A detailed new analysis published by the Center for Retirement Research at Boston College finds that investing part of Social Security's reserves in equities represents a "feasible, safe and effective" means of improving the program's financial standing.
As the report warns, however, Social Security's primary trust fund used to pay retirement benefits is "careening towards zero" — and rebuilding the fund in order to create an investment program may not, in the end, be wise or feasible.
The striking new analysis was developed by Alicia Munnell, director of the Center for Retirement Research at Boston College, alongside Michael Wicklein, a research associate.
As the researchers explain, investing part of Social Security's reserves in equities has obvious appeal. A higher return over the traditional investment into government bonds would mean fewer tax hikes or benefit cuts to achieve solvency.
But, as the authors acknowledge, critics of this approach also have an important point, starting with the fact that equity investments involve greater risk and raise concerns about interference in private markets — and about "misleading accounting that suggests the government can get rich simply by issuing bonds and buying equities."
Ultimately, Munnell and Wicklein conclude, the real-world experience of other government retirement programs suggests that equities could work for Social Security, but the time may have passed for such an approach to be realistic.
Why Invest Social Security in Stocks?
As Munnell and Wicklein observe, the major attraction of equity investment is that it has a higher expected rate of return relative to safer assets, such as Treasury bonds or bills. By using equity investment as part of a holistic reform approach, the argument goes, restoring balance to Social Security would require less in tax increases or benefit cuts.
According to the Congressional Budget Office, Social Security faces a shortfall equal to 4.9% of taxable payroll over the next 75 years. This shortfall is equal to 1.7% of GDP over that time.
The CBO's projections posit that restoring solvency would require the equivalent of reducing projected benefits immediately and permanently by 26% or increasing dedicated taxes by 40%. By 2096, according to the CBO, the cash shortfall will rise to 7.4% of taxable payroll, the equivalent of 2.5% of GDP.
A bill introduced in the House in February, the Social Security and Medicare Lock-Box Act, would allow riskier investments with trust fund assets, though it does not specify what kinds of investments. Advocates for retirees say this approach would put retirement funds at risk, especially during down markets.
Munnell and Wicklein note that efficient risk-sharing across a lifecycle requires individuals to bear more financial risk when young and less when old, and since the young have little in the way of financial assets, investing the trust fund in equities is one way to achieve that goal.
Canada's Experience
Acknowledging that both proponents and critics have strong arguments in their favor, the researchers proceed to review the experiences of three retirement programs that already utilize equity investments — the Canada Pension Plan, the U.S. Railroad Retirement system and the Federal Thrift Savings Plan.
The Canada Pension Plan, the major component of Canada's retirement system, was initially set up in 1966 as a pay-as-you-go plan with a modest reserve, similar to the U.S. Social Security program. Also like the U.S. system, demographic change began to put significant pressure on the CPP, raising the prospect of rapidly rising payroll contribution rates going forward.
To improve fairness across generations and ensure the long-term financial sustainability of the plan, Canada enacted legislation in 1997 that increased payroll contributions to its projected long-term rate and began investing some of the fund accumulations in equities.
To implement the investment strategy, the 1997 legislation created the CPP Investment Board, organized as a government-owned corporation managed independently from the CPP itself and operates at arm's length from governments. The board has since built a broad-based portfolio that includes not just investments in stocks and bonds, but also real estate, infrastructure projects and private equity.
As Munnell and Wicklein observe, the Canadian experience is "impressive and even enviable," but it most likely involves more quasi-government investment activity than Americans could tolerate.
"The bottom line is that the Canadian investment initiative has paid off, while addressing the concerns of critics," they write. "Investments represent a small share of the Canadian economy; they are governed by strict fiduciary standards; the board uses its influence in the private sector only to enhance long-run returns; and the assumed investment returns used for evaluating the solvency of the CPP are on the conservative side."
A U.S. Example
Turning stateside, the researchers look primarily at the Railroad Retirement program, a relatively small plan that also boasts a broad investment portfolio.
As the paper recalls, Congress created the Railroad Retirement system in 1934, when it took over the rail industry's tottering pension plan. The program was funded on a pay-as-you-go basis financed by a payroll tax on workers and employers. It started with a modest trust fund with assets invested solely in government bonds.
