Social Security, risk and choice

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Some commentators have lately declared dead the administration initiative to "privatize" Social Security. However, I suspect they don't believe that. Why, otherwise, would they continue challenging even the philosophical underpinnings of the Social Security reform advocated by the president?

For example, in a recent issue of the New Republic, Jonathan Cohn questions whether Americans desire greater "choice" when their economic "security" is at stake.

Such arguments assume that, given the option, Americans always prefer security over choice. But Americans often do not prefer security above choice. For example, though SUVs are less safe because of their high center of gravity, many Americans prefer them to more secure vehicles.

Perceptions matter greatly and it seems, in telling pollsters they prefer the "security" of the current Social Security system, many are considering how that program has operated in the past, not how it will operate in the future.

Social Security reform opponents don't deny personal accounts (like school vouchers, Health Savings Accounts, etc.) would provide a chance to diversify retirement funds' investments. Although greater risk accompanies greater investment choice, this should not end the discussion as it often does. What kind of risks are we considering? What are the alternatives?

Let's dispense with silliness: Some have unfairly likened individual accounts with permission to take the money to a Las Vegas roulette wheel. Under all the personal account reform proposals I have seen, the accounts would be regulated to ensure safety and soundness. One extreme would limit investments to broad-based market index mutual funds.

However, if investing individual accounts in anything other than U.S. Treasury bonds is, indeed, more "risky," the relevant question is: Could that still prove safer than continuing under the current Social Security system?

Proponents of the "choice is worse" theory answer with an unequivocal "no" because they wish to portray Social Security benefits as inviolable. However, attributing "perfect security" to the current system is based on assumption, not fact.

Many personal accounts opponents say Social Security is as secure as investing in Treasury bonds. That is not even remotely true. A Treasury bond promises payment upon maturity of a fixed sum of money regardless of all outcomes except general default by the federal government. Almost everyone regards a general default as all but impossible.

There is a somewhat greater risk inflation will erode the real value of the principal and interest of the bonds. But that, too, can be avoided by purchasing inflation-indexed Treasury securities. And Treasury bonds can be bequeathed and can serve as collateral for borrowing in emergencies.

But the current Social Security system provides a "soft promise" of future benefits, of unknown size and duration. Social Security benefits cannot be used as collateral for borrowing funds and cannot be bequeathed.

Moreover, because Social Security's finances are unsustainable, the likelihood some, especially younger, participants' future payroll or other taxes will be increased or benefits reduced is considerably larger than zero. That increases the risk of Social Security's future benefits, reducing their expected value.

People are starting to figure out the game and some Social Security participants, especially younger ones, are not content with a false sense of security. Owning part of their payroll taxes and greater choice in investing personal account balances in exchange for reduced future benefits (which have low expected values) is now acceptable to many.

I suspect reform opponents see the danger (and, thus, the merit) of this argument and are trying to discredit it by attacking the weight most Americans place on greater "choice." But a comparison of "choice" against "security" can only be valid when the security offered is real.

Jagadeesh Gokhale is a senior fellow at the Cato Institute.