Does Newt Really Want to Privatize Social Security Along the Chilean Model?

02/02/2012 11:19 am ET | Updated Apr 03, 2012
  • Reid Cramer Director of the Asset Building Program, New America Foundation

Newt Gingrich doesn't shy away from taking dramatic policy positions. But he doesn't always stick with them. For instance, he no longer supports limiting carbon emissions through a system of cap and trade permits. Nor is his proposal to execute anyone convicted of bringing two ounces of pot into the U.S. being featured in his presidential run (The Drug Importer Death Penalty Act of 1996). His support of other big ideas, such as privatizing Social Security, is more enduring and particularly deserving of scrutiny.

When the topic of Social Security comes up, Gingrich has proposed the U.S. follow the Chilean model of pension reform. By allowing workers to divert payroll taxes into personal savings accounts, he argues that workers would receive much higher benefits than what they would get under the current system and if there's a market downturn, the government can step in. At a recent debate, Newt said that "Chile has promised that if you don't have as much savings as you would get from Social Security, the government would make up the difference. In 30 years time, they've paid zero dollars." Is it really that easy? At first glance, this type of transition in the U.S. would change our underfunded Social Security system into an unfunded one, creating a huge liability for future generations. But my colleague Vishnu Sridharan and I decided to take a closer look at the Chilean experience to see how the process of reform has unfolded down there.

Before reforms, Chile had approximately 100 retirement plans that were administered by 32 different funds, each with its own requirements, pension levels, and mechanisms for calculating payouts. Each group of workers bargained independently, with teachers having different options than manual laborers and bankers, so benefit levels reflected the lobbying power of each special interest.

In 1981, under the austere rule of Augusto Pinochet, Chile consolidated the pension system and replaced the pay-as-you-go regime, where taxes are transferred to current retirees, with a pension system based on individual capital accounts. All workers were mandated to contribute 10 percent of their monthly salary to their accounts, plus a 3 percent premium for disability and life insurance. Private pension management funds were created to manage these accounts and administer benefits, and their investments were restricted mostly to government bonds. The state promised to finance a minimum pension to those who met statutory requirements but had not accumulated sufficient funds by their retirement.

This is the point in the story where Gingrich appears to have stopped paying attention. By 2006, politicians in Chile had come to the consensus that the system required major reforms. One problem was under-coverage. Not everybody was able to open and manage a private account. Half of the population had no pension coverage. Another problem was people's ability to make regular and sufficient contributions. In Chile, these were issues especially relevant for women and those working in the informal economy. The government estimated that in 20 years 85 percent of Chileans would have a pension that was below the minimum benefit level. It turned out that shifting to private accounts didn't fix the retirement security problem, but created new puzzles to solve.

In 2008, Chile moved to strengthen its social safety net by providing a basic, noncontributory benefit to 60 percent of the poorest individuals, and provide a supplement for those who made contributions but didn't qualify for the minimum benefits. In other words, Chile was forced to own up to the promise that the government was on the hook to make up the difference if people failed to adequately save for retirement. The same would be true for us.

Luckily, we already have in place a retirement security infrastructure with near universal reach -- the Social Security program. Instead of scrapping it, we should improve its financing so it provides a strong foundation for everyone. One of the easiest reforms is lifting the income cap on contributions, so everybody contributes at the same rate. Then, we should make sure people can supplement their basic benefits with additional savings in an account on top of Social Security. In fact, Gingrich himself has previously endorsed making sure every newborn child gets their own account, so no one is left out and they can begin making contributions as early as possible.

Additionally, we should focus policy efforts to especially encourage those with lower incomes to save by offering targeted incentives, facilitating automatic contributions, and promoting prudent investment choices.

Rather than following Chile's initial missteps, we should take a more measured approach to better financing Social Security and making sure everyone can prepare for retirement by accessing savings and investment opportunities throughout their lives. If Newt gets up to speed on how Chile's experiment with pension reform has played out, he might have second thoughts on its desirability as an import.