Investing a portion of the Social Security Trust Fund’s assets in stocks has always had a distinct appeal. Because equity investments have higher expected returns than safer assets, Social Security may need less tax increases or benefit cuts to achieve long-term solvency. Equity investments, on the other hand, carry greater risks, raising concerns about interference with private markets and misleading accounting that suggests governments can create wealth simply by issuing bonds and buying stocks.
The real world provides compelling examples of how governments can invest in stocks in a smart way. Canada has large actively managed funds that follow fiduciary standards and employ conservative return assumptions. In the United States, much like the Federal Thrift Savings Program, in which the government plays an essentially passive role, the Rail Retirement Plan is also invested in a wide range of assets without interfering with the private market.
But does proven success mean that equity investments should be part of the social security solution? Two developments suggest that time may have passed.
First, a prerequisite for such activities is a trust fund with a large amount of assets to invest. The social security trust fund created by the 1983 reform is rapidly heading towards zero. Restructuring the trust fund would require tax increases to cover the current costs of the program and to generate an annual surplus to build up the trust fund’s reserves.
The problem is that the cost curve is flattening, so even if Congress were to raise the payroll tax rate by 4 percentage points from 2030 (roughly the amount needed to pay benefits over the next 75 years), it would only generate a small temporary surplus followed by a cash flow deficit. For context, these surpluses are less than 40 percent of the surplus created by the 1983 law (see Figure 1).
Of course, should action be taken long before 2030, the combination of current trust fund balances and the immediate surplus generated by tax increases could result in meaningful accumulation. However, it is not clear whether the political will to make such a move exists.
The second development concerns intergenerational equity. By increasing the tax before the end of the baby boomer generation, it became a mechanism to equalize the burden between generations. Workers in 1980 had to pay 11% of their taxable income to cover program costs, and workers in 2050 were expected to pay 17%. It makes sense to pay a little more for workers in 1980 and a little less for workers after that. But now costs have leveled off. In 2030, the labor cost rate will be 16%, and in 2100, the labor cost rate will be 18%. Costs are set to flatten out, so there is no dispute that today’s workers should pay more to build trust funds so that tomorrow’s workers will be paid less.
The bottom line is that while it has proven feasible, safe and effective for governments to invest trust fund assets in equities, it may not be feasible or wise to rebuild trust funds at this time.