December 17, 2002
Hispanics Would Disproportionately Benefit from Social Security Choice
by Ian Vásquez
Ian Vásquez is the director of the Project on Global Economic Liberty at the Cato Institute, and editor of the book "Global Fortune: The Stumble and Rise of World Capitalism" (Cato Institute, 2000). This speech was given at the Hispanics and Social Security Conference, Cato Institute, May 21, 2002
Hispanics in the United States can be proud that there is an idea emanating from Latin America that can solve the imminent crisis in Social Security in a way that increases individual liberty and personal wealth and that creates security in old age. In the words of Newsweek magazine, the reform of pensions is probably the first policy initiative coming out of Latin America with relevance and applicability to the United States and other rich countries.
All Americans have a lot to gain from fundamental Social Security reform. The single most important element of a pension system based on individual retirement accounts is choice. A private system increases your freedom to choose how to invest, with whom and when to invest, when to use your money and when to retire. A private system would also have a profound effect on the American economy. Increasing savings and thus investments, a private system would create a sort of virtuous cycle in which there would be higher productivity, higher wages, more job opportunities and economic growth. We have already seen that happening in countries that have implemented that reform.
Harvard economist Martin Feldstein calculates that the privatization of U.S. Social Security would permanently increase GDP in the United States by 5%, which translates into an increase of about $5,000 per year for a family of four. But it is Hispanics as a group, who have the most to gain from reform and much to lose from the lack of fundamental reform. That is because Hispanics get a raw deal from Social Security today. It is true that Hispanics disproportionately benefit under the current system as a result of their low incomes and their longer life expectancies. But that does not mean that the benefits that they receive today are good. It does not mean that the benefits that they receive will last. And it does not mean that the benefits that they receive even begin to compare to the benefits received under a system of private retirement accounts.
The current system has failed Hispanics and has failed to reduce poverty in old age among Hispanics. It has made them extremely dependant on Social Security for their pension benefits, putting them in a very precarious situation.
About 24% of Hispanics over the age of 65 live below the poverty line, compared to about 9% of whites and about 25% of blacks. Hispanic families have few assets. The median Hispanic household has about $1,200 in financial assets and less than half of such households were net savers in 1998. The fact that the current system does not allow for the creation of wealth and instead diverts income into the payroll tax, which is the biggest tax that most Hispanic households pay, is holding back Hispanics.
By contrast, a private retirement system would not only encourage the accumulation of wealth that belongs to contributors, but its benefits far outstrip the benefits of the current system. Naomi Lopez of the Hispanic Business Roundtable notes, for example, that average income Hispanic males born after 1950 will get a return of 1.4-2.3% on their Social Security contributions. But this is poor compared to a portfolio that is conservatively invested 50% in stocks, 50% in bonds. That investment would yield 4.95%, more than double the rate of the current system.
To take another example, an average single male born in 1973 can expect just a 1.57% return from Social Security. If he could invest his payroll taxes and earn just 4.5%, which is a modest rate by historical standards, he would double his income at retirement. This is a tremendous difference that would make a huge impact on the quality of life of Hispanics in retirement and would thus help to reduce poverty and increase security. It is the difference between driving a Mercedes Benz and sitting on a public bus. But even the more timid reform proposals based on partial privatization show the potential for dramatic improvements in the conditions of Hispanic retirees.
Mario Rodriguez, who was a member of the President's Commission to Strengthen Social Security, notes that under the Commission's proposals, low-wage workers would receive more than the current system even promises. For instance, a low-wage worker retiring in 2042 would under one of the commissions proposals build a personal account nest egg of over $70,000. Combined with his traditional benefits this could pay $986 per month for life, which is $330 more than what Social Security can afford to pay. The difference between the two systems, between the Mercedes Benz and the public bus, become even larger if that public bus breaks down along the way--and that is precisely the situation that Social Security finds itself in today. That is bad news for everybody, but it is particularly bad news for Hispanics because Hispanics are overwhelmingly a young population.
As a group today they are putting much more into the system than they are getting out of it, without any guarantee that when the currently working Hispanics retire, the system will be there to support them. To fix the shortfall in the system the government will have to raise payroll taxes from 12.4% to eventually 18% or cut benefits by 25% or more. And that will only postpone the crisis, it will not solve it.
That is a draconian and unnecessary solution. And it suggests that to get paltry returns Hispanics will need to sacrifice even more or they will simply have to settle for a system whose return is significantly lower than today's. That is why a system of private retirement accounts would disproportionately benefit Hispanics. A private system is sustainable and the returns are much higher than those of any other scenario.
So if the benefits are so clear, why not do it? Surprisingly, a common objection that is often made even by those who purport to represent Hispanics is that Hispanics somehow are not capable of making their own investment decisions since they don't have much experience in that area or are maybe not sophisticated enough or even smart enough to do so. And the evidence is that they have a low level of assets. But I submit that the Social Security system is in part responsible for that situation since it prevents Hispanics from accumulating wealth. Moreover, a private system allows assets to be passed on to heirs, an option that is not possible today.
As a number of studies have found, it is today's Social Security system, by preventing that wealth accumulation and by preventing such wealth from being passed on to heirs, which actually increases inequality in society. The low level of assets that we see today with Hispanics is in any case a function of income since there is a strong relationship between the two. But the idea that Hispanics are not sophisticated enough to participate in the system is belied by the fact that tens of millions of ordinary Hispanics are already participating in private retirement systems in Chile, Mexico, Peru and elsewhere in Latin America. The number of Hispanics participating in those systems is about equal to the number of Hispanics living in the United States and that is in countries that are much poorer with infrastructure not nearly as developed as that of the United States.
My point here is that Latin Americans understand very well when they see their accounts that it is their money, that they are accumulating wealth for themselves and their family and that they have more control over the fund managers that they hire or fire than they do over the politicians who control public resources. And indeed that may be one of the reasons why polls show a majority support among Hispanics for some form of privatization of Social Security. A poll by the Hispanic Business Roundtable in the year 2000 shows, for example, 69% support for personal retirement accounts among Hispanics. 58% of Hispanics have little or no faith that Social Security will be there when they retire, and of course, among young Hispanics, support for personal retirement accounts is even higher.
Let me conclude by saying that Hispanics are ready for Social Security privatization. They understand the issues and what is at stake. They understand how much they have to lose if fundamental reform is not undertaken. They understand how much they have to gain from a fundamental reform. And we are leading the intellectual debate in this policy issue, which has been applied, with so much success, in our countries of origin. Thank you.
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