More on Social Security privatization from Henry Aaron at Brookings:

As American financial markets are hammered by a financial storm more frightening and more damaging than hurricane Ike, it is worth imagining what the world would have been like had president Bush’s Social Security proposal been enacted and been effective for a couple of decades. Of one thing, we can be sure. Whatever changes in regulation of banks and financial organizations Congress may yet enact, another financial storm will surely strike. It will differ from the current calamity, as surely as the current mess differs from that of the Great Depression. But regulators, however well intentioned, cannot anticipate the infinite imaginativeness of really smart financial and legal experts at finding new ways to skirt controls put in place to prevent the recurrence of the last crisis. It would be naive to imagine that regulators who have never been able to plug all the ways around previous safeguards will suddenly find the perfect fix that prevents financial crises from ever happening again.

So, picture this imaginary future. President Bush’s partial privatization plan was enacted. People have been socking away funds in individual accounts for years. Social Security benefits have eroded continuously, as was inevitable under president Bush’s plan. People will have adjusted their consumption and savings to leave themselves with savings that they expect to be sufficient for retirement.

Then, bang! After people have retired or become disabled, or just on the eve of claiming benefits, a financial panic they could not possibly have anticipated strikes. Even worse, stock prices collapse as much as they did in 2001 when over-the-counter shares fell roughly 80 percent and the New York Stock exchange fell by more than 40 percent. Those are the assets in which private accounts were invested. Retirement income, once thought adequate, becomes insufficient. To be sure, Social Security benefits would remain, as they are today, rock solid. But under the typical privatization plan, they would provide much less of retirement income than they do today. The financial crisis would become a personal calamity for tens of millions of retired baby-boomers and their successors.

In the midst of today’s well-founded angst about whether current financial turmoil will precipitate serious and sustained economic recession or even depression, it is worth taking a moment to recognize that Social Security has remained what it was intended to be—a solid foundation of financial security for retirees and people with disabilities. It is also worth breathing a sigh of relief that Congress recoiled from the proposal that president Bush put forward to partially privatize Social Security, a measure that would have eroded that foundation as surely as Hurricane Ike washed away homes and businesses on the Texas coast.

And if you’re overwhelmed by all the recent government bailouts, consider:  If this had happened, and senior citizens and near-retirees across the country were suddenly left destitute, is there any chance at all that the government would not have stepped in to help these victims of the stock market bust?  No way.  Imagine adding that to our current tab.

Marketplace did an interesting story on what the under-30 set thinks about the economy.  A recent poll found that the economy is the number one issue for this group in this election cycle–the first time in five years that that honor did not go to the Iraq war.

During the reporter’s interviews with twenty-somethings, Social Security came up a few times.  And while this wasn’t mentioned explicitly, it’s fascinating to me that the public perception of how this program functions is so completely different from the reality.  There is no box with your name on it, into which all of your contributions are deposited; the tax you pay is immediately transferred to a current senior citizen.  Most people do not realize this, and that confusion is of course intentional.   It’s easier, politically, to sell a retirement program that everyone thinks they benefit from than to sell a social insurance program (cf. Medicaid, Medicare, Welfare), but Social Security is most definitely the latter type of government initiative.

What makes Social Security so successful is also its largest flaw: that it is funded by a dedicated tax. This makes it trickier to adjust the program’s funding.  It also makes people feel like they are investing in something.  But while it’s sort of true that their money is going towards a stake in future benefits (though there is no guarantee what those benefits will be), Social Security is not an investment vehicle.  Nor should it be.  And it drives me crazy to hear people compare the return on their Social Security contributions against the returns they’re seeing in the stock market–and then use this as evidence that the program should be transformed into something like a 401k. We all have plenty of opportunity to invest in 401ks–and stocks and bonds and houses and education and every other risky asset under the sun.  What we don’t have–and what only the government can provide–is a safety net if all those other investments don’t work out.  (Take a look at your investment portfolio this week.  You really think people don’t need any insulation from the market?)

Social Security is generally described by economists as insurance against living too long–i.e., longer than you expected to live.  You will receive benefits for as long as your live, and a larger payoff if you outlive the average person on whom benefits are based.  Women, especially, often outlive their spouses and their savings, and would be destitute without some other source of income. Social Security also provides insurance against income risk: Not everyone will earn enough during their working years to adequately save for retirement, and Social Security’s very progressive benefit structure makes up for this a bit.  Yes, personal responsibility is important and moral hazard is bad.  But pure luck has a massive impact on our lives–where we’re born, who our parents are, where we go to school, the friends (and networks) we make along the way.  Not everyone fully “deserves” what they get.

There’s a lot of talk of means-testing the program, and that would be fine if it weren’t for the political consequences of doing such a thing: Far, far fewer Americans will have a stake in its long-term health and funding, and most will begin to see it as something for some “other” group–which will almost certainly lead to its demise.  There are other intermediate steps that we can take to shore up Social Security’s finances, and it’s really a pretty basic math problem: Raise taxes and/or cut benefits to make up the known shortfall.  That’s it.  This is particularly striking when we compare it to much more intractable issues like Medicare and health care spending generally, where prices continue to increase exponentially with no end in sight.  If you want to worry about the return we’re getting on our investments, and government programs’ effects on our nation’s solvency, worry about those.