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The Case for Equity Investment in Social Security: A Reevaluation

August 18, 2023
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Investing a portion of the Social Security trust fund’s assets in equities has always been an enticing proposition. The allure lies in the higher expected returns associated with equity investment, potentially reducing the need for tax increases or benefit cuts to ensure the long-term solvency of the program. However, this approach also comes with its fair share of risks, including concerns about government interference in private markets and the potential for misleading accounting practices that could mistakenly suggest that the government can amass wealth simply by issuing bonds and purchasing equities.

While these concerns are valid, looking at real-world examples provides a compelling argument for governments to invest in equities in a responsible manner. For instance, Canada manages a substantial actively managed fund, adhering to fiduciary standards and adopting conservative return assumptions. Similarly, the United States’ Railroad Retirement system and Federal Thrift Savings Plan have successfully invested in a diverse range of assets without interfering in the private market, with the government playing a passive role.

However, we must ask ourselves whether equity investment remains a viable solution for Social Security today. Two significant developments suggest that the time for such an approach may have passed.

The Prerequisite: A Trust Fund with Substantial Assets

The success of equity investment hinges on having a trust fund with significant assets available for investment purposes. Unfortunately, Social Security’s trust fund, which originated from the 1983 amendments, is rapidly depleting and is projected to reach zero in the near future. To rebuild such a trust fund, it would require a tax increase to cover both the program’s current costs and generate an annual surplus to replenish reserves.

Read: Social Security could have been saved — is it too late to undo the damage?

Considering this challenge, it raises questions about the feasibility of implementing equity investment as part of the solution for Social Security.

Read: Congressional Republicans want big cuts to Social Security

The Challenge of Rebuilding Social Security Trust Fund

The sustainability of Social Security has been a topic of concern in recent years. The cost curve has flattened, posing a problem for the future of the program. Even if Congress were to raise the payroll tax rate by 4 percentage points starting in 2030, which is roughly the amount needed to cover benefits for the next 75 years, it would only lead to small temporary surpluses followed by cash-flow deficits. However, it’s important to note that these surpluses would be significantly less than those generated by the 1983 legislation (see Figure 1).

In the unlikely event that action is taken before 2030, there could be a meaningful accumulation of funds due to the combination of current trust fund balances and the immediate surpluses resulting from the tax increase. However, it remains uncertain whether there is enough political will to make such a move.

The Issue of Intergenerational Equity

Another development to consider is intergenerational equity. Historically, raising taxes ahead of the retirement of the baby boomer generation helped distribute the burden evenly across different generations. In 1980, workers needed to contribute 11% of their taxable earnings to cover program costs, while in 2050, this percentage was scheduled to rise to 17%. This approach made sense as it allowed earlier workers to pay slightly more, enabling later workers to pay slightly less. However, with costs now leveling off, the argument for present-day workers paying more to build up a trust fund for future workers becomes less compelling. By 2030, workers will face a cost rate of 16%, and by 2100, this rate will rise to 18%.

In conclusion, while investing trust fund assets in equities has proven to be feasible, safe, and effective, rebuilding the trust fund at this particular time may not be either feasible or wise. The changing cost dynamics and the need to consider intergenerational equity pose significant challenges that must be carefully considered moving forward.

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Tags: Equity InvestmentGovernment InterferenceSocial SecurityTax IncreaseTrust Fund
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