United States General Accounting Office

GAO Testimony

Before the Special Committee on Aging, U.S. Senate

For Release on Delivery

Expected at

1 p.m.

Wednesday,

April 22, 1998

SOCIAL SECURITY

FINANCING

Implications of Stock

Investing for the Trust Fund,

the Federal Budget, and the

Economy

Statement of Barbara D. Bovbjerg

Associate Director, Income Security Issues

Health, Education, and Human Services Division

GAO/T-AIMD/HEHS-98-152

Mr. Chairman and Members of the Committee:

Thank you for inviting me to speak about the implications of stock

investing for the Social Security program. Social Security faces a long-term

financing shortfall—by 2029, it will only be able to pay about 75 percent of

promised benefits. In order to address this shortfall, investing in the stock

market has been proposed along with other reform options. Stock

investing could potentially improve the investment earnings on retirement

funds. Some reform proposals would fundamentally alter Social Security’s

structure to allow individuals to invest on their own behalf. Others would

maintain the current program structure, permitting the government to

invest some of Social Security’s funds in the stock market. Regardless of

ownership, investing in stocks or other assets outside of the government

would be a new concept for Social Security.

You asked me to discuss the government stock investing option, the

subject of a report we just completed for you.1

 More specifically, I would

like to focus my remarks on (1) the implications of government stock

investing for the Social Security trust fund,2

 (2) the impact of stock

investing on the federal budget and national saving, and

(3) implementation issues related to selecting and managing a stock

portfolio that could affect the degree of government involvement in

corporate affairs. Throughout this discussion, I will also touch upon

important ways in which the government stock investing approach

contrasts with the alternative of individual accounts.

Our report on government stock investing did not address any specific

Social Security reform proposals. Instead, as discussed with Committee

staff, we studied changing trust fund investment policy in isolation from

any other program changes in Social Security. Although my testimony is

based primarily on our report on government stock investing, it also draws

on other work we have done on Social Security reform and budget issues.3

In summary, government stock investing is a complex proposal that has

potential consequences for Social Security, the federal budget, and

1

Social Security Financing: Implications of Government Stock Investing for the Trust Fund, the Federal

Budget, and the Economy (GAO/AIMD/HEHS-98-74, April 22, 1998).

2

The Social Security trust fund consists of two separate accounts: Old-Age and Survivors’ Insurance

(OASI), which funds retirement and survivor benefits, and Disability Insurance (DI), which provides

benefits to disabled workers and their families.

3

A list of related GAO products appears at the end of this statement.

Page 1 GAO/T-AIMD/HEHS-98-152
national saving. It also differs in key ways from proposals to establish

individual accounts.

For the Social Security trust fund, government stock investing offers the

prospect of higher returns but, by itself, is unlikely to solve the program’s

long-term financial imbalance, and it would be accompanied by greater

risk. The key distinction between stock investing through the government

and through individual accounts is that under government stock investing,

the risks and returns would be shared collectively through the government

rather than borne individually. More generally, individual accounts

proposals would alter Social Security’s current structure and scale back

the income redistribution aspect of the current program.

From a budget perspective, shifting a portion of trust fund assets into the

stock market would raise deficits or diminish surpluses in the short term

but would not significantly affect national saving. While government stock

investing by itself has no direct effect on saving, it indirectly could prompt

actions to raise saving by revealing the size of federal deficits excluding

Social Security’s temporary surpluses.

Implementing a government stock investing proposal would raise issues

about stock selection, administrative costs, and shareholder voting rights

that, conceptually, do not pose major obstacles. However, some of these

issues could raise concerns about increased government influence over

the private sector.

Background The Social Security system is largely a pay-as-you-go system under which

each current working generation pays for the benefits of the retired

generation. Under a pure pay-as-you-go system, annual tax revenues

roughly match each year’s benefits, while allowing for a contingency

reserve to weather short-term economic downturns. However, as a result

of previous financing reforms, Social Security currently receives more

cash revenue each year than it needs to pay current benefits, which is

building up the trust fund’s balance beyond the amount needed as a

contingency reserve.4

4

In our work, we relied on data and actuarial projections from The 1997 Annual Report of the Board of

Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds. We

used the intermediate assumptions, which reflect the Board of Trustees’ best estimate. Due to the

inherent uncertainty surrounding long-term projections, the Trustees’ report also includes two other

sets of assumptions, a high cost and a low cost alternative.

Page 2 GAO/T-AIMD/HEHS-98-152
By law, the Social Security trust fund currently invests solely in U.S.

government securities—a policy that dates back to the program’s origin in

1935 and is intended to ensure the safety of the trust fund’s assets. Interest

on the trust fund’s Treasury securities is credited in the form of additional

securities, which add to the trust fund’s balance available to finance future

benefits. By 2012, Social Security’s annual tax revenues are expected to be

insufficient to cover its benefit payments. To cover the cash shortfall, the

trust fund will begin drawing on the Treasury, first relying on its interest

income and eventually drawing down its assets. The Treasury will need to

raise the required cash through some combination of borrowing from the

public,5

 spending cuts in other federal programs, or revenue increases.

A number of Social Security reform proposals would make the trust fund

buildup even larger and other proposals would create individual accounts

that would also build up the size of retirement funds. The prospect of

building up retirement funds has brought increased attention to stock

market investing. On either publicly or privately held retirement funds,

potentially higher investment earnings could help provide retirement

income and complement other Social Security reforms. The larger the

retirement funds, the more investment earnings they would have and the

more the rate of return on investments matters. Under current policy, the

buildup occurring in Social Security is relatively small in comparison to

the program’s expected future costs; therefore, the rate of return received

on investments has been less important.

To assess the implications of changes in investment policy and other

reforms, it is important to understand how Social Security fits within the

federal budget. Although the Social Security trust fund is technically

excluded from the budget, its finances contribute to the government’s

impact on the economy. Therefore, Social Security is included, along with

all other federal programs, in the commonly used “unified” budget

measure. The unified budget is the means used to measure the

government’s current draw on financial markets. However, in considering

the long-range implications of federal policies, it is also useful to consider

the impact that Social Security’s temporary surplus has on the

government’s unified budget. By reducing the Treasury’s need to borrow

from the public to finance government spending, Social Security’s current

5

If the unified budget were in surplus, then financing the excess benefits would require less debt

redemption, rather than increased borrowing.

Page 3 GAO/T-AIMD/HEHS-98-152
cash surplus partially offsets the deficit in the rest of the government’s

accounts.6

Social Security has an important influence on the government’s overall

fiscal position, which, in turn, affects national saving, a key determinant of

long-term economic growth.7

 Raising saving and investment levels above

today’s relatively low levels would improve the long-term productivity of

the economy, thereby boosting economic growth. A more robust economy

would make it easier for future workers to meet the dual challenges of

paying for the baby boomers’ retirement and achieving a rising standard of

living for themselves.

Social Security reform proposals that permit stock investing use one of

three basic approaches. In the first, the government would own and

control the Social Security trust fund’s investments. In the second, the

government would manage individually owned accounts. Such accounts

might resemble the federal employees’ Thrift Savings Plan (TSP). For TSP,

Congress established several indexed investment options, and TSP

participants allocate their balances among these options. In the third

approach, individuals could control and manage their own accounts with

greater discretion over how to invest them. These accounts might

resemble existing individual retirement accounts (IRAs).

Balancing Returns

and Risks

Stock investing is one option to increase the trust fund’s revenue but, by

itself, it is not the solution to Social Security’s financing problem. Higher

investment returns could extend Social Security’s long-range solvency

somewhat, but their effectiveness is limited as long as the program

remains largely pay-as-you-go. Also, in exchange for the prospect of higher

returns, the Social Security trust fund would have to take on greater risk.

This risk/return trade-off would also apply to individual accounts

proposals, but it would apply to each worker individually rather than to all

workers collectively as under government stock investing.

In our report, we developed two scenarios to illustrate potential effects on

the trust fund of investment in the stock market assuming no other

program changes. Under our more aggressive scenario, the trust fund

would invest both its projected annual cash surplus and interest in the

6

Interest credited on the trust fund’s Treasury securities has no current effect on the unified federal

deficit because it is a payment from one part of the government to another part.

7

National saving is composed of the private saving of individuals and businesses and saving (surplus)

or dissaving (deficit) of all levels of government.

Page 4 GAO/T-AIMD/HEHS-98-152
stock market, while maintaining a contingency reserve of special Treasury

securities equal to at least the next year’s expected expenditures. Under

our alternative scenario, the trust fund would invest only the cash surplus,

and Social Security’s cash deficit, beginning in 2012, would be financed

from stock earnings and sales. At our request, the Social Security

Administration’s (SSA) Office of the Chief Actuary simulated the potential

outcomes of our two scenarios using the Social Security Trustees’ 1997

intermediate actuarial assumptions and the 1994-1996 Advisory Council on

Social Security’s assumptions about stock returns and administrative

costs. (See attachment I for more details.) The results of these simulations

illustrate some outcomes associated with two investment alternatives;

they should not be interpreted as forecasts and are not intended to

represent the full range of possible outcomes for the Social Security trust

fund.

Higher investment returns would allow the trust fund, even without other

program changes, to pay benefits longer before depleting its assets. Under

the more aggressive scenario, assuming the historical average stock

return, the trust fund’s exhaustion could possibly be delayed by about a

decade, from 2029 to 2040. This potential delay well into the baby

boomers’ retirement years would result only from the Social Security trust

fund investing aggressively in the stock market. The trust fund would

invest more than 70 percent of its assets in the stock market, which would

be a dramatic shift from investing solely in Treasury securities. Under the

cash surplus scenario, still assuming the historical average return, the

possible delay in the trust fund’s exhaustion would be only 3 years. The

possible extension of the trust fund’s solvency resulting from any stock

investment scenario would be significantly shorter if the future stock

returns are lower than the historical average of 7 percent after inflation.8

Moreover, if the return on stocks over the next 20 or 30 years averages less

than the expected return on Treasury securities, the trust fund would be

exhausted sooner than in 2029, exacerbating Social Security’s long-term

financial imbalance.

The only way for the Social Security trust fund to earn the higher returns

possible with stock investing is to take on greater risk. The trust fund

would be particularly vulnerable to losses in the event of a general stock

market downturn if stock investing is implemented in isolation from other

program changes. Just as it will have to draw down its Treasury securities

to cover Social Security’s cash shortfall, the trust fund will have to

8

As an illustration, if the future return on stocks is 1 percentage point lower, the delay in the trust

fund’s exhaustion under the aggressive scenario would be reduced to only 6 years. The delay under the

cash surplus scenario assuming the real return is 1 percentage point lower would be 2 years.

Page 5 GAO/T-AIMD/HEHS-98-152
liquidate its stocks to pay benefits. Riding out a stock market downturn

could be difficult for the trust fund as it faces growing numbers of retirees.

The more the trust fund is counting on stock sales to raise cash, the

greater its vulnerability in the event of a general market downturn. In

contrast to our scenarios, reform packages that include stock investments

along with other changes to Social Security typically envision that the

Social Security trust fund would hold its stock portfolio and mainly draw

on its stock earnings. In this context, the trust fund would be less

vulnerable to the risk inherent in liquidating stocks to pay promised

benefits.

Caution is warranted in counting on future stock returns in designing

Social Security reform. Historically, returns on stocks have exceeded

returns on Treasury securities over the long term, averaging about

7 percent after inflation. However, an average over nearly a century

obscures the reality that stock returns fluctuate substantially from year to

year. Over the past 70 years or so, stock returns were negative in nearly 1

out of 4 years. There is no guarantee that investing in the stock market,

even over 2 or 3 decades, will yield the long-term average return. However,

even if future stock returns are lower than the historical average of

7 percent, the conventional wisdom is that stock returns would be higher

than those on Treasury securities over the long term. How much higher is

uncertain. Indeed, investing in the stock market would not ensure a higher

return than might be possible investing in bonds. The stock market could

drop and stay depressed for a prolonged period of time.

With government stock ownership, the risk and potential returns would be

shared collectively by workers and beneficiaries. As shown in our

simulations, any gain would extend the trust fund’s solvency and thus

reduce the size of benefit cuts or tax increases that would otherwise be

required. On the other hand, any shortfall might require further benefit

cuts or tax increases. The distribution of any gains or losses across

workers and beneficiaries would ultimately depend on the structure of the

Social Security program and any changes to it.

For any system of individual accounts, the risk of stock investing would be

borne by those individuals who chose to invest in the stock market.

Reform proposals that use government managed accounts would

constrain investment choices to reduce the risks that individuals could

take and, thereby, could also moderate their returns. In contrast, under

proposals that place few restrictions on investment choices, investors

could take much greater risks and potentially earn greater returns. In

Page 6 GAO/T-AIMD/HEHS-98-152
either case, individuals would benefit directly from any higher returns, and

their retirement income would vary depending on their investment

decisions and the timing of their investments. Some individuals could do

very well under such an approach, but others could experience a

significant drop in their expected retirement income. Those who are

reluctant to invest in the stock market, such as appears to be the case with

lower income individuals, may not benefit from the potentially higher

returns of stock investing.

Focusing on the risks associated with stock investing in isolation ignores a

significant impact that individual accounts proposals would have on other

risks individuals would face. Individual accounts proposals would

fundamentally alter the role of Social Security as a social insurance

program and focus instead on providing a vehicle for retirement savings.

Under a social insurance model, the government tries to help insure

adequate income by largely taking responsibility for a wide variety of risks

that individuals face. They face some risks individually, such as how long

they will be able to work, how long they will live, whether they will be

survived by spouses or dependents, and how much their lifetime earnings

will be. They also face some risks collectively, such as the performance of

the economy and inflation. Social insurance tends to minimize such risks

to individuals. In the process, Social Security redistributes income in a

variety of ways—for example from high to low earners—and lowers the

rate of return some workers earn on their retirement contributions. In

contrast, under an individual retirement savings model, individuals could

have greater freedom and control over their income and have more to gain

or lose from their own choices but they could face many of these risks

alone.

Effects of

Government Stock

Investments on the

Federal Budget and

National Saving

In the short term, under current budget scoring rules, government stock

investing would increase reported budget deficits or decrease budget

surpluses because stock purchases would be treated as outlays.9, 10 Each

dollar invested in stocks is a dollar no longer available to the Treasury to

finance other government spending or reduce debt held by the public.

Depending on how much the trust fund were to invest in stocks, the

change in the reported deficit/surplus could exceed $100 billion annually.

9

Stock investing could also prevent a budget surplus from materializing, depending on the size of any

expected surplus and the amount that the Social Security trust fund invests in stocks.

10While stock purchases would be treated as outlays under current budget scoring rules, such rules

could be changed for stock investing. However, such a change would conflict with the way most other

asset purchases are treated in the budget and it would raise some complicated technical issues. If,

despite these considerations, stock purchases were not counted as outlays, stock investing would have

no major impact on the reported budget deficit/surplus.

Page 7 GAO/T-AIMD/HEHS-98-152
If, after accounting for this effect, the government were in deficit, the

Treasury would have to borrow more from the public, unless action were

taken to reduce other spending or raise revenues. If, instead, the

government were running a budget surplus, the Treasury would have less

cash available to reduce debt held by the public. To the extent that

individual accounts proposals redirect existing payroll tax revenues into

private accounts, the budgetary impact would be similar to the impact of

government stock investing.

Over the long term, the impact of government stock investing on reported

budget deficits/surpluses could largely be neutral. While stock purchases

would mean money flowing out of the government, any stock sales would

bring money into the government. So, when Social Security begins running

cash deficits in the future, it could sell stocks to finance benefits, rather

than drawing on the Treasury. This approach would result in smaller

future budget deficits or larger future budget surpluses than under current

policy. This longer-term improvement could offset the near-term

deterioration in the deficit/surplus. If stock earnings were to exceed any

increase in federal borrowing costs that might result from a stock

investing policy, there could be at least a slight benefit for the budget.

However, any improvement in the government’s position would result

from capturing a portion of stock returns that would otherwise have

accrued to private investors.

The long-term impact of individual accounts proposals on budget

deficits/surpluses would be different than the impact under government

stock investing. Money would flow out of the government to fund the

accounts, but it would not flow back in because the accounts would be

owned by individuals, not the government. Recognizing this dynamic,

individual accounts proposals typically would reduce the size of the

guaranteed benefit provided by Social Security, which would reduce

future government spending. The net outcome on future deficits/surpluses

would depend on the specific provisions of the individual accounts

proposal.

Despite the budget reporting effects, government stock investing would

have no significant impact on national saving. Although any federal

borrowing from the public to finance stock purchases would absorb

money from capital markets, the stock investments themselves would add

money to the markets, offsetting the effect of the additional borrowing.

This exchange between the government and the financial markets would

constitute an asset shuffle among investors—the Social Security trust fund

Page 8 GAO/T-AIMD/HEHS-98-152
would buy some stocks from private investors and private investors would

buy more Treasury securities from the government. This asset shuffle

would likely be accompanied by changes in bond and stock prices that

might, to some extent, undercut the government’s expected gain on stock

investments and increase the government’s cost of borrowing. The

magnitude and duration of these price changes in the stock and bond

markets is uncertain and could be small.

The fact that government stock investing does not significantly affect

saving is important. It means that any higher returns earned by the Social

Security trust fund would be offset by lower returns earned by other

investors, who would hold fewer stocks and more bonds in their

portfolios. A similar result could apply to some individual accounts

proposals. Redirecting a portion of current payroll taxes from the Social

Security trust fund into individual accounts, without any other changes in

Social Security benefits or revenues, would have no appreciable effect on

national saving. Some individual investors would undoubtedly achieve

higher returns by investing in the stock market but, without any additional

resources available for investment, others would receive lower returns. In

short, simply altering the ownership of financial assets among investors

would not boost national saving and long-term economic growth.

While stock investing, by itself, does not have a significant effect on

national saving, the higher reported budget deficits or lower surpluses

could indirectly lead to fiscal changes that could boost saving. By reducing

the Treasury’s available cash, stock investing would make more visible the

underlying condition of the government’s finances excluding the Social

Security surplus. Policymakers could react to a higher unified deficit by

cutting spending and/or raising taxes. Such fiscal restraint could

contribute to a higher level of national saving. Or, if instead of contributing

to a unified deficit, stock investing were to reduce an anticipated unified

surplus, policymakers might be reluctant to enact tax cuts or additional

spending. In this case, fiscal restraint might not promote higher saving, but

it would avoid policy actions that could cause saving to decline.

Though stock investing could help highlight the budget shortfall that exists

when Social Security’s surplus is excluded, it represents a circuitous way

of essentially duplicating an existing measure—the on-budget deficit.11 If

policymakers wanted to take actions to boost national saving, they

certainly could do so directly by running annual surpluses in the unified

11The on-budget deficit, which excludes Social Security, is the budget measure that is used as the basis

for the budget controls under the Budget Enforcement Act. However, it is not as commonly used as the

unified budget measure, which best reflects the current impact of federal finances on the economy.

Page 9 GAO/T-AIMD/HEHS-98-152
budget and devoting the surplus funds to reducing the level of outstanding

debt held by the public. If the government ran a unified budget surplus

equal to Social Security’s cash surplus, the Treasury would no longer need

to rely on Social Security revenues to finance federal spending on other

activities. While attaining and sustaining surpluses could prove extremely

challenging, such a policy would strengthen the fiscal position of the

government and, by promoting higher saving, better position the economy

to handle the baby boomers’ retirement costs.

Implementation

Issues Associated

With Government

Stock Investing

Government stock ownership, and to a lesser extent government

management of individual accounts, would raise certain implementation

issues, the most significant of which are stock selection and shareholder

voting rights. Conceptually, these issues do not pose major obstacles.

However, they could prove controversial to resolve because critics have

expressed concern about increased government involvement in financial

markets and corporate affairs.

For stock selection, proponents of government stock investing typically

recommend investing in a broad-based stock index. An indexing approach

could reduce (1) the costs of selecting and managing a stock portfolio,

(2) the exposure to some investment risks, and (3) the likelihood of the

government controlling the corporate affairs of individual companies.

Unlike active investment managers, an index manager generally does not

incur high expenses in the process of doing research and trading

individual stocks of companies with profit potential. As a result, the costs

of managing an indexed portfolio tend to be significantly lower than an

actively managed portfolio. Most of the cost of managing an index fund is

incurred maintaining thousands of individual accounts. In contrast, the

government, as a single investor, would incur negligible costs as a

percentage of its assets. Therefore, investing collectively through the

government would result in significant administrative savings compared to

investing through individual accounts.12 However, individual accounts’

proponents argue that administrative costs would be consistent with the

costs of existing private retirement investment accounts.

12For its analysis, the Advisory Council assumed that the annual costs for government stock

investments would be only one-half of a basis point of total assets. For individual accounts proposals,

the Advisory Council assumed administrative costs of 10.5 basis points for accounts that would be

centrally managed by the government and 100 basis points for accounts that would be set up by

individuals through private financial institutions.

Page 10 GAO/T-AIMD/HEHS-98-152
Given that a broad-based indexed portfolio would represent many

different sectors of the economy and individual companies, the risk is

greatly reduced that any loss related to an individual firm or group of

companies would greatly affect the overall performance of the

government’s portfolio. However, stock index investing would be riskier

than the government’s current investment in special Treasury securities.

Indexing across the stock market does not reduce the government’s risk of

loss in the event of a general stock market downturn.

A broad-based indexing strategy would reduce the possibility of owning a

significant percentage of the stocks of an individual company, thereby

reducing the likelihood of influencing its corporate affairs. However,

indexing does not eliminate the possibility that there could be pressure for

the government to include or exclude companies based on nonfinancial

objectives. Under individual accounts proposals, these pressures would

probably be either less significant or nonexistent. Even if government

were responsible for selecting the investment options for individual

accounts, it might likely choose widely recognized indexes like it did for

TSP.

The issue of how to handle stock voting rights also must be addressed.

Critics of government stock investing have expressed concerns that the

government’s right to vote its sizable number of shares would allow it to

influence corporate decisions. To blunt such concerns, the government’s

stock voting rights could be restricted by statute, but any restriction would

need to be designed carefully. For example, simply prohibiting the

government from exercising its voting rights would favor other

stockholders or investment managers by effectively increasing their voting

rights.

These issues are somewhat different for individual accounts, depending on

the structure of the accounts. Under a proposal for individual accounts

managed centrally through the government, stock voting would likely be

delegated to external investment managers (one of the options under

government stock investing). Concerns about shifting power into the

hands of a few investment managers selected by the government could be

diminished by spreading stock investments among many different

managers. Under an alternative type of individual accounts proposal

where individuals are free to invest funds as they wish, the government

would have no influence over stock voting.

Page 11 GAO/T-AIMD/HEHS-98-152
Observations In the report we issued to you today, we looked in detail at investing a

portion of Social Security trust fund assets in the stock market. In

contrast, alternative proposals would allow individuals to invest in the

stock market. I would like to conclude with four key observations about

stock investing through the government and through individual accounts.

First, risk would be shared collectively under government stock investing,

but individually with individual accounts. By the same token, any higher

returns would also be distributed differently. Under government stock

investing, the distribution of returns among taxpayers and beneficiaries

would depend on the structure of the Social Security program and any

changes to it. Under individual accounts, the distribution of any higher

returns would vary according to each individual’s investment choices and

outcomes. Also, the degree of risk and size of potentially higher returns

would depend on the range of investment choices permitted by the

government.

Second, simply shifting assets from the trust fund into the stock market,

either through the government or individual accounts, does not by itself

increase national saving. Stock investing could indirectly prompt actions

to raise saving by revealing the size of federal deficits excluding Social

Security’s temporary surpluses. However, saving could increase directly if

reforms further build up either public or private retirement funds. Such a

build-up could result from either increasing retirement contributions or

decreasing benefits. However, even then saving would not increase if

either the government or individuals responded by reducing saving

elsewhere.

Third, administrative costs for government stock investing would be

significantly less than for individual accounts. Costs as a share of assets

are generally greater for smaller accounts than for larger ones, though

stock indexing could reduce costs for both the government and

individuals. Also, proponents of individual accounts believe that the cost

issue does not outweigh the issues associated with the government owning

and managing a sizable stock portfolio.

Fourth, critics of government stock investing have cited its potential to

increase government influence over the private sector. Stock investing by

the government could affect financial markets and raises the issue of how

to handle stock voting rights on a sizable portfolio. Under individual

accounts, such concerns would be reduced or eliminated. The government

Page 12 GAO/T-AIMD/HEHS-98-152
would only exert influence to the extent that it defines individuals’

investment options and controls shareholder voting rights.

On a broader level, individual accounts proposals would fundamentally

change Social Security in ways that are not directly related to permitting

stock investment. Some proposals would substantially reduce the role of

Social Security in helping ensure adequate income, sharing a variety of

risks, and redistributing income. Other proposals would do so to a

somewhat lesser degree.

Finally, although stock investing could delay the trust fund’s exhaustion, it

cannot fix Social Security by itself. Restoring the program’s long-term

solvency will still require difficult choices about benefit cuts and tax

increases.

This concludes my testimony. I would be happy to answer any questions.

Page 13 GAO/T-AIMD/HEHS-98-152
Attachment I 

Assumptions Used in Estimating How

Higher Returns Affect the Social Security

Trust Fund

For our report on government stock investing,1 we used simulations to

illustrate how changing the investment policy can affect the future

outcome for the Social Security trust fund. Simulations are useful for

comparing alternative investment policies within a common framework

but should not be interpreted as forecasts given the range of uncertainty

about the amount and timing of any Social Security stock investments as

well as about future stock returns and potential economic changes in

response to government stock investing. While our report discussed

potential stock investment alternatives, it did not suggest any particular

course of action, since the choice of the most appropriate investment

policy is a decision to be made by the Congress and the President.

We examined the potential effect of government stock investing in

isolation from other changes in the Social Security program. At our

request, the Social Security Administration’s (SSA) Office of the Chief

Actuary simulated the potential effect of higher returns from stock

investing on the trust fund using the Social Security Trustees’ 1997

intermediate assumptions about future program revenues and

expenditures as well as their demographic and economic assumptions. We

did not audit or validate SSA’s actuarial projections.

According to the Trustees’ 1997 intermediate estimates, the trust fund

expects to collect roughly $30 billion more in cash than is needed to pay

benefits each year from 1998 until 2008 and continue to receive some

excess cash until 2012. In addition, the interest credited on the trust fund’s

special Treasury securities was roughly $40 billion in 1997. We assumed

that the trust fund would continue to hold a contingency reserve of special

Treasury securities equal to at least 100 percent of the next year’s

expected expenditures, given that stock prices are highly variable in the

short term. Given that the trust fund’s balance now exceeds 150 percent of

its annual expenses, we assumed that the Social Security trust fund could

begin investing in the stock market in 1998. Under the Trustees’

intermediate projections, the trust fund does not anticipate that it would

need to tap its investment income and assets for nearly 15 years. By 2012,

assuming no other program changes, Social Security’s tax revenue will be

insufficient to pay benefits each year, and the trust fund will have to

finance the program’s cash deficit by drawing on its investment income

and eventually depleting its assets.

1

Social Security Financing: Implications of Government Stock Investing for the Trust Fund, the Federal

Budget, and the Economy (GAO/AIMD/HEHS-98-74, April 22, 1998).

Page 14 GAO/T-AIMD/HEHS-98-152
Attachment I 

Assumptions Used in Estimating How

Higher Returns Affect the Social Security

Trust Fund

The potential gain from stock investing would depend on what future

stock returns are. In the simulations, we used the historical average real

yield on stocks assumed by the 1994-1996 Advisory Council on Social

Security (“the Advisory Council”) in estimating future stock performance.

The 7 percent long-term historical average return on stocks is

4.3 percentage points more than the ultimate 2.7 percent yield on special

Treasury securities under the Trustee’s 1997 intermediate assumptions. In

light of the uncertainty about future stock returns, we also tested a stock

return that is 1 percentage point lower than the historical average. This

alternative return is intended only to demonstrate that stock investment

simulation results are sensitive to the rate of return assumed and does not

represent the worst or most likely return outcome for the Social Security

trust fund. We also used the Advisory Council’s assumption that the trust

fund’s annual administrative costs would be 0.5 basis points.2

Administrative costs would reduce the spread between the real yields on

stocks and Treasury securities by 0.005.3

 Based on the Trustees’ 1997

intermediate assumption for inflation, the ultimate nominal yield on

special Treasury securities would be 6.29 percent. Thus, the ultimate

nominal yields on stocks would be 10.74 percent (assuming a 7 percent

real yield) and 9.70 percent (assuming a 6 percent real yield).

The potential gain from stock investing would also depend on how much

the Social Security trust fund invests in the stock market. We developed

two stock investment scenarios: (1) an aggressive scenario investing both

Social Security’s future annual cash surplus and interest in the stock

market, while maintaining a contingency reserve of special Treasury

securities equal to at least 100 percent of the next year’s expected

expenditures, and (2) a more conservative scenario investing only Social

Security’s cash surplus. Under the aggressive scenario, the trust fund

would hold its balance of special Treasury securities constant as of the

beginning of 1998. From 1998 until 2008, all of Social Security’s cash

surplus and the interest on its special Treasury securities would be

invested in the stock market. Beginning in 2008, the trust fund would need

to begin investing more in Treasury securities to maintain a 100 percent

reserve level. Under the cash surplus scenario, the trust fund would invest

in the stock market until 2012 and then it would begin drawing on its stock

earnings and sales to finance Social Security’s cash deficit. In both

scenarios, stock earnings are reinvested in the market unless the trust

2

A basis point is 1/100 of 1 percentage point, so one-half of a basis point is 0.00005.

3

The spread over the real yields on Treasury securities would be 4.295 percent under the 7 percent real

stock return assumption and 3.295 percent under the 6 percent assumption.

Page 15 GAO/T-AIMD/HEHS-98-152
Attachment I 

Assumptions Used in Estimating How

Higher Returns Affect the Social Security

Trust Fund

fund needs cash to pay benefits or to invest in Treasury securities to

maintain its contingency reserve.

Table I.1 shows, under current law and the two stock investment

scenarios, the years when (1) the trust fund would be exhausted, (2) its

asset level would fall below 100 percent of expected annual expenditures,

and (3) its asset level would fall below 150 percent. These simulation

results illustrate some outcomes associated with two alternative

investment policies. These results should not be interpreted as forecasts

and do not represent the full range of possible outcomes for the Social

Security trust fund.

Table I.1: Key Dates Under Current

Law and Two Stock Investment

Scenarios Trust fund

exhausted

Assets less than

100 percent of

annual outgo

Assets less than

150 percent of

annual outgo

Current law 2029 2025 2022

Aggressive scenario

7 percent real yield 2040 2036 2034

6 percent real yield 2035 2032 2029

Cash surplus scenario

7 percent real yield 2032 2028 2026

6 percent real yield 2031 2027 2025

Source: SSA, Office of the Chief Actuary.

Page 16 GAO/T-AIMD/HEHS-98-152
Page 17 GAO/T-AIMD/HEHS-98-152
Page 18 GAO/T-AIMD/HEHS-98-152
Page 19 GAO/T-AIMD/HEHS-98-152
Related GAO Products

Social Security Financing: Implications of Government Stock Investing for

the Trust Fund, the Federal Budget, and the Economy (GAO/AIMD/HEHS-98-74,

April 22, 1998).

Budget Issues: Long-Term Fiscal Outlook (GAO/T-AIMD/OCE-98-83, February 25,

1998).

Social Security: Restoring Long-Term Solvency Will Require Difficult

Choices (GAO/T-HEHS-98-95, February 10, 1998).

Social Security Reform: Implications for Women’s Retirement Income

(GAO/HEHS-98-42, December 31, 1997).

Social Security Reform: Demographic Trends Underlie Long-Term

Financing Shortage (GAO/T-HEHS-98-43, November 20, 1997).

Budget Issues: Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19,

October 22, 1997).

Retirement Income: Implications of Demographic Trends for Social

Security and Pension Reform (GAO/HEHS-97-81, July 11, 1997).

Federal Debt: Answers to Frequently Asked Questions (GAO/AIMD-97-12,

November 27, 1996).

(935271) Page 20 GAO/T-AIMD/HEHS-98-152
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