Should Social Security invest in stocks?

Pension funds do it. Insurance companies do it. Canada does it, and so does Japan. So, why doesn’t our Social Security system invest in the stock market–and should it?

I’m not talking about transforming Social Security into a system of private, individual IRA-style investment accounts, as proposed by former President George W. Bush and some conservative policy experts. The question here is whether Social Security should invest a portion of its reserve funds in equities to help the program’s long-term solvency.

By law, Social Security must invest its reserve funds in safe, low-return Treasury securities. Proposals to shift a portion of reserves into equities have arisen from time to time, but never moved forward due to concerns about government control of private sector assets, and worry in some quarters that the move would open the door to broader privatization of Social Security.

Advocates for the idea note that the higher returns offered by equities could be used to ease the burden on taxpayers to fund the program–and even to boost benefits. But those arguments really only apply to Social Security’s very long-range outlook. Equity investing does not offer a solution to the short-term solvency issues facing the program.

Social Security faces a financial imbalance that would force sharp benefit cuts in 2034 unless the government makes changes. The problem stems from falling fertility rates and labor force growth–which reduces collection of payroll taxes that fund the system–and also from the retirement of baby boomers, which increases benefit costs.

Absent reform, Social Security could continue to pay roughly 75% of promised benefits. The cuts would mean the typical 65-year-old worker could expect Social Security to replace 27% of pre-retirement income, down from 36% today, according to the Center for Retirement Research at Boston College.

That problem must be solved through injection of new revenue, benefit cuts or some combination of the two. I’ve argued often for the former, and not the latter. But Social Security also projects its solvency 75 years into the future. And over that longer-term horizon adding equities to the mix would be a smart move.

History of the Debate

Debate about investing some portion of Social Security assets outside of Treasuries isn’t new. Lawmakers considered asset diversification when the program was created in the 1930s–although the option considered then was corporate bonds rather than stocks, according to Nancy Altman, author of The Battle for Social Security: From FDR’s Vision to Bush’s Gamble, a history of the program.

“Lawmakers who opposed Social Security objected to asset diversification,” says Altman, president of the Social Security Works advocacy coalition. “They thought this kind of government investment in the private sector smacked of socialism.”
In the mid-1990s, President Bill Clinton asked a government-appointed advisory panel of outside experts to make recommendations to improve Social Security’s long-term solvency, and it identified three options that included equity investment. Two options involved setting up private individual accounts; the third recommended investing a portion of assets in the Social Security Trust Fund assets in stocks.

The idea surfaced again in the early 2000s when Altman co-authored a plan to balance the program’s long-range finances with the late Robert Ball, one of the most influential figures in Social Security history. Ball served as Social Security’s commissioner from 1962 to 1973 and also founded the National Academy for Social Insurance.

The Ball/Altman plan included a proposal to authorize Social Security to invest a portion of the SSTF in broadly diversified index funds. In order to safeguard against government interference in the markets, a Federal Reserve-type board with staggered terms would have been appointed to select the funds and to hire fund managers through a competitive bidding process.
Ball/Altman proposed gradual investment in equities, starting with one percent of SSTF assets in 2006, adding an additional percentage point annually with a cap of 20% of SSTF assets.

None of these ideas have advanced due to the difficult politics. Conservatives worry that equity investment could give government inappropriate control over the private sector, and that this control could be used to meet political goals.

“I do worry that people would try to politicize the investments, although it would be possible to protect against that,” says Andrew Biggs, resident scholar at the American Enterprise Institute and a former deputy commissioner of the Social Security Administration during the Bush years.

Investing in stocks also could provoke concern from segments of the public that don’t participate in the equity markets. Social Security is a near-universal program covering many workers who don’t hold stocks. That’s about half of all adults: A 2016 Bankrate.com survey found that 52% of Americans don’t invest in stocks or mutual funds; the most frequent reasons cited include a lack of knowledge about equity investing, a lack of trust in stock brokers and financial advisers, and the riskiness of investing in stocks. Just 16% of adults view the stock market as the best place to invest money they don’t need for 10 or more years.

“The history of market crashes have left a lot of Americans distrustful of the stock market–much more so today than they were even 15 years ago,” says economist Gary Burtless, a senior fellow at the Brookings Institution.

Conservative policy experts have argued that rather than invest the SSTF in the stock market, individuals should be permitted to divert part of their payroll tax contributions to private accounts. But that would undermine Social Security as a source of guaranteed lifetime annuity-style payments, and could leave account-holders exposed to much greater market risk than they would face with a massive, professionally managed SSTF equity investment.

Measuring the Boost

How much would equities help?

Burtless is the co-author of a recent research study for the Center on Retirement Research at Boston College that attempts to answer the question. The report looks at the question two ways. First, it uses historical market data to determine how the SSTF would have been impacted had it been invested partially in equities beginning in 1984; then it considers investments in equities beginning this year as part of a broader package of reforms, using Monte Carlo analysis to project a range of possible outcomes over the next 75 years.

The historical analysis follows the recommendation of the mid-1990s Social Security commission–it increases the percentage of trust fund reserves invested in equities by 2.67 percentage points each year up to a ceiling equity allocation of 40%.

The results are expressed using the trust fund ratio–the ratio of assets to benefits (a ratio of 1.0 is the Social Security trustees’ benchmark for short-term financial adequacy). If equity investment had started in 1984, the trust fund ratio in 2016 would have been 4.2 compared with an actual ratio of 3.0. If equity investment had started in 1997, the ratio would have been 3.8. (Social Security has been building large reserves since the reforms of 1983, which will be drawn down as the baby boom generation retires.) “History looks like what you’d expect,” says Burtless. “Stocks give you better returns than the goverment bond market.”

The paper also found that if Social Security had begun investing in the stock market in 1984 or 1997, the program would own less than 4% of the market today; by comparison, state and local pension plans currently hold about 6% of total equities.

The forward-looking analysis assumes that investment in equities begins only after implementation of reforms that put Social Security into actuarial balance for the coming 75-years without any extra boost from stocks.

“The analysis is only interesting if you first raise the tax rate,” explains Burtless. “Since we expect the trust fund to be depleted by 2034, between now and that date the size of the fund will be small, so the differences in what you could earn on the reserves are immaterial, especially with ups and downs of the market. If you instead build up the trust fund and add return on investment from equities, then the differences become very material.”

The key result of the Monte-Carlo analysis: at the 50th percentile of outcomes, the trust fund with equity investments finishes the 75-year period with a ratio of 3.3–far above the 1.0 benchmark.

That would leave Social Security with a permanent fix to its periodic financial shortfalls, and it would give lawmakers room to consider ways to make benefits more generous.

“If you get to that point, there could be some opportunistic ways to improve benefits for certain groups that are especially deserving–families with disabled kids or very low income beneficiaries,” says Burtless. “Or, you might be able to cut payroll taxes. Those opportunities are not going to present themselves if you’re invested only in bonds.”

Still, the SSTF is stuck with Treasuries for now–and that doesn’t seem likely to change anytime soon. Says Altman: “It would be good policy, but it is difficult for people to understand.”

Comments

  1. John Dewey says:

    Where would one get the cash to invest in equity markets?

    There is no cash in the Social Security Trust Fund. Only $2.8 trillion in IOUs from the government to the Social Security Trust Fund.

    Social Security cash distributions to retirees and to the disabled now exceed Social Security tax revenues. No cash there.

    Where’s the cash for this investment proposal?

  2. Mark Miller says:

    Perhaps you missed below paragraphs from the article. Also, the IOU trope makes sense only if you accept the notion that every note issued by the Treasury is an “IOU” (I don’t).

    “The forward-looking analysis assumes that investment in equities begins only after implementation of reforms that put Social Security into actuarial balance for the coming 75-years without any extra boost from stocks.
    “The analysis is only interesting if you first raise the tax rate,” explains Burtless. “Since we expect the trust fund to be depleted by 2034, between now and that date the size of the fund will be small, so the differences in what you could earn on the reserves are immaterial, especially with ups and downs of the market. If you instead build up the trust fund and add return on investment from equities, then the differences become very material.

  3. John Dewey says:

    I guess I did miss that paragraph.

    So this is really just a thought exercise, right? It seems very unlikely that Social Security will ever have any cash balances. It never has had any. At least, not since 1939. All FICA taxes are deposited in the Treasury’s general fund. Social Security distributions are paid from that fund. Any FICA taxes in excess of those distrubutions have always been used for other purposes.

    Today, and for the forseeable future, Social Security distributions exceed FICA taxes. Social Security benefits paid in 2016 were $922 billion. Social security payroll tax contributions were $836 billion. Yeah, that’s pretty small – a negative $86 billion.

    https://www.ssa.gov/oact/STATS/table4a3.html

    Within just a few years the FICA taxes will only cover 73% of Social Security distributions.

    In order to have any cash to invest, FICA taxes would have to be raised from current 12.3% to higher than 16.8%. Is anyone suggesting that will happen?

    Of course, that current and future shortfall doesn’t include the even larger shortfall projected for Medicare.

    As I see it, any increase in taxes would have to be used for the current and projected shortfalls for both Social Security and Medicare. There simply will not be any cash to invest. Just as there is no cash to invest right now.

  4. Mark Miller says:

    Yes, it is a “thought exercise” in the main. You might find the Burtless paper interesting – I provide a link in the article.

    Just a couple other things. First, it’s worth noting that the trust funds are invested in Treasury notes, not just sitting in the Treasury general fund.

    Second- the new trustee report issued yesterday states that total income, including interest, to the combined OASDI Trust Funds amounted to $957 billion in 2016. ($836 billion in net contributions, $33 billion from taxation of benefits, and $88 billion in interest) Total expenditures from the combined OASDI Trust Funds amounted to $922 billion in 2016 – that includes administrative cost. Social Security paid benefits of $911 billion in calendar year 2016.

    There is no reason to ignore interest income and taxation of benefits when weighing this. So benefits are not yet larger than total income.

    Not disputing your basic point, however – which is that there is a long-range solvency problem. That’s obviously the case.

    Would we ever raise taxes to create permanent solvency? Or, to expand benefits -as I think we should do? Not likely now, but you never know.

  5. John Dewey says:

    Mark,

    I’m not sure you understand Social Security accounting.

    All those Treasury notes you apparently consider to be investments are just IOU’s that future taxpayers will have to repay. There is no investment of Social Security Trust Fund cash and there never has been.

    FICA taxes are most definitely deposited directly into the U.S. Treasury General Fund. That’s been happening since 1939. And any time FICA tax collections have exceeded Social Security benefits, Congress has used the cash for other purposes.

    So what are the special purpose Treasury Securities which you apparently believe to be investments? Those are simply promises by the federal government that future taxpayers will fund Social Security. And all the “interest” accumulated on those promises – or investments, as you call them – is simply an increase in those promises that future taxpayers will fund Social Security.

    So how will future taxpayers meet those promises to pay future Social Security benefits? Exactly the same way they would fund future Social Security benefits if the special purpose Treasury Securities did not exist. They will have to either pay more taxes or reduce benefits. (Or perhaps sell assets owned by the U.S. government. Would U.S. taxpayers sell Yellowstone to Disney in order to pay future retiree benefits?)

    There is no cash in the Social Security Trust Fund, and there are no investments in that fund which could be sold to raise cash.

    So, please, think this through. If the Social Security Trust Fund has no cash and cannot raise cash, how does it “fund” future Social Security benefits?

    The only way to evaluate the real solvency of Social Security is to analyze the cash flows. And the cash flows are simply FICA taxes coming in and Social Security benefits going out. The Social Security Administration adds to that the cash generated by income taxes on Social Security. But that tiny amount is not dedicated by law to Social Security. Buteven if you included that tiny amount (tiny relative to benefits being paid), Social Security is currently cash flow negative. And it will get much worse long before 1934.

  6. Mark Miller says:

    I don’t need to think this through; it’s a tired, false argument that I’ve been hearing for years. Referring to the new trustee report (and I could refer to every one previous), Section III A. 1):

    “By law, the Department of the Treasury must invest trust fund reserves in
    interest-bearing securities backed by the full faith and credit of the United
    States Government. Those securities currently held by the OASI Trust Fund
    are special issues, that is, securities sold only to the trust funds. These special
    issues are of two types: short-term certificates of indebtedness and longerterm
    bonds. Daily receipts are invested in the short-term certificates of
    indebtedness which mature on the next June 30 following the date of issue.
    The trust fund normally acquires long-term special-issue bonds when special
    issues of either type mature on June 30 and must be reinvested. The amount
    of long-term bonds acquired on June 30 is equal to the amount of special
    issues maturing (including accrued interest earnings), plus tax receipts for
    that day, less amounts required to meet expenditures on that day.

    Section 201(d) of the Social Security Act provides that the obligations issued
    for purchase by the OASI and DI Trust Funds shall have maturities fixed
    with due regard for the needs of the funds. The usual practice has been to
    reinvest the maturing special issues, as of each June 30, so that the value of the securities maturing in each of the next 15 years are approximately equal.
    Accordingly, the Department of the Treasury, in consultation with the Chief
    Actuary of the Social Security Administration, selected the amounts and
    maturity dates of the special-issue bonds purchased on June 30, 2016, so that
    the maturity dates of the total portfolio of special issues were spread evenly
    over the 15-year period 2017 through 2031. The bonds purchased on that
    date have an interest rate of 1.875 percent, reflecting the average market
    yield, as of the last business day of the prior month, on all of the outstanding
    marketable U.S. obligations that are due or callable more than 4 years in the
    future. Table III.A7 shows additional details on the investment transactions
    during 2016, including the amounts of bonds purchased on June 30, 2016.”

    Enough here, John. If you want to push this IOU nonsense, do it on your own website.

  7. Darryl Depew says:

    Many people mistakenly believe Social Security is a retirement system similar to FERS, Nevada PERS, or a 401(k). The U.S. Supreme Court ruled in Helvering v. Davis (1937) that Social Security taxes paid by the employer and employee (two separate taxes that happen to be at the same rate) go directly into the [US T]reasury and are not earmarked in any way. Translated – Social Security monies collected are not deposited into the so-called “Trust Fund.” Congress must appropriate funds to pay Social Security benefits.

  8. Lawrence Tagrin says:

    Social Security is currently secure. It’s future can be secured forever with two simple changes:

    1. Remove the cap. At the current time all income about about $118,000 is exempt from Social Security.

    2. Make ALL income, including profits from stocks and bonds and dividends subject to the social security tax.

    Problem solved.

  9. This is not about helping SSA or regular people.
    With a market based on supply and demand, if a lot of SSA money, and it would be a lot, were suddenly thrown into the market, all the current stock holders would see their shares go up dramatically in price. There are only some many companies in the markets after all. Given that most people that own stocks are well to do, this is really just a great case of the rich coming up with an argument to sell to regular people in order to make themselves more money. Think about all the consequences of this not just the potential for some future gain for regular people over time. The immediate benefit if this happened would be stock brokers getting easy commissions and the ones that already own the stock that would have to be bought in such a scheme.

  10. Mark Miller says:

    Tom, as noted in the story, the Burtless paper estimates”that if Social Security had begun investing in the stock market in 1984 or 1997, the program would own less than 4% of the market today; by comparison, state and local pension plans currently hold about 6% of total equities.”

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