Social Security Financing: Implications of Stock Investing for the Trust
Fund, the Federal Budget, and the Economy (Testimony, 04/22/98,
GAO/T-AIMD/HEHS-98-152).

Pursuant to a congressional request, GAO discussed its work on the
government stock investing option, focusing on: (1) the implications of
government stock investing for the Social Security Trust Fund; (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.

GAO noted that: (1) government stock investing is a complex proposal
that has potential consequences for Social Security, the federal budget,
and national saving; (2) it also differs in key ways from proposals to
establish individual accounts; (3) for the Social Security Trust Fund,
government stock 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; (4) 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; (5) more generally, individual accounts proposals would
alter Social Security's current structure and scale back the income
redistribution aspect of the current program; (6) 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; (7) while government
stock investing by itself has no direct effect on saving, it indirectly
could prompt actions to raise savings by revealing the size of federal
deficits excluding Social Security's temporary surpluses; (8)
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; and (9) however,
some of these issues could raise concerns about increased government
influence over the private sector.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-AIMD/HEHS-98-152
     TITLE:  Social Security Financing: Implications of Stock Investing 
             for the Trust Fund, the Federal Budget, and the
             Economy
      DATE:  04/22/98
   SUBJECT:  Trust funds
             Stocks (securities)
             Financial management
             Investments
             Social security benefits
             Future budget projections
             Budget deficit
             Fiscal policies
             Economic analysis
             Unified budgets
IDENTIFIER:  Federal Thrift Savings Plan
             Social Security Trust Fund
             
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Cover
================================================================ COVER


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

GAO/AIMD/HEHS-98-152T


(935271)


Abbreviations
=============================================================== ABBREV

  DI -
  IRA -
  OASI -
  SSA -
  TSP -

============================================================ Chapter 0

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
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. 


--------------------
\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. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:1

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

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 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). 


--------------------
\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. 

\5 If the unified budget were in surplus, then financing the excess
benefits would require less debt redemption, rather than increased
borrowing. 

\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. 


   BALANCING RETURNS AND RISKS
---------------------------------------------------------- Chapter 0:2

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 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 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 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. 


--------------------
\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. 


   EFFECTS OF GOVERNMENT STOCK
   INVESTMENTS ON THE FEDERAL
   BUDGET AND NATIONAL SAVING
---------------------------------------------------------- Chapter 0:3

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.  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 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 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. 


--------------------
\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. 

\10 While 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. 

\11 The 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. 


   IMPLEMENTATION ISSUES
   ASSOCIATED WITH GOVERNMENT
   STOCK INVESTING
---------------------------------------------------------- Chapter 0:4

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. 

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. 


--------------------
\12 For 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. 


   OBSERVATIONS
---------------------------------------------------------- Chapter 0:5

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 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. 


-------------------------------------------------------- Chapter 0:5.1

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


ASSUMPTIONS USED IN ESTIMATING HOW
HIGHER RETURNS AFFECT THE SOCIAL
SECURITY TRUST FUND
=========================================================== Appendix I

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. 

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 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

                                            Assets less    Assets less
                                               than 100       than 150
                              Trust fund     percent of     percent of
                               exhausted   annual outgo   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. 

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). 

--------------------
\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 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. 


*** End of document. ***