2004 Nobel Prize in Economics recipient Edward C. Prescott writes this outstanding Wall Street Journal op-ed in which he makes a persuasive case that the time for transition of the current Social Security system to one based on mandatory individual retirement accounts is now:

The time is right to act, and we don’t need a special commission to analyze the problem and recommend solutions because we already had one, and it submitted its report three years ago next month — The President’s Commission to Strengthen Social Security. The trouble is that little has happened since. It’s time to dust off that report, sharpen our policy pencils and get to work on reforming our Social Security system before it’s too late.
The main contribution of that 2001 bipartisan commission was to propose the establishment of a system of voluntary personal accounts, which would increase national savings as well as increase labor-force participation — more on that later. But this contribution is also the commission’s main flaw, for the proposal does not go far enough. We need to establish a system of mandatory savings accounts for retirement, not voluntary. Without mandatory savings accounts we will not solve the time-inconsistency problem of people under-saving and becoming a welfare burden on their families and on the taxpayers. That’s exactly where we are now.

Professor Prescott debunks the notion that individual retirement acccounts are somehow riskier than the current Social Security system:

Some politicians have vilified the idea of giving investment freedom to citizens, arguing that those citizens will be exposed to risks inherent in the market. But this is political scaremongering. U.S. citizens already utilize IRAs, 401Ks, PCOs, Keoghs, SEPs and other investment options just fine, thank you. If some people are conservative investors or managing for the short term, they direct their funds accordingly; if others are more inclined to take risks or looking at the long run, they make appropriate decisions. Consumers already know how to invest their money — why does the government feel the need to patronize them when it comes to Social Security?
It would be one thing if the government’s Social Security system paid a decent return, but as the President’s Commission reported, for a single male worker born in 2000 with average earnings, the real annual return on his currently-scheduled contributions to Social Security will be just 0.86%. And for a worker who earns the maximum amount taxed (then $80,400), the real annual return is a negative 0.72%. A bank would have to offer a pretty fancy toaster to get depositors at those rates of return.

Indeed, as Professor Prescott points out, the trend internationally is to such individual retirement accounts:

Further, about two dozen countries have reformed their state-run retirement programs, including Chile, Sweden, Australia, Peru, the U.K., Kazakhstan, China, Croatia and Poland. If citizens in these countries can handle individual savings accounts, especially citizens in countries without a history of financial freedom, then U.S. citizens should be equally adept. At a time when the rest of the world is dropping the vestiges of state control, the United States should be leading the way and not lagging behind.

In fact, Professor Prescott notes that the economic benefits of such accounts are substantial:

The benefits of such reform extend beyond the individual retirement accounts of U.S. citizens (although that would be reason enough for reform) — they also accrue to the economy. As noted above, national savings will increase, as will participation in the labor force, both to the benefit of society. On the first point, more private assets means there will be more capital, which will have a positive impact on wages, which benefits the working people, especially the young. More capital also means that the economy will have more productive assets, which also contributes to more production.
Regarding labor supply, any system that taxes people when they are young and gives it back when they are old will have a negative impact on labor supply. People will simply work less. Put another way: If people are in control of their own savings, and if their retirement is funded by savings rather than transfers, they will work more. And everyone is better off. These are the type of win-win situations that politicians and policy makers should be falling over themselves to accomplish.

And what about the horrendous “transition costs” that we hear would undermine the transition from the current Social Security system to one based on mandatory individual retirement accounts? Professor Prescott keenly dispenses with that objection:

Some analysts have suggested that we can’t move from a transfer system to a saving system because current retirees will be left in the lurch. Who will pay for them if workers’ money is suddenly shifted to individual savings accounts? There will indeed be a period of time, likely no more than 10 years, when narrowly defined government debt relative to gross national income would increase before decreasing. But government debt is small relative to the present value of the Social Security promises that currently exist. Further, the sum of the value of government debt and the value of these promises will start declining immediately.
Under a reformed system there will always be some individuals who, owing to disabilities or other reasons that prevent them from working, will not have sufficient savings in their old age. The solution is to include a means-tested supplement to ensure that those citizens receive a required payment — just like they receive today. Nobody gets left behind under this new system, and most will move ahead. U.S. citizens deserve more than a minimum payment, and the U.S. economy deserves more than to have its savings, capital and labor weighed down by an increasingly costly tax-and-transfer system.

And how would such a system work? Professor Prescott touts one:

Have three-quarters of employer and employee Social Security contributions (currently 12.4% of wages, salaries and proprietors’ income up to $87,900) put into an individual savings account. This would be deferred income with taxes paid when people receive their retirement benefits. The other one-quarter of Social Security contributions would finance welfare and increase the labor supply, resulting in higher output and an increase in tax revenues.

Read the entire piece. Ed Prescott is definitely a clear thinker.
Update: Tyler Cowen at Marginal Revolution makes the case against forced savings accounts and for turning Social Security into a welfare program for the elderly.