Sunday, September 20, 1998

Social Security lessons from abroad

By DANIEL J. MITCHELL

Knight Ridder/Tribune News Service

We interrupt the Monica Lewinsky saga for a brief discussion of something with far more impact on the typical American's life: Social Security.

Even as you read this, lawmakers are reviewing rescue packages for the financially doomed Social Security system. If there's any consensus about what to do, it's that Social Security must be at least partly privatized -- that is, turned into a system in which Americans are allowed to invest some of their Social Security taxes in real assets.

As they iron out the details, politicians would do well to look at the experience of the more than two dozen countries that have already privatized their Social Security systems, including Australia, Great Britain, Chile, Poland, Singapore, Hungary and Mexico.

These nations can teach the United States which features of privatization work well and, just as important, which don't.

All success stories

First, the good parts. All of the nations that have privatized can be considered success stories. They show that private retirement systems do work. The key features usually include:

-- Mandatory retirement savings. Individuals are required to set aside a certain percentage of their income. The money cannot be touched until retirement.

-- Real investment. Professionals in the financial services industry -- not governments -- invest the money in stocks, bonds and other income-producing assets. All annual income, such as interest and dividends, is reinvested.

-- Phased withdrawal. Workers in privatized systems retire with big nest eggs but are not allowed to spend all the money right away. Some must be preserved to ensure the worker will have a comfortable income in later retirement.

-- Inheritable assets. Under private systems, the entire retirement account belongs to the retired worker. Unused parts can be passed on to children or donated to charity.

-- Protections for retirees. During the shift to private systems, benefits for those already retired (or the soon-to-be retired) are protected.

Pitfalls to be avoided

A retirement system based on these principles will mean a safer and more comfortable retirement for today's workers. But the worldwide evidence also reveals the pitfalls to be avoided. These include:

-- Don't let the government invest. Singapore's private retirement system succeeds in many ways, but workers can't fully benefit because government bureaucrats control how the money is invested. As a result, workers get relatively low returns. True, they're doing better than American workers under Social Security. But they would retire with far more income if private-sector professionals invested the money.

-- Don't overregulate. Chile's private system works well, but government policy limits the investment choices of the pension funds that manage retirement accounts. This decreases earnings and could make the accounts vulnerable by preventing fund managers from diversifying assets to protect against risk.

-- Keep costs low. Giving workers complete freedom to choose their own funds can result in higher expenses. Not only must fund managers pay for advertising to compete for customers, they incur costs every time workers switch to another fund. In Chile and Great Britain this has caused relatively high administrative costs, which of course come out of the earnings workers make on their accounts. Australia has avoided the problem with a system akin to 401(k) plans here in the United States, which keep administrative costs low but limit investment choices.

-- Don't tax away the benefits. Australia's private retirement system is a tremendous success, but the individual accounts fall prey to multiple layers of taxation. Workers pay taxes on the money that goes into the accounts, they pay taxes on the annual earnings, and they pay taxes when they withdraw the money. Workers will still retire with far more than they could get from the old government-run program, but with less than they could get under a system that taxes the money only one time.

-- Ensure that the money goes toward retirement. Because private accounts build up tremendous stores of wealth, workers are tempted to consume the money before retirement. In Australia and Chile, workers have some ability to access their accounts before they retire. This creates the risk that some people will spend the money too early, leaving them dependent on the government later on.

U.S. lagging behind

The United States has lagged behind the rest of the world in privatizing Social Security, stranding Americans in a system that demands high taxes in return for meager retirement benefits. The good news is that other countries have shown us various ways to construct a privatized system.

We can learn from their successes and avoid their mistakes, thus ensuring that America has the world's best retirement system.

Now back to Monica.

Daniel J. Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation, a Washington-based public policy research institute. Readers may write to the author in care of The Heritage Foundation, 214 Massachusetts Ave. NE, Washington, D.C. 20002.