Can Social Insurance Be Reformed?

Sreya Sarkar Cascade Commentary

Summary

The financial liabilities of social insurance programs in the United States in the near future are staggering, but the Wall Street meltdown has many Americans worried about “private” solutions. Around the world, other countries are replacing traditional pay-as-you-go schemes with hybrid arrangements of government social insurance programs and individual-based accounts, which may be a workable solution to the crisis.

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The financial uncertainty currently gripping the American and global economies raises more questions about our financial prospects over the next few decades than anyone has answers for. Politicians in Washington have been debating the future solvency (or lack thereof) of Social Security for years. The current Wall Street meltdown has American workers, counting on their individual retirement accounts, uneasy about the prospects of using the stock market for retirement “savings.”

On the other hand, there is no question that massive reforms must be made, and soon, if Social Security is to be afloat for the next generation. Keeping the status quo is not an option. Yet, at the moment, American investors regard with a wary eye, putting their retirement eggs entirely in one basket or another. Is there any other response to this meltdown on both fronts? Can government provide retirement security to all American workers under a system created for the economy of the 1930s? In a slowing economy, is there a better way for workers to meet their own needs than government Unemployment Insurance? Can private investment accounts be counted on for either retirement or unemployment?

These are difficult questions for the best economists and financial analysts, but some background on social insurance programs in the United States, and related solutions being tried in other countries, can help illuminate the discourse.

“In the U.S.,…Social Security, Medicare and Unemployment Insurance…account for 9% of the Gross Domestic Product (GDP).”

Social insurance programs have become a very costly and a politically divisive aspect of government domestic policy, not only in the United States but also in many other countries. In the U.S., these programs are mainly made up of Social Security, Medicare and Unemployment Insurance. Together these three programs account for 9% of the Gross Domestic Product (GDP). This percentage is rapidly increasing with the aging population.

Social insurance programs differ from both private insurance and government welfare programs. They are income-transfer programs that deal with risks like job loss or inadequate assets during retirement, but they are not the same as private insurance. They require mandatory participation and are stimulated by government subsidies. Social Security and Unemployment Insurance programs may appear to be redistributing income to those in need, but they are not chiefly a redistribution policy lever.

One problem with broad-based social insurance programs is that they promote blanket “solutions” that are the same for all with no opportunity to customize according to individuals’ or families’ unique needs. Everyone must contribute to them, whether they meet people’s needs or not. This is why the option of a hybrid system combining government insurance with individual investment-based accounts cannot be overlooked anymore.

Martin Feldstein, a renowned economist at Harvard and a regular contributor to the Wall Street Journal, has done extensive research on Unemployment Insurance. He suggests that one way of saving social insurance programs from crumbling altogether is to consider a hybrid arrangement of government insurance and individual-based accounts—in unemployment’s case, Unemployment Insurance Accounts backed by a government line of credit or Personal Retirement Accounts that supplement ordinary pay-as-you-go Social Security benefits.

“Martin Feldstein…suggests that one way of saving social insurance programs from crumbling altogether is to consider a hybrid arrangement of government insurance and individual-based accounts….”

Conversion of Unemployment Insurance (UI) to Individual Asset Accounts (IAAs), coupled with a small common-pool fund to subsidize certain low-balance accounts, is a way to reform the present UI arrangement. This could be done by having most of the current UI payroll tax placed in the individual worker’s account, with a small portion of it shared with joint accounts for hardship cases where IAAs might be inadequate.

IAAs would accumulate tax-free for life and could be used at the discretion of each worker for unemployment insurance or mid-career job training or professional development. They can also accumulate in Individual Development Accounts, which is an existing asset-building medium for low-income individuals. If the funds are never used for the above purposes, they could be merged with the worker’s IRA upon retirement, thereby providing long-term incentives to manage the money wisely.

IAAs are inspired by the present UI system in Chile. Individual Unemployment Accounts have been implemented successfully in Chile since 2002. In the Chilean system, the employee payment of 0.6% of wages goes directly to the worker’s IAA, while the employer makes a payment of 2.4% of wages. The 2.4% is split between the worker’s IAA (1.6%) and a joint account to help subsidize low-balance accounts (0.8%). In contrast to the U.S. system, workers in Chile receive benefits regardless of whether they quit or were fired. This solves one significant problem of the present Unemployment Insurance system: Currently, there is a financial incentive for workers to remain unemployed for as many weeks as government benefits are available to them.

The United Kingdom, Australia, China, Sweden and Chile are in the process of restructuring their social insurance programs along these lines. This transformation is driven by two main factors: growing fiscal liability to the government and recognition that these programs have substantial undesirable effects on individual incentives and broader economic performance.

Interest is growing around the world in personal savings accounts as a useful tool for reorganizing social insurance or social expenditure, replacing traditional pay-as-you-go schemes with defined benefits systems. Hybrid arrangements can be used to save social insurance programs like Unemployment Insurance and Social Security from complete dilapidation before it is too late.

Sreya Sarkar is Director of the Asset Ownership Project at Cascade Policy Institute, Oregon’s free market public policy research center. Kathryn Hickok is Publications Director at Cascade.

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