Tyler Cowen has been beating the drum against social security privatization for a good while, and it has finally sunken in with me. After thinking about it enough, it appears that he is right: we will end up with two programs if we transition to private accounts and it won’t reduce the unfunded liability, which is the central problem. Presumably, when the actuaries refer to an unfunded liability they are referring to an excess in the present value of all cash outflows versus the present value of all inflows. If the first number exceeds the second, you have a liability. We’ve promised to pay too much and benefits will have to be reduced, or taxes raised, to bring the system into balance.

Private accounts alone won’t change the unfunded liability. However, Tyler offers an intriguing solution to part of that problem: auction off the right to leave the system. An auction provides a great mechanism to separate those that are risk averse from those that are not; those with financial savvy from those with none. It also creates a logical break point to show where they have left the system and have acknowledged that the system owes them nothing, though they have paid into it. They should similarly understand that they will need to save enough for their own retirement and will have to keep working without enough savings.

There would be an initial inflow of money that could be used to retire debt—thereby enabling future borrowing for the government to cover shortfalls—and presumably an increase in savings from those that leave the system; no more payroll taxes, higher disposable income. The system could then transform into a poverty program for the elderly, which should be far [Ed.: got a little carried away.] smaller than in its current setup.

I’m sure the details would need to be hammered out by actuaries—how many people would pay to leave the system, how much would they pay (meaning how much current debt could we retire) and how much would the unfunded liability would be reduced. Even with these questions, it seems like a sounder suggestion than getting people into a forced savings program where the government still implicitly takes responsibility for everyone’s retirement and the unfunded liability is unchanged.

Cass has more here.