Social Security needs more than risky wagers

Gulf Today

6 hours ago

I have been a pension nerd since I was 20 years old. So I have been hearing for literally decades that there is a simple, magical solution to all our retirement funding problems: Just take more risk! When the investments pay off, the coffers will be replenished and all will be well. Now two US senators, Republican Bill Cassidy of Louisiana and Democrat Tim Kaine of Virginia, have offered a bipartisan proposal to create a separate fund for Social Security, whose existing trust fund can invest only in US government bonds. The new fund would be allowed to invest 'in stocks, bonds and other investments that generate a higher rate of return.'
There is some merit to their idea. But make no mistake: This would be a huge leveraged bet on behalf of the taxpayer. And — spoiler alert — taking risks doesn't always work. Many public-sector pensions are underfunded, despite their ability to invest in a market that has seen some pretty stellar returns over the last 20 years. There's little doubt Social Security is facing a difficult decade. In 2033, the existing trust fund is expected to run out of money. So the government must cut benefits, raise taxes or issue more debt to make up the shortfall — which will amount to $25.1 trillion, the Social Security administration estimates.
The senators' proposed new fund for Social Security would be seeded with $1.5 trillion, presumably financed with debt. They estimate that in 75 years, the fund will have earned enough to pay back the Treasury that $25.1 trillion plus fund future benefits. That means no one would have to take a benefit cut. It would be the equivalent of adding an extra 3.6% of payroll taxes each year. Cassidy and Kaine argue that there is even a great model of such a plan: public pension funds.
Again, and in theory, this is not a terrible idea. Prefunding pension benefits rather than relying on future generations to pay them is sensible when you have a shrinking population (though the debt involved undermines this case). Historically, the Social Security program has often taken in more in taxes than it paid in benefits. The extra money was invested in government bonds. In hindsight, the program would not be facing a shortfall in the next decade if it had invested in stocks, too.
But investing is always easy in hindsight. And there is no guarantee that the market will replicate the returns of the last 20 years. The senators' proposal would require at least a 5% real return each year (more if interest rates increase). What if the US faces decades of low returns, as Japan did?
The performance of public-sector pension funds offers no comfort. These pensions also don't account for risk and assume a high return each year, and despite a booming stock market for the last few decades, many funds face huge shortfalls. Maybe the new Social Security fund could be better managed, and could avoid investing in political pet causes or being raided by politicians looking for cash (although it's a big ask). Canada offers a model. Its CPP fund is well-managed and has delivered higher returns for Canadian retirees. It does have a large share of its funds abroad, with only 14% invested domestically. It's unclear whether the US would be able to replicate that strategy, or if it would want to. If all $1.5 trillion of the new Social Security fund were in US markets, that could have some distortionary effects: The S&P itself is worth about $50 trillion.
Any proposal for the government to borrow trillions of dollars to make a leveraged bet on risky assets should give Americans pause. If well implemented, with smart risk management and realistic expectations, it could help reduce the debt and offload some of the burden from future taxpayers. Still, some tax increases and benefit cuts are probably inevitable. The first rule of investing, after all, is that there is no such thing as a free lunch.
Allison Schrager,
Tribune News Service