The Social Security Dilemma
Javier Escamilla
Poverty & Prejudice: Social Security at the Crossroads

Congress instituted the Social Security program in 1935 in order to provide retired U.S. citizens with a system of benefits that would make retirement easier to endure. Due to the fact that there was a ratio of approximately 37 workers for every 1 retiree, it was very feasible that the American work force could provide enough to completely support the program. Today, the ratio of participants in the work force to Social Security beneficiaries has shrunk to less than 3 to I and is expected to decline even further in the next few years. Compounding the problem of decreasing worker to beneficiary ratio has been the increase in the life expectancy of an adult living in the United States. When the Social Security program was initiated in 1935, the average life expectancy was 61 years old. Considering that the average age for retirement has remained consistently around 65, beneficiaries in the early years of the program were receiving payment for a much shorter time. Currently, average life expectancy has increased to 75 and the average retirement age has remained at 65.1 So, not only are there more beneficiaries as compared to workers, but these beneficiaries are receiving payments for a much longer period of time. Due to these demographic changes and the problems that are predicted to arise as a result, there has been a large movement towards the reformation of the Social Security program. Though the majority of the American population believes that changes should be made in the program, there has been serious debate over which is the best course of reformation. The proposals with the most merit, such as privatization and means testing will be discussed briefly, with the focus of this paper being on programs in foreign countries that may provide some solutions to the problems faced by the United States.

1 Moon, Marilyn and Mulvey, Janemarie, Entitlements and the Elderly: Protecting Promises, Recognizing Reality, (Washington, D.C., Urban Institute Press, 1996) pg. 27

Reform Proposals

When discussing possible means of reforming the Social Security program, there are generally three proposals that have been given the most consideration; investment in the stock market, privatization and means testing. Currently the United States has collected almost $600 billion in the Social Security Trust Fund. Due to the impending retirement of the generation of Americans known as the "baby boomers," there is going to be a large strain placed on the Trust Fund in the early 21" century. Optimistic predictions have stated that the Trust Fund will be completely expended by the year 2035.

With the tremendous amount of money that is currently being held in the Social Security Trust Fund, an obvious proposal to improve the Social Security program is to invest the money in some form of stock, such as U.S. government securities. By placing the money into these government securities, the Trust Fund is able to earn interest with a relatively low risk of losing money through a decrease in the stock value. However, because of the inherent risks associated with the stock market and the possibility that the government could end up as a major stockholder in many American companies, this proposal is usually met with a negative response.2

Another common proposal for the reformation of the Social Security Program is the implementation of means testing for the disbursement of Social Security funds. Currently, middle- and upper-class retirees are given more benefits as compared to the lower-class but they are given less in proportion to what they earned when they were working. The proposal of means-testing is to reduce or even eliminate the Social Security benefits for middle- and upper-class retirees that will earn a substantial amount of money off of personal investments during their retirement: Though the adoption of this proposal may promote national savings, it may also transform the image of the Social Security program from one that provides benefits to all retirees to a program devoted to improving the conditions of only lower-class retirees.

2 Baker, Dean, Saving Social Security with Stocks: The Promises Don't Add Up, (New York, Twentieth Century Fund Press, 1997), pg. 15

3 Aaron, Henry J. and Reischauer, Robert D., Social Security's Future, (New York, Century Foundation Press, 1998) pg. 135

A final proposal for the reformation of the Social Security program is that it be privatized. The key aspects of privatization would be that all retirees would receive a guaranteed minimum amount of benefits, with additional benefits being based on an individuals "personal security account." In this method, each worker is still subject to a payroll tax but anything over the minimum contributed by the worker is placed in one of these "personal security accounts."4 The worker maintains control of these accounts and can invest in whatever type of stock or security they choose. Therefore the worker determines the return on these accounts by investing in as risky or as safe a stock as he/she desires. Though privatization would provide much more individual control in the benefits seen by retirees, there are enormous costs associated with the transition from the current form of Social Security benefits to one in which privatization is the key.

The Structure of Social Security in Other Economically Advanced Countries

There are seven countries considered to be economically advanced and industrialized. Germany, Japan, the United Kingdom, Canada, Italy, France and of course the United States. Of these, all seven have social security systems that provide benefits for retirees and those people with disabilities. Like the United States, each of these systems is funded on a pay-as-you-go basis. Payments to retirees or other beneficiaries are financed through payroll taxes on current workers and employers. A few countries, such as Japan and Germany, use gener~ tax revenues in addition to payroll tax collections to finance social security benefits. In addition, Japan accumulates some reserves for future use just as the United States does.

4 Achenbaum, W. Andrew, Social Security: Visions and Revisions, (New York, Cambridge University Press, 1995) pg. 38

Levels of spending on Social Security programs vary across the seven major industrialized countries. The United States spends about 6.9 percent of GDP on Social Security. Other countries, including Germany, France, and Italy, spend more than 10 percent of their GDP on Social Security.5 The structure of retirement benefits varies across nations as well. All of the seven major industrialized nations pay an earnings-related pension. The United Kingdom and Japan also pay retirees a flat benefit based on the number of years they made payroll tax contributions. Canada supplements its earnings-related pension program with a noncontributory, universal pension.

U.S. Social Security earnings replacement rates (the percentage of one's income at retirement replaced by Social Security) are low compared to the other major industrialized nations. The maximum earnings replacement rate for a retiree with average career earnings is about 42 percent in the United States, compared to more than 50 percent in Germany, France, and Italy. While the maximum rate of earnings-related pension in Canada, the United Kingdom, and Japan are lower than in the United States, these nations supplement their earnings-related pensions with flat benefits that everyone receives regardless of their prior income. In the case of the United Kingdom, however, the base amount is very low.6

5 Koitz, David, "Social Security: Brief Facts and Statistics," Congressional Service Report, Washington D.C., 1997, pg. 10

6lbid, pg. 14

Needs for Reform

The International Monetary Fund projects that, without changes, over the next fifty years, the social security systems in each of the seven major industrialized nations will experience a funding shortage. The U.S. projected deficit is small compared to most of the other nations. Only the British social security system appears to face a shortfall comparable to the one projected for the United States. To compensate for the shortage, the United Kingdom and the United States would need to increase their annual revenues by less than 1 percent of GDP. All of the other nations would require an increase of about 2 to 3 percent of GDP.7 In order to deal adequately with the impending funding shortage, other sources of income must be found and made available to retirees.

Since the 1980s, the United States as well as most of the industrialized countries in general have become increasingly aware of the impending retirement of the "baby-boom" generation. Several countries, including Germany, Sweden, and Italy have made impressive changes in their systems, restoring fiscal balance through relatively minor alterations in revenues or expenditures. These changes include increasing the retirement age, tightening eligibility requirements for early retirement or disability benefits, and lowering benefits. In addition, means-testing some or all of the public pension benefit has been implemented in Canada and Denmark.

More drastic reforms that alter the nature of the social insurance system have been adopted in several countries, most notably in Latin American, Asian, and African countries. Some of these countries have even implemented the privatization proposal discussed earlier in the paper. The United Kingdom has privatized one component of its public pension program, while Chile has moved to a substantially privatized model, albeit one that is tightly controlled by the government, including a mandatory personal pension deduction from payroll. Because privatization is one of the most promising proposals for reform of the United States' social security program, the effects privatization has had on these countries will be discussed in depth.

7 Ibid., pg.20

Pension Privatization in the U.K. and Chile: The United Kingdom

Those people that have pushed for privatization in the United States' Social Security program are using the changes in the United Kingdom as a possible model for future reformations. The British pension system is now made up of two parts. The first part, National Insurance, is a minimal, flat benefit supported by lump-sum contributions by workers and employers. In 1978, an earnings-related benefit, the so-called State Earnings Related Pension Scheme (SERPS), was put into place. SERPS is also financed by payroll tax contributions. The SERPS term is roughly equivalent to the personal security account described previously. Unlike the current U.S. Social Security system, the British system allows SERPS contributions to be taken out of the government 5 retirement system and placed into approved, private defined-benefit schemes. To compensate for "contracting out," workers and their employers pay a lower rate for the National Insurance contribution .8

8 Schultz, James H., The Economics ofAging, 6th ed. (Westport, Conn., Greenwood, Press, 1995), pg. 105

The switch to privatization has not seen the positive results most policy makers would have liked. Rather, SERPS benefits have been reduced and the pensionable age for women increased. Many Britons have found themselves with smaller pensions because of a change in the index for inflation and poor investment decisions with their pnvate accounts. Lower pensions have led to an increase in means-tested income maintenance programs. In addition, the national government has been left with new administrative expenses, lost tax revenues, and responsibilities to bail out some failed private pension programs.9


The degree of pension privatization in Chile has been even more dramatic than in the United Kingdom. Before 1981, Chile had a pension system that was theoretically fully funded, with most of the contributions made by employers. But the system was riddled with problems. Many individuals did not participate in the program and rapid inflation was devaluing the accumulated pensions. Moreover, benefits were calculated on the basis of an individual's earnings in only the last few years of work, creating more costly obligations than if his or her entire work history (with lower wages in the early years) were taken into account.10

The privatized pension scheme was put into place by a military dictator, Augusto Pinochet, and his assistant, Jose' Pinera. In contrast to the old system, the new, privatized system is financed entirely by employee contributions, with at least 10 percent of workers' salaries going for old-age pensions and 3 to 3.5 percent for survivor and disability pensions. These personal investment accounts are managed by a small number of private companies. In addition, the Chilean government supports a minimum benefit provision (about 85 percent of the legal minimum wage), which is financed through general tax revenues. Unlike the U.S. public pension system, which has a long history, the Chilean model is still very young."

Though the Chilean model seems very promising in the early stages, those who oppose the model predict increasing problems. One prediction is that administrative costs are likely to increase when current workers begin to collect pensions from their private accounts. Another prediction is that original estimates on rates of return for investments in the personal investment accounts were too optimistic and that moderate rates of return in the future will diminish the replacement rates of the benefits. Finally, under the Chilean model, it is possible for the benefits seen by a retiree to "run out."


Clearly the United States is going to have to improve the structure of its social security program. At this point in time, the Trust Fund is still operating with a surplus and continues to grow. However, by the year 2013 the payout to retirees and beneficiaries will become greater than the intake generated through taxes. It is proposed that the United States move towards privatization but with the examples given by the United Kingdom and Chile, this may not be the best solution. In order to reform the Social Security program, much more research must be done on means-testing, privatization and the other proposed solutions. With time running down, programs already initiated in other countries should be studied carefully and used as models.

9 Ibid, pg. 113

10 Myers, Robert J., "Social Security Reform in Chile: Two Views," in Social Security: What Role for theFuture?, ed. Peter Diamond, David C. Lindeman, and Howard Young, (Washington D.C., National Acadamy of Social Insurance, 1996), pg. 217

11 Ibid., pg 220


  1. Aaron, Henry J., and Robert D. Reischauer, Social Securitv's Future, (New York,
  2. Century Foundation Press, 1998)

  3. Achenbaum, W. Andrew, Social Security: Visions and Revisions, (New York,
  4. Cambridge University Press, 1995)

  5. Baker, Dean, Saving Social Security with Stocks: The Promises Don't Add Up, (New
  6. York, Twentieth Century Fund Press, 1997)

  7. Koitz, David, "Social Security: Brief Facts and Statistics," Congressional Service
  8. Report, Washington D.C., 1997

  9. Moon, Marilyn and Mulvey, Janemarie, Entitlements and the Elderly: Protecting
  10. Promises, Recognizing Reality, (Washington, D.C., Urban Institute Press, 1996)

  11. Myers, Robert J., "Social Security Reform in Chile: Two Views," in Social Security
  12. What Role for the Future?, ed. Peter Diamond, David C. Lindeman, and Howard

    Young, (Washington D.C., National Acadamy of Social Insurance, 1996)

  13. Schultz, James H., The Economics ofAging, 6th ed. (Westport, Conn., Greenwood,

Press, 1995)

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