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Social Security: A Primer September 2001

Some proposals for Social Security reform envision having the government issue debt and invest the proceeds in corporate stocks. Such a policy raises concerns about possible government interference in corporate decisionmaking (discussed in Chapter 4). It also raises questions about how such investments would affect the overall economy. Those economic effects are uncertain, however, because they would ultimately depend on how future Congresses allocated the risks and the returns of stock investments among various people.

Such a policy would essentially represent a swap of assets between the public and private sectors. The government would buy shares of stock from private investors and issue Treasury bonds of the same value. Other things being equal, such an exchange cannot create wealth for the government: the value of the stocks in the government's portfolio would exactly match the value of the bonds that it sold to the public.

The investment policy would affect the economy only to the extent that it redistributed income. That redistribution could either increase or decrease saving depending on how the government reallocated the income from the investments. If, for example, current generations received higher benefits when the stock market did well but did not receive lower benefits when the market soured, government investments in stocks would redistribute income toward current generations. That would encourage current consumption, reducing national saving and future gross domestic product.⁽¹⁾ Current generations would be better off because of such a policy, but future generations would be worse off.

The government could also redistribute investment income to people who do not own stocks now.⁽²⁾ However, the economic impacts of such a policy are uncertain. On one hand, that redistribution could raise interest rates, which might cause some people to save more.⁽³⁾ On the other hand, it would increase the income of people who save but do not own stocks, which could cause some of those people to save less. The latter effect could be significant: by one estimate, it could cause the private stock of capital to decline by 50 cents for each dollar invested by the Social Security trust funds.⁽⁴⁾

Some people argue that because the government could pool the risks of stock investments broadly over time and among people, it could bear such risks at less cost than individuals can. However, that argument ignores the fact that people already implicitly share the risks and rewards of stock market investments through the income tax system. Indeed, some of the recent improvement in the federal budget can be traced to the rise in the stock market and the resulting revenues from capital gains realizations. Explicit stock investments might produce no additional benefit. Moreover, to pool risks, the government would have to distribute stock losses as well as gains to people who do not hold stocks now. There are doubts that the government would really do that, especially since many of those people have low income.

In addition to the effects on saving and risk sharing, government investments in the stock market could raise interest rates on government debt and reduce returns on stocks. Those possibilities stem from the fact that to induce private investors to buy additional government bonds instead of stocks, interest rates on bonds would have to rise relative to those on stocks.

1. Kent Smetters, Investing the Social Security Trust Fund in Equities: An Option Pricing Approach, Technical Paper 1997-1 (August 1997), available from CBO's Macroeconomic Analysis Division or at www.cbo.gov/tech.html.

2. People may not own stocks for a variety of reasons, including transaction costs (the explicit charges associated with buying or selling stocks as well as the implicit costs of acquiring information about the stock market).

3. Peter Diamond and John Geanakoplos, Social Security Investment in Equities I: Linear Case, Working Paper No. 7103 (Cambridge, Mass.: National Bureau of Economic Research, April 1999).

4. Andrew B. Abel, "The Effects of Investing Social Security Funds in the Stock Market When Fixed Costs Prevent Some Households from Holding Stocks," American Economic Review, vol. 91, no. 1 (March 2001), pp. 128-148.

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