneously converting Social Security into low-income insurance.