Government Investment of the Social Security Trust Fund


Mr. Chairman, distinguished Members of the Committee:

Given Social Security’s dire financial condition, there isgrowing interest in attempting to harness the power of privatecapital markets to bail out the faltering system. However, despiteits surface attractiveness, allowing the government to invest fundsfrom the Social Security trust fund in private capital marketswould be a terrible mistake that would have severe consequences forthe U.S economy.

It is easy to see why this approach has appeal. The trust fundis currently “invested” in government bonds. Allowing this money tobe invested instead in private capital markets would appear to givethe trust fund an opportunity to earn a much higher rate of return.Using this return to fill in some of the gap between futurerevenues and benefits would reduce the need for future taxincreases or benefit cuts.

In reality, however, this approach is fraught with danger.Allowing the government to invest the Social Security trust fund inprivate capital markets would amount to the “socialization” of atleast a large portion of the U.S. economy. It would put ownershiprights over much of the American economy in the hands of the U.S.government.

At its peak, the Social Security trust fund will containapproximately $2.9 trillion. [1] Thetotal value of all 2,723 stocks traded on the New York StockExchange was about $6 trillion at the end of 1995. [2] It is easy to see, therefore, that investingthe trust fund would allow the U.S. government to purchase if not acontrolling then a commanding share of virtually every majorcompany in America.

Many of the strongest proponents are actually advocates ofincreasing government control over business. Gerald Shea of theAFL‐​CIO has said that it would be “good for for corporategovernance” if government owned and voted its stock. [3]

Others, recognizing the potential dangers posed by governmentownership of such a large portion of the American economy, attemptto allay such concerns some proposals have called for using stockindex funds, not actual direct stock investments. [4] Exactly how this would be accomplished hasbeen left vague, but there are essentially two possible approaches.The government itself could establish an index and purchase equalnumbers of shares in every stock included in the index. Or thegovernment could purchase shares in an existing index fund, such asFidelity’s Market Index or Vanguard’s Index 500.

Government creation of an index fund would do little to avoidthe pitfalls of government investment. Government decision makerswould acquire property rights in corporate enterprises. Either theywould exercise their rights, thus creating a direct politicalinfluence in the management of private enterprises, or they wouldgive up the voting rights and other shareholder privileges, thusindirectly enhancing the power of existing shareholders. In eithercase, ownership of the enterprises would be powerfully influencedby political agents, and the entire arrangement would be financedby the taxpayers. Recall that the Employee Retirement IncomeSecurity Act of 1974 (ERISA) places the fiduciary duty on allpersons in control of private retirement funds to use such funds inthe sole interest of the pension plan participants. This law doesnot apply to the Social Security Administration. In whose interest,then, will investment and management decisions be made?

Would it make a difference if the government purchased existingindex funds from a third party, such as an investment company? Notsignificantly. In order for the government to purchase shares in anindex fund, it would have to do so through either a mutual fundcompany selling an index fund, which would then purchase actualshares of stocks included in the index, or through some otherfinancial institution creating an index, which would alsoeventually purchase actual shares. Although the index fund wouldprovide a layer of insulation between the government and thecorporations whose stocks were purchased, the problems of controlwould not be completely avoided.

First, the government will acquire control over the index fundmanager itself and thus indirect control over the corporations. Ifindex fund A controls the majority of shares in company B, and thegovernment controls the management of fund A, the government cancontrol company B.

However, even if the government does not attempt to exercisecorporate control, there is reason to be concerned over allowingindex fund managers to use taxpayer money to increase theirownership of corporate America. The huge number of shares purchasedwith Social Security money will represent powerful voting blocks,and, in contrast to most stock purchases, they will be uniformlyvoted. Yet these powerful new stockholders will not answer toanyone and will derive all of their new powers from the aggregatedfunds of average American citizens. Never in the history of thiscountry has there been a proposal to hand over this much power tounelected officials with this little responsibility attached toit.

In essence, it is being proposed that the federal government usetax money to pick corporate winners and losers. Using fundsborrowed from Social Security’s future beneficiaries, thegovernment would purchase massive blocks of shares, to becontrolled either by the government or by financial institutionsthat are fortunate enough to receive government contracts for suchpurchases. It is difficult to imagine a more egregious proposal for“corporate welfare.”

With ownership comes control. What if a company whose stock ispurchased by the Social Security trust fund decides to move itsoperations overseas? Should the administrators of the investmentsof the trust fund remain indifferent to the plight of the company’sworkers, who after all will be future beneficiaries of the system?Shouldn’t the trustees at least attempt to convince the company toretain its American operations? And if the company moves, wouldn’tthe ownership of shares represent an indirect subsidy to foreignemployees extended by the American workers who are losing theirjobs to them? What if the company is convinced by the authoritiesto keep its operations in the United States and this leads to aconsistent stream of losses and subpar share performance?

The investment itself provides the opportunity for centralplanning and control. After all, companies whose stocks areselected will receive a substantial investment boost not availableto competitors who are not chosen. This raises a host of questionsabout what types of investments should be allowed.

For example, cigarette smoking is a major health concern to thenation and to the federal and state governments that spend publicmoney to provide health care for those suffering fromsmoking‐​related diseases. Should Social Security be allowed toinvest in cigarette companies? Is it appropriate for the SocialSecurity system to offer price support to those shares whileMedicare and Medicaid spend their resources in treating patientssuffering from the long‐​term consequences of smoking?

Other controversial issues are easy to imagine. Should SocialSecurity invest in nonunion companies? Companies that make nuclearweapons? Companies that pay high corporate salaries or do not offerhealth benefits? Companies that do business in Burma or Cuba?Companies that extend benefits to the partners of gay employees?The list is virtually endless.

Public employee pension funds have long been subject to suchcontroversies. [5] For example, at onetime more than 30 states prohibited the investment of pension fundsin companies that did business in South Africa. Approximately 11states restricted investment in companies that failed to meet the“MacBride Principles” for doing business in Northern Ireland.[6] Companies doing business in Libya,other Arab countries, and communist states have also been barredfrom investment. [7] Some states haveadditional restrictions on investing employee pension funds,including requirements for investing in in‐​state companies, homemortgages, and alternative energy sources, including solar pow​er​.In some states investments are prohibited in companies that areaccused of pollution, unfair labor practices, or failing to meetequal opportunity guidelines. Some public employee pension fundsare prohibited from investing in the alcohol, tobacco, and defenseindustries. In a recent example, the city of Philadelphia announcedit would sell its employee pension fund’s Texaco stock because ofalleged racist practices by that company. [8]

Use of a passive index – either one created by the government oran existing one – would reduce, but not eliminate, the problem.There would remain questions about what stocks should be includedin the index. Almost inevitably there would be a huge temptation tocreate a better, more socially appealing index of companiesfriendly to the public policies of the current administration orthe current congressional majority.

Those looking for evidence of this temptation need look nofurther than attempts by the Clinton administration to forceprivate pension plans to invest a portion of their portfolio in“socially redeeming” ways. [9] Actually,the last days of the Bush administration saw the first explorationof the idea of directing private pension investment. In November1992, the Labor Department released a report discussing a procedurefor valuing the “net externalities” of investments as a way ofbroadening the prevailing rate test permitted under ERISA to allowfor politically targeted investments. The Clinton administrationjumped on the idea with undisguised enthusiasm. In September 1993,Olena Berg, the Assistant Secretary of Labor for Pensions andWelfare Benefits, announced an expansive interpretation of theprevailing rate test that would “allow collateral benefits to beconsidered in making investment decisions.” She especially urgedpension fund investment in “firms that invest in their own workforce.” [10]

A year later, in September 1994, Labor Secretary Robert Reichcalled for investment of a portion of private pension funds ineconomically targeted investments (ETIs), which would provide such“collateral benefits” as “affordable housing, infrastructureimprovements and jobs.” [11]Fortunately, Congress has resisted this dangerous idea. But it isclear that some politicians are anxious to gain control overpension investments.

A study by the World Bank of government‐​managed pension fundinvestments around the world found that such investments generallyearned lower annual returns than privately managed pensioninvestments. [12] The study found thatgovernments generally pursued one of two policies for theirinvestments, both fundamentally flawed.

One policy was to invest heavily in government securities, whichearn much lower returns than, for example, in stocks. There are tworeasons for this policy. First, there is a cautionary search forsafe investments because governments fear the political reaction ifa more aggressive investment policy were to lead to adverseresults. Second, buying up government debt allows the government todefer the consequences of its own overspending. Indeed, there isevidence that the power to shift government debt into pension fundsmay actually induce governments to spend and borrow more. [13] Borrowing from the pension fund is lesstransparent than borrowing from the open capital market.

The other investment policy pursued by government‐​controlledpension funds is to invest in government‐​supported projects such asstate‐​owned enterprises or public housing. Again, the result isoften extremely low rates of return. In fact, such investmentsfrequently lose money. [14]

Is there a better way to harness the power of private capitalmarkets to guarantee a secure retirement for America’s elderly?

Rather than allowing the government to control investments, weshould give true power to the people, allowing individually ownedand privately managed investment accounts similar to IndividualRetirement Accounts (IRAs), and 401(k) and 403(b) plans.

Individuals would be free to invest the money in theiraccounts – and could probably do so through qualified moneymanagement companies – in stocks, bonds, and other investments, withcertain limited restrictions to prevent very risky speculation.Government control would be limited to defining the options thatcould be offered for investment with actual control would remain inthe hands of individuals.

This approach has proved highly successful in Chile and in anumber of other countries. [15] Therehas been growing interest in individual private accounts in thiscountry as well: A second option being supported by five members ofthe Social Security Advisory Council would allow approximately 50percent of Social Security taxes to be diverted to privateaccounts. Other proposals in Congress and elsewhere would allowgreater or lesser amounts of an individual’s Social Security taxesto be privately invested.

Americans have shown themselves willing to embrace such aprivatization of Social Security. According to a poll of 800registered voters conducted by Public Opinion Strategies on behalfof the Cato Project on Social Security Privatization, more thantwo‐​thirds of all voters, 68 percent, would support transformingthe program into a privatized mandatory savings program. More thanthree‐​quarters of younger voters support privatization. Support forprivatization cuts across party and ideological lines, particularlyamong young voters. [16]

If we are truly serious about harnessing the power of privatecapital markets to solve Social Security’s problems, we shouldallow investment in individual accounts, not a government takeoverof capital markets.


Much of my testimony is drawn from Krzysztof Ostaszewski,“Privatizing the Social Security Trust Fund? Don’t Let theGovernment Invest,” Cato Institute SocialSecurity Paper no. 6, January 14, 1997.2

[1]. 1996 Annual Reportof the Board of Trustees of the Federal Old‐​Age and SurvivorsInsurance and Disability Trust Funds (Washington: GovernmentPrinting Office), p. 180, table III.B3. (Intermediate Assumptions,Year 2020).

[2]. 1995 Annual Reportof the New York Stock Exchange (New York: New York Stock Exchange,Inc., 1995).

[3]. Michael Eisenscherand Peter Donohue, “The Fate of Social Security,” Z Magazine, March1997, p. 29.

[4]. One can, andacademics in the field of finance do, argue whether any additionalreturns can be earned by using active management instead of marketindex approaches (see, e.g., Michael C. Jensen, “The Performance ofMutual Funds in the Period 1945 – 64”, Journal of Finance, May 1968;also Robert A. Haugen, Modern Investment Theory, Third Edition(Englewood Cliffs, NJ: Prentice‐​Hall, 1993). Clearly, utilizing amarket index eliminates the costs of active management, thus savingfuture beneficiaries an amount of about 1 percent of their assetsannually. (See Zvi Bodie, Alex Kane, and Alan J. Marcus,Investments, Second Edition, [Homewood, IL: Richard D. Irwin, Inc.,1993], p. 111.) However, in this proposal it appears that the useof an index has been guided more by concern for the actual formalownership of shares than purely by the costs of the option.

[5]. For a thoroughdiscussion of state employee pension systems and their investmentpolicies, see Carolyn Peterson, State Employee Retirement Systems:A Decade of Change (Washington: American Legislative ExchangeCouncil, 1987).

[6]. Roop Mohunlall, etal., The 1989 – 90 Source Book of American State Legislation, Vol​.VI, A Pro‐​Growth Economic Policy (Washington: American LegislativeExchange Council, 1990), pp. 98 – 9.

[7]. Carolyn Peterson,State Employee Retirement Systems: A Decade of Change, pp.63 – 5.

[8]. Del Jones, “CityPension Fund to Sell Texaco Stock,” USA Today, November 22,1996.

[9]. Cassandra ChronesMoore, “Whose Pension Is It Anyway? Economically TargetedInvestments and the Pension Funds,” Cato Institute Policy Analysisno. 236, September 1, 1995.

[10]. See, forexample, Thomas Jones, “Social Security: Invaluable, Irreplaceable,and Fixable, ” Participant, February 1996.

[11]. Robert Reich,“Pension Fund Raid Just Ain’t So,” letter to the editor, WallStreet Journal, October 26, 1994.

[12]. World BankPolicy Reports, Averting the Old‐​Age Crisis.

[13]. Ibid., p.94.

[14]. World BankPolicy Reports, Averting the Old‐​Age Crisis, pp. 94 – 95.

[15]. For adescription of Chile’s system see Jose Pinera, “Empowering Workers:The Privatization of Social Security in Chile,” Cato’s Letter no.10, 1996. Other countries following Chile’s example includeArgentina, Peru, Colombia, Uruguay, and Mexico. In Europe, Britainprovides a low minimum benefit through its traditionalpay‐​as‐​you‐​go social security system, but has also allowed peopleto opt out of its benefits above this minimum through contributionsto an expanded IRA. Nearly 70 percent of Britons have done so.

[16]. Michael Tanner,“Public Opinion and Social Security Privatization,” Cato InstituteSocial Security Paper no. 5, August 6, 1996.

Michael D. Tanner

Subcommittee on Securities
Committee on Banking, Housing and Urban Affairs
United States Senate